Business Finance

Module 8
FUTURE VALUE, PRESENT VALUE AND LOAN AMORTIZATION
In this activity, it will help you to introduce the concept of future and present
value of money and loan amortization.

Time Value of Money

One of the most fundamental concepts in finance is the Time Value of Money. It
states that “A peso today is worth more than a peso tomorrow.”
The time value of money is a concept integral to all parts of business. A
business does not want to know just what an investment is worth today; it wants to
know the total value of the investment.
Let us take a look at the given situation.
Danna was puzzled about something, so she went to talk to Betty about it. She
told her friend that the problem is whether she would want a peso today or a peso one
year from now. She doesn't see what the difference is, since it's still one peso, no
matter when you get it.
Betty had to think about this for a while. When she sees Danna again, she tells
her to take that peso now and put it in a savings account. The bank will pay interest,
so one year from now she'll have more than one peso.
To sum up the time value of money, money that you have right now will be
worth more over time. So one dollar now will be worth more than a dollar in a year
from now.

DISCOVER Future Value

Danna went home and did some research and she discovered a formula for future
value, or how much money put in the bank today will turn into at some point in the
future with the interest. She needs to know three things:

1. How much she has now?

2. What the interest rate is?
3. How many years she wants to put the money away for?

Then she can use a formula to figure out how much she'll have at the end. The
formula is:
FV = PV (1 + r)n

In this formula,

• PV is how much she has now, or the present value

• r equals the interest rate she will earn on the money
• n equals the number of periods she will put the money away, and  FV equals
how much she will have at the end, or future value.

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 Let's imagine that Danna puts Php100 in the bank for five years at five percent
interest, and plug that into the equation.

Solution:
FV = 100 (1 + 0.05)5

FV = 100 x 1.2762

FV = Php127.62

Present Value

Danna's parents think she's a pretty smart girl, especially after she shows her
Dad these cool formulas. Dad knows he will need money in a few years to pay for
Danna's college. He's wondering how much he can invest today in some CDs that
would be worth $20,000 or so in 10 years when he'll need it. Danna shows him a
formula for present value, or how much you need to save today to have a specific
amount at some point in the future. Here's the formula:
PV = FV / (1 + r)n

In this formula,

• PV equals how much he needs to have today, or present value

• r equals the interest rate he'll earn
• n equals the number of periods before he needs the money, and  FV equals how
much he will need in the future, or future value.

So, if Dad needs the Php20,000 in 10 years and can invest what he has for five
percent, let's find out how much he needs to invest today.

Solution:
PV = Php20,000 / (1.05)10

PV = Php20,000 / 1.6289

PV = Php12,278
Her dad is very happy to hear that.

Loan Amortization

What is an Amortized Loan?

An amortized loan is a type of loan with scheduled, periodic payments that are
applied to both the loan's principal amount and the interest accrued. An amortized
loan payment first pays off the relevant interest expense for the period, after which the
remainder of the payment is put toward reducing the principal amount. Common
amortized loans include auto loans, home loans, and personal loans from a bank for
small projects or debt consolidation.

How an Amortized Loan Works?

The interest on an amortized loan is calculated based on the most recent ending
balance of the loan; the interest amount owed decreases as payments are made. This is
because any payment in excess of the interest amount reduces the principal, which in
turn, reduces the balance on which the interest is calculated. As the interest portion of

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 an amortized loan decreases, the principal portion of the payment increases. Therefore,
interest and principal have an inverse relationship within the payments over the life of
the amortized loan.

An amortized loan is the result of a series of calculations. First, the current

balance of the loan is multiplied by the interest rate attributable to the current period
to find the interest due for the period. (Annual interest rates may be divided by 12 to
find a monthly rate.) Subtracting the interest due for the period from the total monthly
payment results in the dollar amount of principal paid in the period.

The amount of principal paid in the period is applied to the outstanding balance
of the loan. Therefore, the current balance of the loan, minus the amount of principal
paid in the period, results in the new outstanding balance of the loan. This new
outstanding balance is used to calculate the interest for the next period.

Equal Principal Repayments

Let us look at an example of a corporate loan to illustrate how a loan

amortization table is prepared. For some corporate long-term loans, principal payment
is fixed, and the interest expense is adjusted based on the declining principal balance.

Illustrative Example: On July 1, 2015, DD Company borrowed Php3 million from ASC
Bank at the rate of 10% a year. The loan is paid at the rate of Php500 000 every
December 31 and June 30 until the full amount is paid. Below is an amortization table
for the loan.

