2-1

Time Value of Money

Time Value of Money is a concept related to time in calculating

the value of money. The time value of money shows the change
in the value of money due to time.
The money a person has today will not be of the same value as
one year from now. Money received now has a greater value
than money received in the future.
The time value of money is related to its present value and
future value

Future value
Present value
 2-2

Time lines show timing of cash flows.

0 1 2 3
i%

CF0 CF1 CF2 CF3

Time 1 is the end of Period 1; or the

beginning of Period 2.
 2-3

What’s the FV of an initial $100 after 3

years if i = 10%?

0 1 2 3
10%

100 FV = ?

Finding FVs (moving to the right

on a time line) is called compounding.
 2-4

After 1 year:
FV1 = PV + INT1 = PV + PV (i)
= PV(1 + i)
= $100(1.10)
= $110.00.
After 2 years:
FV2 = FV1(1+i) = $110 (1.10) =121.00
or
FV2 = PV(1 + i)(1+i) = PV(1+i)2
= $100(1.10)2
= $121.00.
 2-5
After 3 years:

FV3 = FV2(1+i) = $ 121 (1.10) = $133.10

or
FV3 = PV(1 + i)2(1+i) = PV(1+i)3
=

In general, FVn = PV(1 + i)n.

FVn = PV x FVIFi,n

Table FVIFi
 2-6

What’s the PV of $100 due in 3 years if

i = 10%?

Finding PVs is discounting, and it’s

the reverse of compounding.

0 1 2 3
10%

PV = ? 100
 2-7

Solve FVn = PV(1 + i )n

for PV:
n
 1 
PV =
FVn
= FV    FV 1  i n

1 + i n n
 1 + i 
n

3
 1 
PV = $100  
 1 + 0,1 
= $100 0.7513  = $75.13.
PV = $100 (1 + i )-n PV = FV PVIFi,n
Table PVIFi
 2-8

Periodic rate (iPer )

 iPer = iNom/m, where m is number of
compounding periods per year. m = 4 for
quarterly, 12 for monthly, and 360 or 365
for daily compounding.
 Used in calculations, shown on time lines.
 Examples:
8% quarterly: iPer = 8%/4 = 2%.
8% daily (365): iPer = 8%/365 =
0.021918%.
 2-9
FV Formula with Different Compounding
Periods (e.g., $100 at a 12% nominal rate with
semiannual compounding for 5 years)
mn

FVn = PV 1 +
iNom
 .
 m
2x5
FV5S 
= $100 1 +
0.12

 2 
= $100(1.06)10 = $179.08.
 2-10
FV of $100 at a 12% nominal rate for 5
years with different compounding
FV(Annual)= $100(1.12)5 = $176.23.
FV(Semiannual)= $100(1.06)10=$179.08.
FV(Quarterly)= $100(1.03)20 = $180.61.
FV(Monthly)= $100(1.01)60 = $181.67.
FV(Daily) = $100(1+(0.12/365))(5x365)
= $182.19.
 2-11

Time line for an ordinary annuity of

$100 for 3 years.

0 1 2 3
i%

100 100 100

 2-12

What’s the difference between an

ordinary annuity and an annuity due?

Ordinary Annuity
0 1 2 3
i%

Annuity Annuity Annuity

Annuity Due
0 1 2 3
i%

Annuity Annuity
Annuity Annuity
PV FV
 2-13

What’s the FV of a 3-year ordinary

annuity of $100 at 10%?

0 1 2 3
10%

100 100 100

110
121
FV = 331
 2-14

FV Annuity Formula
The future value of an annuity with n
periods and an interest rate of i can
be found with the following formula:
(1 i)  1
n
A
i
(1 0.10)  1
3
100  331
0.10
FVA = A FVIFAi,n
Table FVIFA
 2-15

What’s the PV of this ordinary annuity?

0 1 2 3
10%

100 100 100

90.91
82.64
75.13
248.69 = PV
 2-16

PV Annuity Formula
The present value of an annuity with n
periods and an interest rate of i can
be found with the following formula:
1
1-
(1 i)n
PVA = A PVIFAi,n
A
i
Table PVIFA
1
1-
(1 0.10) 3
100  248.69
0.10
 2-17

Find the FV and PV if the

annuity were an annuity due.

0 1 2 3
10%

100 100 100

 2-18

PV and FV of Annuity Due

vs. Ordinary Annuity

PV of annuity due:

 = (PV of ordinary annuity) (1+i)
= (248.69) (1+ 0.10) = 273.56
FV of annuity due:
= (FV of ordinary annuity) (1+i)
= (331.00) (1+ 0.10) = 364.1