Professional Documents
Culture Documents
Prepared by:
Shajedul Alam
Senior Lecturer, USB
This is a core principle of finance. A sum of money in the hand has greater value than the
same sum to be paid in the future.
Important points
Time value of money means that a sum of money is worth more now than the
same sum of money in the future.
This is because money can grow only through investing. An investment delayed
is an opportunity lost.
The formula for computing the time value of money considers the amount of
money, its future value, the amount it can earn, and the time frame.
For savings accounts, the number of compounding periods is an important
determinant as well.
Investors prefer to receive money today rather than the same amount of money in the
future because a sum of money, once invested, grows over time. For example, money
deposited into a savings account earns interest. Over time, the interest is added to the
principal, earning more interest. That's the power of compounding interest.
If it is not invested, the value of the money erodes over time. If you hide $1,000 in a
mattress for three years, you will lose the additional money it could have earned over that
time if invested. It will have even less buying power when you retrieve it because
inflation has reduced its value.
As another example, say you have the option of receiving $10,000 now or $10,000 two
years from now. Despite the equal face value, $10,000 today has more value
Interests
There two types of interest. Simple interest and compound interest. Let’s examine them
with examples:
Bank or financial institutions use the exponential terms and logarithm in their calculations
to find the future value, principal, rate or loan tenure.
Simple interest:
Interest, I = Prt
Where, P= Principal
r= rate
t= time (Expressed in year)
Future value, F= P + I = P + Prt = P(1+rt)
Compound interest
Future value, F = P (1 + r)n
Example:
Find the interest on $1460 for 72 days at 10% interest using a) the exact method and b) the
ordinary method
Here, P= $1460, r= 10%= 0.1
a) I (exact method) = Prt = (1460)(0.1)(72/365) =$28.8
b) I (Ordinary method) = Prt = (1460)(0.1)(72/360)= $29.2
Example:
If Tk. 1 is deposited in an account earning 6% compounded annually, then after n years the
account will contain
F= P(1+r)n= 1.(1+6%)n=1. (1+ 0.06)n = 1.06n [n= 20 years; 1.0620 =3.207]
If you have deposited Tk. 1,000 in a 12-month deposit account which yields 6% per annum.
How much money will you have after one year? If you re-invest the total amount for another
year at the same rate what will you have after two years?
Solution
For the first year, F = 1000 (1+0.06)1= 1000 x 1.061 = Tk. 1060
Exercise
John has $1,000 to invest and finds that interest rate is 6% per annum compounded annually.
John wants to know how many years will it take for the investment to grow from $1,000 to
$2,000. (Money double scheme).
We know,
F= P(1+r)n
2000= 1000 (1+6%)n
Or, (1+0.06)n = 2000/1000
Or, (1.06)n = 2
Or, ln (1.06)n = ln 2 [Taking ln in both sides]
Or, n ln(1.06) = ln 2
ln 2
Or, n = ln 1.06 = 11.896 years = 11.9 years
Exercise
Find the future value if $20,000 is invested at 6% simple interest for 3 months.
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Future value, F= P(1+rt) = 20000 (1 + 0.06 x 12 ) = 20000 (1 + 0.015)=$20,300
Interest= F – P= $20,300 - $20,000 = $300
Exercise
Joly received $50 loan in December 1, 2019 and a month later paid $53.50 to repay the loan.
Find the interest rate.
1
Here, P= $50, F=$53.50, n= 12 year
F= P(1+rt)
1
Or,53.50 = 50 (1+r x 12)
53.5 𝑟
Or, = (1 + 12)
50
𝑟
Or, 1.07 = 1 + 12
𝑟
Or, 1.07- 1 = 12
𝑟
Or, 0.07 = 12
Or, r= 0.07 x 12 = 0.84= 84%
F= P(1+rt)
530=500(1+8%t)
Or, 530/500= 1+0.08t
Or, 1.06= 1 + 0.08t
Or, 0.08t= 1.06-1=0.06
Or, t= 0.06/.08= 0.75 year
In months= 0.75 x 12 = 9 months
Exercise
How much will Fran has to invest in the employees 8% savings account in order to have $600 a
year from now?
F= P(1+rt)
Or,600= P (1+0.08x1)
Or, P = 600/1.08= $555.56
Exercise: If $500 is invested at 6% compounded annually, what will be the future value after 30
years?
We know,
F= P(1+r)n
Exercise: Compute the future value of $5,000 @ 9% compounded monthly for 10 years. (Ans:
$12,256.79)
Exercise: At 8% compounded annually, how many years will it take for $2,000 to grow to
$3,000?
We know, F= P(1+r)n
Or, 3000 = 2000(1+0.08)n
3000
Or, 2000 = 1.08n
Or, 1.5= 1.08n
ln 1.5 = ln 1.08n
or, ln 1.5 = n(ln 1.08)
ln 1.5
or, n = ln 1.08 = 5.268 years
[5 years + .268x12=3.2 month; if you want to know the exact days then 0.2x30= 6 days]
Exercise: At what interest rate compounded annually will a sum of money double in 10 years?
Here double means $100 grows to $200 or $25 grows to $50 or $1 grows to $2. Therefore, the
time required the same in any doubling.
We can use, P=$1 and A/F=$2
We know, F= P(1+r)n
Or, 2 = 1(1+r)10
Or, (1+r)10 = 2
Classwork
1. A loan of Tk. 200,000 is to be repaid in 10 equal installments. Interest being @ 8% per
annum compounded and first payment was made after one year. What amount will be
paid in each installment? [Tk. 29,795]
Given,
PV= Tk. 200,000
r=8% per annum= 0.08
n= 10 years
A, Annuity= ?
We know,
𝐴 1
PV= 𝑟 {1 − }
(1+𝑟)𝑛
𝐴 1
Or, 200,000 = 0.08 {1 − }
(1+0.08)10
1
Or, 200000 x 0.08 = A {1 − }
(1.08)10
1
Or, 16000 = A {1 − }
2.158924997
We know,
FV= PV(1+r)n
𝐹𝑉
PV= 𝑟 4𝑛
(1+ )
4
2500
Or, PV = 0.1 4𝑥4
(1+ )
4
2500
Or, PV = (1+0.025)16
2500
Or, PV = (1.025)16
Or, PV = Tk. 1684 (Ans)
3. Find the present value of Tk. 5,000 due 5 years from now if interest is at 4%
compounded semi-annually. [Tk. 4102]
4. In how many months will it take @ 10% compounded quarterly of a year for Tk. 5,000 to
grow to Tk. 20,000? [168 months]
Given that,
P= Tk. 5,000
F= Tk. 20,000
r= 10% = 0.1
n=?
We know,
𝒓
A = P (1+𝟏𝟎𝟎𝒙𝟒)4n
0.1 4n
Or, 20000 = 5000 (1 + )
4
20000 0.1 4n
Or, = (1 + )
5000 4
or, 4 = 1.025 4n
or, 1.025 4n = 4
or, ln 1.025 4n = ln 4 [Taking natural logarithm in both sides]
or, 4n ln 1.025 = ln 4
or, 4n = 56.14
56.14
or, n = = 14.035 years= 14 years
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