Basic Long-

term Financial
Concepts
CHAPTER 5
 OVERVIEW

This chapter covers the mathematics of finance that focus on the time value of
money. The concepts of interest is explained particularly the difference between
simple and compound interest. Future and present value computations are also
discussed using different flow patterns. Basic time value of money applications are
illustrated including loan amortization examples, effective interest rate
calculations, and the net present value method in assessing the financial
feasibility of projects. Concepts of risk-return trade-off is also discussed in this
chapter.
LEARNING OBJECTIVES:

At the end of this lesson, the learners will be able to:

❖Define the concepts regarding the

time value of money.
❖Compute the present value and
future values with the aid of formulas and
tables.
❖Apply the concepts in real life scenarios.
 Why TIME
considered MONEY?
 WHAT’s IN
“A peso today is worth more than a peso tomorrow”. The time value of money
would tell us that a peso today is not equal to a peso in the future.

All individuals and businesses face the same two basic finance-
related problems:

• Where to put the money? – investment decisions

• Where get the money? – financing decisions

There are various reasons why money loses value over

time:
1. Inflation
2. Opportunity cost

The concept of Time value of money is necessary for consideration in financial decisions
when evaluating cash flows from different time periods.
THE CONCEPT OF
INTEREST
The most basic finance-related
formula is the computation of
interest. It is computed as
follows:

I=PXRXT
Where:
I = interest
P = Principal
R = Interest
rate
T = Time period
 Let’s try!

Identify the a) principal b)interest rate and c) time period

in the following examples:

1. Your mother invested P18,000 in government securities

that yields 6% annually for two years.
2. Your father obtained a car loan for P800,000 with an annual
rate of 15% for 5 years.
3. You deposited P5,000 from the savings of your daily allowance
in a time deposit account with your savings bank at a rate of
15% per annum. This will mature in 6 months.
 Let’s try!

For example, Ms. Lee borrowed P1,000 from a local bank at

an interest rate of 9% over a one year period.

I=PXRXT
Where: = P1,000 x 9% x 1 year
P = P1,000
R = 9% = P90 - the interest on the loan
T = 1 year
INTEREST
is the cost of holding money.

- It is the amount charged by

the lenders to the borrowers/
users of money, and is usually
paid at regular intervals.
SIMPLE AND
COMPOUND
INTEREST
 SIMPLE INTEREST
If the interest earned or incurred is always based on the original principal, then simple
interest is assumed.

For example, you invested P10,000 for years at 9% and the proceeds from the investment will be collected
at the end of 3 years. Using the simple interest assumption, interest will be computed as follows:

Cumulative
Year Principal Rate Time Interest Total
Interest

1 P10,000 9% 1 P900 P900 P10,900

2 P10,000 9% 1 P900 P1,800 P11,800

3 P10,000 9% 1 P900 P2,700 P12,700

In the example, interest is always calculated based on the original principal of P10,000.
Under the assumption, the interest every year is the same, P900 annually. The total interest for
the 3 year period is P2,700 (P900 x 3 years).
 Let’s try!
Fill in the blanks of the table involving a simple interest.
Principal Rate Time Interest
P8,000 1) 4.5% 7 months P210
P15,000 4.8% 2) 5 months P300 Calculate Interest, solve for I
I = Prt
3) P33,333.33 4.5% 4 months P500 Calculate Principal Amount, solve for P
1 yr & 3 P = I / rt
P1,000 4) 5.6% P70 Calculate rate of interest in decimal, solve for r
months
r = I / Pt
5 and a half Calculate rate of interest in percent
P4,500 25% 5) P6,187.50 R = r * 100
years
Calculate time, solve for t
t = I / Pr
 COMPOUND INTEREST
Interest paid on both the principal and the amount of interest accumulated in prior
periods.

