Universidad Ana G Méndez

Division of Business, Tourism & Entrepreneurship

Fina 202 – Business Finance
Assignment 3 TVM
Chapter 5- Time Value of Money
Due Date: Friday, December 10, 10:00am

Part I – Questions

1. What is the difference between future value and present value? Which approach is generally
preferred by financial managers?
- Future value: the value on some future date of money that you invest today./FV is the sum an
amount today will grow to equal by a future date with compound interest.
- Present value: the value in today’s dollars of some future cash flow./PV is the dollar value today
of an amount promised at a specific future date for a given interest rate. If invested today at the given
interest rate, would grow to equal the future amount.
- The financial managers will generally prefer present value because investors can make decisions
whether to accept/reject the proposal with help present value method. Future value shows only future
gain of total investment so the importance for investment decisions making is less./because decisions
are typically made before a project starts(time period zero)

2. Define and differentiate among the three basic patterns of cash flow: (1) a single amount, (2) an
annuity, and (3) a mixed stream.
-A single amount: a lump-sum amount either currently held or expected at some future date (single
payment)
-An annuity: a level periodic stream of cash flows. (periodic equal stream of cash flows;every period)
-Mixed stream: a stream of cash flow that is not an annuity. (periodic unequal stream of cash
flows;every period)

3. How is the compounding process related to the payment of interest on savings? What is the general
equation for future value?
Compounding of interest occurs when an amount is deposited into a savings account and the interest
paid after the specified time period remains in the account, thereby becoming part of the principal for
the following period. The general equation for future value in year n (FVn) can be expressed using the
specified notation as follows: FVn = PV x (1+i)n. Future Value techniques typically measure cash flows at
the end of a project’s life. Future value is cash you will receive at a given future date. The future value
technique uses compounding to find the future value of each cash flow at the end of an investment’s life
and then sums these values to find the investment’s future value. We speak of compound interest to
indicate that the amount of interest earned on a given deposit has become part of the principal at the
end of the period. • Compounding more frequently than once a year results in a higher effective interest
rate because you are earning on interest on interest more frequently. •As a result, the effective interest
rate is greater than the nominal (annual) interest rate. Furthermore, the effective rate of interest will
increase the more frequently interest is compounded. • A General Equation for Compounding More
Frequently than Annually:

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With continuous compounding the number of compounding periods per year approaches infinity.

Through the use of calculus, the equation thus becomes:

4. What effect would a decrease in the interest rate have on the future value of a deposit? What effect
would an increase in the holding period have on future value?
- The decrease in the interest rate will cause the future value of a deposit decrease. Because of
the decline in the amount of interest on which additional interest is subsequently paid (the deposit
compounds at a lower rate.)
- The increase in the holding period will cause the future value increase. Because interest is paid
on interest over a longer period of time (the deposit compounds longer)

5. What is meant by “the present value of a future amount”? What is the general equation for present
value?
The present value, PV, of a future amount indicates how much money today would be equivalent to the
future amount if one could invest that amount at a specified rate of interest. Using the given notation,
the present value (PV) of a future amount (FVn) can be defined as follows:

6. What effect does increasing the required return have on the present value of a future amount? Why?
- If increasing the required return that will decrease the present value of a future amount,
because future value is worth more than present value. With a higher interest rate (compounding
periods and future value held constant), a smaller sum now would grow to the same future value

7. How are present value and future value calculations related?

Present value calculations are the exact inverse of compound interest calculations. Using compound
interest, one attempts to find the future value of a present amount; using present value, one attempts
to find the present value of an amount to be received in the future.

8. What is the difference between an ordinary annuity and an annuity due? Which is more valuable?
Why?
- Ordinary Annuity: an annuity for which the cash flow occurs at the end of each period
- Annuity Due: an annuity for which the cash flow occurs at the beginning of each period
- The future value and present value of an annuity due is always greater than the ordinary
annuity. Because each payment of an annuity due comes one period sooner than the equivalent
payment on an ordinary annuity. /PV: discount for one less year until today (for annuity
due.)/FV: compound interest for one more year until last year (for annuity due.)

9. What are the most efficient ways to calculate the present value of an ordinary annuity?
The present value of an ordinary annuity, PVAn, can be determined using the formula: PVAn = PMT x
(PVIFAi%,n). Where: PMT = the end of period cash inflows; PVIFAi%,n = the present value interest factor
of an annuity for interest rate i and n periods

10. What is a perpetuity?

A perpetuity is an infinite-lived annuity.

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Part II. Computational

1) Find the future value of the following stream of cash flows assuming an opportunity cost of 14
percent.

Index of cost of percentage amount future value

1.25 10000 12,500
1.5625 35000 54,688
1.953125 24000 46,875

2) Find the present value of the following stream of cash flows assuming an opportunity cost of 25
percent. (ordinary annuity and annuity due) 27,168

3) Find the present value of the following stream of cash flows assuming an opportunity cost of 9
percent.

Year Cashflow ($) C.D.F @ 9% P/V

1-5 10,000 3.8897 38,897
6-10 16,000 2.528 40,448
79,345

C.D.F. - CUMULATIVE DISCOUNTING FACTOR

:. PRESENT VALUE OF FIRM'S CASHFLOWS IS $ 79,345.00
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Part III. Exercises and Problems

A. For each of the cases shown in the following table, calculate the present value of the cash flow,
discounting the rate given and assuming that the cash flow is received at the end of the period noted.

Case Single cash flow ($) Discount End of Period Present Value
Rate (%)
A 7,000 9 12 2,524.27
B 25,000 10 12 7,965.77
C 3,200 5 10 1,964.52
D 16,000 8 7 9,335.85
E 15,400 5 6 11,491.72

B. For each of the cases shown in the following table, calculate the future value of the single cash flow
deposited today at the end of the deposit period if the interest is compounded annually ar the rate
specified..

Case Single cash flow ($) Discount End of Period Future Value
Rate (%)
A 25,000 12 4 39,337.98
B 150,000 8 20 699,143.57
C 270,000 14 12 1,300,834.30
D 140,000 11 6 261,858.04
E 57,000 10 8 122,184.56

C. For each of the cases shown in the following table, calculate the present value of the annuity,
assuming that it is (1) An ordinary annuity, (2) An annuity due.

Case Amount of Interest Rate Deposit Ordinary Annuity Annuity Due

Annuity ($) (%) Period
A 33,000 5 7 190,950.32 282,120.59
B 18,000 3.5 12 173,940.02 272,034.55
C 1,200 5 13 11,272.29 22,318.36
D 24,500 5 8 158,348.71 245,650.83

D. For each of the cases shown in the following table, calculate the future value of the annuity,
assuming that it is (1) An ordinary annuity, (2) An annuity due.

Case Amount of Interest Rate Deposit Ordinary Annuity Annuity Due

Annuity ($) (%) Period
A 45,000 12 4 215,069.76 240,878.13
B 150,000 8 20 6,864,294.64 7,413,438.22
C 28,000 14 12 763,580.96 870,482.30
D 10,000 11 6 79,128.60 87,832.74
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E) For each of the mixed streams of cash flows shown in the following table, determine the future value
if deposits are made into an account paying annual interest of 4.5%, assuming that no withdrawals are
made during the period and that the deposits are made
a. At the end of each year
b. At the beginning of each year

Cash Flows
Year A B B
1 850 5,000 1,000
2 1,300 10,000 1,900
3 1,275 20,000 -1,200
4 25,000 1,000
5 30,000 1,000

NPV OA
NPV AD

FV OA 3561.72125 95339.75425 4095.304238

FV AD 3722.00 99630.04 4279.592929