Time Value of Money:

Useful Shortcuts
Michael R. Roberts
William H. Lawrence Professor of Finance
The Wharton School, University of Pennsylvania

Copyright © Michael R. Roberts

 Last Time
Time Value of Money
• Compounding

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 This Time
Time Value of Money
• Useful Shortcuts

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 ANNUITY

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 Annuity
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time
0 1 T-1 T

CF CF CF

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 Annuity
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time
0 1 T-1 T

CF CF CF

E.g., Savings, vehicle, home mortgage,

auto lease, bond payments

Copyright © Michael R. Roberts

 Annuity
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time
0 1 T-1 T

CF CF CF

Copyright © Michael R. Roberts

 Annuity
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time
0 1 T-1 T

CF CF CF

*The first cash flow arrives one period from today

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 Example 1 – Savings
How much do you have to save today
to withdraw $100 at the end of each
of the next 20 years if you can earn
5% per annum?

Copyright © Michael R. Roberts

 Example 1 – Savings
How much do you have to save today
to withdraw $100 at the end of each
of the next 20 years if you can earn
5% per annum?
0 1 19 20

? 100 100 100

Copyright © Michael R. Roberts

 Example 1 – Savings
How much do you have to save today
to withdraw $100 at the end of each
of the next 20 years if you can earn
5% per annum?
0 1 19 20

? 100 100 100

Copyright © Michael R. Roberts

 GROWING ANNUITY

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 Growing Annuity
A growing annuity is a finite stream of
cash flows that grow at a constant rate
and that are evenly spaced through time
0 1 2 T-1 T

? CF CF(1+g) CF(1+g)T-2 CF(1+g)T-

1

Copyright © Michael R. Roberts

 Growing Annuity
A growing annuity is a finite stream of
cash flows that grow at a constant rate
and that are evenly spaced through time
0 1 2 T-1 T

? CF CF(1+g) CF(1+g)T-2 CF(1+g)T-

1

E.g., Income streams, savings strategies,

project revenue/expense streams

Copyright © Michael R. Roberts

 Growing Annuity
A growing annuity is a finite stream of
cash flows that grow at a constant rate
and that are evenly spaced through time
0 1 2 T-1 T

? CF CF(1+g) CF(1+g)T-2 CF(1+g)T-

1

Copyright © Michael R. Roberts

 Growing Annuity
A growing annuity is a finite stream of
cash flows that grow at a constant rate
and that are evenly spaced through time
0 1 2 T-1 T

? CF CF(1+g) CF(1+g)T-2 CF(1+g)T-

1

*The first cash flow arrives one period from today

Copyright © Michael R. Roberts
 Example 2 – Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on for the
next 19 years if you can earn 5% per annum?

Copyright © Michael R. Roberts

 Example 2 – Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on for the
next 19 years if you can earn 5% per annum?
0 1 2 19 20

? 100 102.5 155.966 159.865

100 x (1 + 0.025) 100 x (1 + 0.025)18 100 x (1 + 0.025)19

Copyright © Michael R. Roberts

 Example 2 – Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on for the
next 19 years if you can earn 5% per annum?
0 1 2 19 20

? 100 102.5 155.966 159.865

Copyright © Michael R. Roberts

 PERPETUITY

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 Perpetuity
An perpetuity is an infinite stream of cash
flows of identical magnitude and equal
spacing in time
0 1 T-1 T …

CF CF CF …

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 Perpetuity
An perpetuity is an infinite stream of cash
flows of identical magnitude and equal
spacing in time
0 1 T-1 T …

CF CF CF …
E.g., Perpetuities, consol bonds

Copyright © Michael R. Roberts

 Perpetuity
An perpetuity is an infinite stream of cash
flows of identical magnitude and equal
spacing in time
0 1 T-1 T …

CF CF CF …

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 Example 3 – Savings
How much do you have to save today
to withdraw $100 at the end of each
year forever if you can earn 5% per
annum?

Copyright © Michael R. Roberts

 Example 3 – Savings
How much do you have to save today
to withdraw $100 at the end of each
year forever if you can earn 5% per
annum?
0 1 2 3 4

? 100 100 100 100

Discount CFs one at a time…impossible!

Copyright © Michael R. Roberts
 Example 3 – Savings
How much do you have to save today
to withdraw $100 at the end of each
year forever if you can earn 5% per
annum?
0 1 2 3 4

? 100 100 100 100

Copyright © Michael R. Roberts

 GROWING PERPETUITY

Copyright © Michael R. Roberts

 Growing Perpetuity
A growing perpetuity is an infinite stream
of cash flows that grow at a constant rate
and that are evenly spaced through time
0 1 2 T-1 T

? CF CF(1+g) CF(1+g)T-2 CF(1+g)T-

1

Copyright © Michael R. Roberts

 Growing Perpetuity
A growing perpetuity is an infinite stream
of cash flows that grow at a constant rate
and that are evenly spaced through time
0 1 2 T-1 T

? CF CF(1+g) CF(1+g)T-2 CF(1+g)T-

1

E.g., Dividend streams

Copyright © Michael R. Roberts

 Growing Perpetuity
A growing perpetuity is an infinite stream
of cash flows that grow at a constant rate
and that are evenly spaced through time
0 1 2 T-1 T

? CF CF(1+g) CF(1+g)T-2 CF(1+g)T-

1

Copyright © Michael R. Roberts

 Growing Perpetuity
A growing perpetuity is an infinite stream
of cash flows that grow at a constant rate
and that are evenly spaced through time
0 1 2 T-1 T

? CF CF(1+g) CF(1+g)T-2 CF(1+g)T-

1

*The first cash flow arrives one period from today

Copyright © Michael R. Roberts
 Example 4 – Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on forever if
you can earn 5% per annum?

Copyright © Michael R. Roberts

 Example 4 – Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on forever if
you can earn 5% per annum?
0 1 2 19 20

? 100 102.5 155.966 159.865

100 x (1 + 0.025) 100 x (1 + 0.025)18 100 x (1 + 0.025)19

Copyright © Michael R. Roberts

 Example 4 – Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on forever if
you can earn 5% per annum?
0 1 2 19 20

? 100 102.5 155.966 159.865

100 x (1 + 0.025) 100 x (1 + 0.025)18 100 x (1 + 0.025)19

Copyright © Michael R. Roberts

 Summary

Copyright © Michael R. Roberts

 Lessons
• An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time

• A perpetuity is an infinite stream of cash

flows of identical magnitude and equal
spacing in time

Copyright © Michael R. Roberts

 Lessons
• A growing annuity is a finite stream of cash
flows growing at a constant rate and equally
spaced in time

• A growing perpetuity is an infinite stream of

cash flows growing at a constant rate and
equally spaced in time

Copyright © Michael R. Roberts

 Caution
• Annuity and perpetuity formulas
assume first cash flow occurs one
period from today
• Growth rate, g, must be less than the
discount rate, R, for PV formulas to
make sense
• Understand excel functions
assumptions

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 Coming up next
• Problem Set

• Taxes

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