Using the previous example, you invested P10,000 for years at 9% and the proceeds from the investment will
be collected at the end of 3 years. Using the compound interest assumption, interest will be computed
as follows:

Cumulative
Year Principal Rate Time Interest Total
Interest
1 P10,000 9% 1 P900 P900 P10,900

2 P10,900 9% 1 P981 P1,881 P11,881

3 P11,881 9% 1 P1,069.29 P2,950.29 P12,950.29

In this example, interest is increasing per period because the principal is also
increasing by amount of interest earned in the previous year. The interest for every year is no
longer the same but is higher as it nears maturity. The total interest for the 3 year period is
P2,950.29 (P900+P981+P1,069.29).
 Let’s try!
Compute the table for a compound interest involving
P40,000 loaned for a period of 5 years with 6% interest
compounded annually.
Principal at the
Amount (at the end of the
start of the Interest
year)
year
1st year P40,000 40,000 x 0.06 x 1= P2,400 P40,000+P2,400 = P42,400
2nd year P42,400 42,400 x 0.06 x 1= P2,544 P42,400+P2,544 = P44,944
3rd year 1) P44,944 2) P2,696.64 3) P47,640.64

4th year 4) P47,640.64 5) P2,858.44 6) P50,499.08

P3,029.94 P53,529.02
5th year 7) P50,499.08 8) 9)
FUTURE
VALUE AND
PRESENT
VALUE OF
MONEY
 FUTURE VALUE OF MONEY
A peso in hand today is worth more than a peso to be received in the future because if
invested, it will earn interest and yield more than a peso in the future.

The process of conversion to future values (FVs) from

present values (PVs) is called compounding.

For example, Assume that P5,000 will be deposited in a bank which pays a guaranteed 3% interest each year. How
much would it be at the end of Year 5?
After 1 year, the interest earned is P150 (P5,000 x
Multiply the initial amount and each 3%) and at the end of 2nd year, the interest is P304.50
succeeding amount by (1 + R ) = (1.03). The results (P5,150 x 3%). So, as the process continues, the beginning
will be shown using a time line to calculate the FV of balance is higher each successive year due to the increase
P5,000 compounded for 5 years, as follows: in the interest earned each year.
 FUTURE VALUE OF MONEY
To calculate Future Value using a formula: The other way of computing the future value, we multiply the initial
value by (1+R)T which is referred to as the future value interest factors
FVT = PV ( 1 + R )T (FVIF). (Refer to Table)

Simply find the intersection of the relevant time period (T) presented
Using the equation, to find the FV of the in the rows of the table and the relevant interest rate ( R ) presented in the
above example will be as follows: columns of the table.

Given the example, FVIF given 5 years and a rate of 3% is equal to 1.1593.
FV5 = P5,000 (1.03)5
That is the intersection of time period = 5 and interest rate = 3% in the FVIF
= P5,796.37 table.

This is equal to (1+3%)5 = 1.1593 (rounded off to 4 decimal places)

P5,796.50 = P5,000 x (1+R)T

P5,796.50 = P5,000 x (1+3%)5

P5,796.50 = P5,000 x 1.1593 Note: Result may vary due to rounded

decimal places
 FUTURE VALUE OF MONEY
To calculate Future Value using a formula:

FVT = PV ( 1 + R )T
Another example: Using the formula, find the future values of P1,000 compounded at a 10% annual
interest at the end of one year, two years and five years.

Solution: PV = P1,000 and rate 10%

Year 1 FV = P1,000 (1+0.10)1 or P1,000 x 1.1000 = P1,100
Year 2 FV = P1,000 (1+0.10)2 or P1,000 x 1.2100 = P1,210
Year 5 FV = P1,000 (1+0.10)5 or P1,000 x 1.6105 = P1,610.50
 FUTURE VALUE OF MONEY
To calculate Future Value using a formula:

FVT = PV ( 1 + R )T
Another example: Determine the compound amount on an investment at the end of 2 years if P20,000
is deposited at 4% compounded a) semi-annually and b) quarterly

Solution:
a) Given: PV = P20,000, r= 0.04/2, t = 2 x 2= 4
FV = 20,000 (1+0.04/2)4 OR P20,000 x 1.0824 = P21,648
b) Given: PV = P20,000, r=0.04/4, t= 4 x 2 = 8
FV = 20,000 (1+0.04/4)8 OR P20,000 x 1.0829 = P21,658
 PRESENT VALUE OF MONEY
The calculation of the present value is simply the reverse of computing for a future value.