Amortization Table for Php3-Million Loan

Amortization Dates Payments Interest Principal Principal Balance
Payment
3 000 000
December 31, 2015 650 000 150 000 500 000 2 500 000
June 30, 2016 625 000 125 000 500 000 2 000 000
December 31, 2016 600 000 100 000 500 000 1 500 000
June 30, 2017 575 000 75 000 500 000 1 000 000
December 31, 2017 550 000 50 000 500 000 500 000
June 30, 2018 525 000 25 000 500 000 -
Note that the interest rate of 10% is for one year. Therefore, for six months, the
interest rate is only 5%. Let us compare the interest expense from June 30 to
December 31, 2015.
Interest = 3 000 000 x 10% x (6 ÷12)
Interest = 150 000
For the next six months ending June 30, 2016, the interest expense is only
Php125 000 because the principal balance is already reduced to Php2 500 000 as of
December 31, 2015.
Thus, the part of semi-annual payment is for the repayment of principal and
interest payments.

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 EXPLORE

Here are some enrichment activities for you to work on to master and strengthen
the basic concepts you have learned from this lesson.

Activity 1: Find My Future Value!

Direction: Using the given situations, compute for the future value at the end of term
of each scenario.

1. Your mother invested Php18 000 in government securities that yields 6%

annually for two years.

2. Your father obtained a car loan for Php800 000 with an annual rate of 15% for 5
years.

3. Your sister placed her graduation gifts amounting to Php25 000 in a special
savings account that provides an interest of 2% for 8 months.

4. Your brother borrowed from your neighbor Php7 000 to buy a new mobile
phone. The neighbor charged 11% for the borrowed amount payable after three years.

5. You deposited Php5 000 from the savings of your daily allowance in a time
deposit account with your savings bank at a rate of 1.5% per annum. This will mature
in 6 months.

DEEPEN

Activity 2: Find My Present Value!

Direction: Using the situations provided in Activity 1, compute the present value of
each scenario.

1. Your mother is expecting to get Php18 000 in two years’ time after investing in
government securities that yield 6% annually.
2. Your father obtained a car loan in lump-sum in 5 years at a total amount of
Php800 000 with an annual rate of 15%.

3. Your sister placed her graduation gifts in a special savings account that
provides an interest of 2% for 8 months. She expects to get Php25 000 after 8 months.

4. Your brother borrowed from your neighbor to buy a new mobile phone. The
neighbor charged 11% for the borrowed amount payable after three years at a total
amount of Php7 000.

5. You deposited your savings from your daily allowance in a time deposit account
with your savings bank at a rate of 1.5% per annum. This will mature in 6 months and
you expect to get Php5 000 at the end of the term.

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Direction: Read each item carefully. Use a separate sheet for your answers. Write the
letter of the best answer for each item.
1. It is the money that you have right now will be worth more over time.
A. future value
B. past value
C. present value
D. time value of money

2. What formula you are going to use if you put your money in the bank which earned
interest?
A. PV = FV / (1 + r)n
B. PV = FV (1 + r)n
C. FV = PV (1 + r)n
D. FV = PV / (1 + r)n

3. It is a type of loan with scheduled, periodic payments that are applied to both the
loan's principal amount and the interest accrued.
A. abandoned loan
B. amortized loan
C. depreciated loan
D. regular loan

4. How is the interest of an amortized loan calculated?

A. It is calculated based on the most recent beginning balance of the loan.
B. It is calculated based on the most previous ending balance of the loan.
C. It is calculated based on the most recent ending balance of the loan.
D. It is calculated based on the most recent beginning balance of the loan.

5. What formula you are going to use if you you need to save today to have a specific
amount at some point in the future.
A. PV = FV / (1 + r)n
B. PV = FV (1 + r)n
C. FV = PV (1 + r)n
D. FV = PV / (1 + r)n

6. In the formula of computing the future and present value of money, what is r?
A. equals how much he needs to have today
B. equals how much he will need in the future
C. equals the interest rate he/she will earn on the money
D. equals the number of periods before he needs the money

7. An amortized loan is the result of a series of _______________.

A. calculations
B. decisions
C. planning
D. performance

8. In the formula of computing the future and present value of money, what is n?
A. equals how much he needs to have today
B. equals how much he will need in the future
C. equals the interest rate he/she will earn on the money
D. equals the number of periods before he needs the money