The process of computing the present value of a cash

flow or a series of cash flows is called discounting.

To calculate Present Value using a formula:

For example, A bank offers to sell a Treasury bond that will pay P5,788.12 three years from now.
Banks are currently offering a guaranteed 5% interest 3-year time deposit certificate. Given the
scenario, there is a need to make a decision whether to invest the money in a treasury bond or just
invest it on a 3-year time deposit certificate.
 PRESENT VALUE OF MONEY
Using the equation, to find the PV of A present table can also be developed using the present value interest
the example will be as follows: factors (PVIF). (Refer to Table)

Simply find the intersection of the relevant time period (T) presented in
the rows of the table and the relevant interest rate ( R ) presented in the
columns of the table.

Given the example, FVIF given 3 years and a rate of 5% is equal to 0.8638. That
is the intersection of time period = 5 and interest rate = 3% in the FVIF table.

This is equal to 1 = 0.8638 (rounded off to 4 decimal places)

(1 + 5%)3

P4,999.77= P5,788.12 x 0.8638

P4,999.77 ~ P5,000 Note: Result may vary due to rounded decimal places
 PRESENT VALUE OF MONEY

Another example: Jack would like to buy a car two years from now using the proceeds of a 20%
investment that is compounded semi-annually. If the projected price of the car is P1,400,000, how
much money must be invested today to earn the price of the car?

SOLUTIONS:

Given: FV = P1,400,000, r= 0.20/2, t= 2 x 2 years = 4

PV = 1,400,000 (1 + 0.20/2) 4 or 1,400,000 x 0.6830 = P956,200

WHAT I HAVE LEARNED?

SOLVE THE
FOLLOWING
PROBLEMS
 1. John wants to have an interest income
of P3,000 a year. How much must he
invest for one year at 8%?
Solution:
Step 1: Write down the formula
I = prt
Step 2: Plug in the values
3000 = p × 0.08 × 1
3000 = p x 0.08
p = 37,500

Answer: He must invest P37,500

 2. Find the amount of interest earned by
P8,000 invested at 5% annual simple
interest rate for 1 year.
Solution:
Step 1: Write down the formula
I = prt
Step 2: Plug in the values
I = P8,000 × 0.05 × 1
I = P400

Answer: Interest earned is P400

 3. To start a mobile dog-grooming service, a
woman borrowed P2,500. If the loan was for two
years and the amount of interest was P175, what
simple interest rate was she charged?
Solution:
Step 1: Write down the formula
I = prt
Step 2: Plug in the values
P175 = P2,500 × 2 x r
P175 = P5,000
r= 3.5%
Answer: simple interest rate charged is 3.5%
 4. You deposited P1,500 in a bank with an interest
rate of 5% for 1 year. What is the future value of
your deposit?

Solution:
Step 1: Write down the formula or used the FVIF Table.
FVT = PV ( 1 + R )T
Step 2: Plug in the values
FV1 = P1,500 (1.05)1
= P1,575
Answer: The future value of the deposit is P1,575
 5. You need to save up for P1,500 in 1 year. How
much should you save now if the bank offers a
rate of 5%? (Find the present value)

Solution:
Step 1: Write down the formula or use the PVIF Table.
FVT
Present Value (PV) = (1 + R)T

Step 2: Plug in the values

PV = 1,500/(1+0.05) = 1,428.57
Answer: Present value is 1,428.57
CONGRATULATIONS! You have
completed your journey in
this topic. Great job!

Thank you everyone and

God bless us all!