Chapter 4

The Time Value

of Money
貨幣的時間價值
Chapter Outline
4.1 The Timeline 時間線
4.2 The Three Rules of Time Travel 穿越時空的三大法則
4.3 Valuing a Stream of Cash Flows 現金流的評價
4.4 Calculating the Net Present Value 計算淨現值
4.5 Perpetuities and Annuities 永續年金與年金的評價
4.6 Using an Annuity Spreadsheet or Calculator 試算表及計算機的應用
4.7 Non-Annual Cash Flows
4.8 Solving for the Cash Payments 求算現金支付額
4.9 The Internal Rate of Return 內部報酬率
4.1 The Timeline
 A timeline is a linear representation of the timing of potential
cash flows. 利用時間線來表示潛在現金流量發生的時間點
 Drawing a timeline of the cash flows will help you visualize the
financial problem.
 Assume that you made a loan to a friend. You will be repaid in
two payments, one at the end of each year over the next two years.
 4.1 The Timeline (cont’d)
 Differentiate between two types of cash flows
• Inflows are positive cash flows. 現金流入以正號 (+)表示
• Outflows are negative cash flows, which are indicated with a –
(minus) sign. 現金流出以負號 (-)表示
Assume that you are lending $10,000 today and that the loan will be
repaid in two annual $6,000 payments.

• The first cash flow at date 0 (today) is represented as a negative sum because it is an
outflow.
• Timelines can represent cash flows that take place at the end of any time period – a
month, a week, a day, etc.
Example 4.1
4.2 The Three Rules of Time Travel
 Financial decisions often require combining or comparing cash
flows that occurs at different points in time. Three rules govern
these processes.
Table 4.1 The Three Rules of Time Travel
Rule 1: Comparing and Combining Values
 A dollar today and a dollar in one year are not equivalent.
➢今天的一元比明年的一元有價值,因為能帶來「利息」!
 It is only possible to compare or combine values at the same
point in time.
• Which would you prefer: A gift of $1000 today or $1210 at a
later date?
• To answer this, you first need to convert the cash flows into the
same units or move them to the same point in time
Rule 2 & 3!
 Rule 2: Moving Cash Flows Forward in Time (Compound)
 To move a cash flow forward in time, you must compound (
複利) it.
Question : Suppose you have a choice between receiving $1000
today or $1210 in two years. You believe you can earn 10% (r) on
the $1000 today but want to know what the $1000 will be worth in
two years.
 Time value of money 貨幣的時間價值: The difference in
value between money today and money in the future.
 Compound interest 複利 : The effect of earning “interest on
interest”
 Rule 2: Moving Cash Flows Forward in Time
 The timeline looks like this:

Future Value of a Cash Flow 現金流量的未來值(終值)

Figure 4.1 The Composition of Interest Over Time
Example 4.2
Rule 3 : Moving Cash Flows Back in Time (Discount)
 To move a cash flow backward in time, we must discount (
折現) it.
 Discounting 折現: Finding the equivalent value today of a
future cash flow.

 Present Value of a Cash Flow現金流量的現值

C
PV = C  (1 + r ) n
=
(1 + r ) n
Example 4.3
 Applying the Rules of Time Travel
 Recall the 1st rule: It is only possible to compare or combine values
at the same point in time. So far we’ve only looked at comparing.
 Suppose we plan to save $1000 today, and $1000 at the end of each
of the next two years. If we can earn a fixed 10% interest rate on our
savings, how much will we have three years from today?
 The timeline would look like this :
Applying the Rules of Time Travel : Approach 1
Applying the Rules of Time Travel : Approach 2
Example 4.4
Example 4.4 (cont’d)
 4.3 Valuing a Stream of Cash Flows
 If we want to find the present value of a stream of cash flows, we
simply add up the present values of each.
 4.3 Valuing a Stream of Cash Flows
 Present Value of a Cash Flow Stream
N N
Cn
PV =  PV (C )
n = 0
n = 
n = 0 (1 + r ) n

 Future Value of a Cash Flow Stream with a Present

Value of PV
FVn = PV  (1 + r ) n
Example 4.5
Example 4.5
4.4 Calculating the Net Present Value 計算淨現值
 Calculating the NPV of future cash flows allows us to
evaluate an investment decision. 計算未來現金流量的
淨現值有助於投資決策的評估
 Net Present Value (淨現值) compares the present
value of benefits (positive, cash inflows) to the present
value of costs (negative, cash outflows ).
NPV = PV(benefits) - PV(costs)
= PV(benefits - costs)
Example 4.6
Example 4.6
 4.5 Perpetuities and Annuities 永續年金與年金
 Perpetuities 永續年金
• When a constant cash flow will occur at regular intervals forever it
is called a perpetuity. 定期支付固定金額直到永久的現金流稱之。

 The value of a perpetuity is simply the cash flow divided by the

interest rate.
 Present Value of a Perpetuity 永續年金現值
C
PV (C in perpetuity) =
r
Example 4.7
4.5 Perpetuities and Annuities (cont’d)
 Annuities 年金
• When a constant cash flow will occur at regular intervals for a
finite number of N periods, it is called an annuity.
定期支付固定金額直到N年的現金流稱之。

 Present Value of an Annuity 年金現值

C C C C N C
PV = + + + ... + =
(1+ r ) (1+ r ) (1+ r )
2 3
(1+ r ) N
n =1 ( 1 + r )
n
Present Value of an Annuity 年金現值
 To find a simpler formula, suppose you invest $100 in a bank
account paying 5% interest. As with the perpetuity, suppose you
withdraw the interest each year. Instead of leaving the $100 in
forever, you close the account and withdraw the principal in 20
years.
Present Value of an Annuity (cont’d)
 You have created a 20-year annuity of $5 per year, plus you will
receive your $100 back in 20 years. So:

$100 = PV (20 − year annuity of $5 per year ) + PV ($100 in 20 years )

 Re-arranging terms:

PV(20 − year annuity of $5 per year) = $100 − PV($100 in 20 years)

100
= 100 − 20
= $62.31
(1.05)
Present Value of an Annuity
 For the general formula, substitute P for the principal
value (本金) and C = r * P, then :

PV(annuity of Cfor N periods)

= P − PV(Pin period N)
P  1 
=P− = P  1 − N 
(1 + r) N
 (1 + r) 
Present Value of an Annuity -- Shortcuts
Annuity(年金） - An asset that pays a fixed sum each year for
a specified number of years.

Asset Year of Payment Present Value

1 2…..t t+1
Immediate Perpetuity C
(first payment in year r
1)
C  1
Delayed Perpetuity  
 r  (1 + r )
t
(first payment in year t + 1)

Annuity from year 1 to year t  C   C  1 

: the difference between an   −   
t 
   
r r (1 + r ) 
immediate and a delayed
perpetuity
 Present Value of an Annuity -- Shortcuts
Annuity (年金） - An asset that pays a fixed sum each year for
a specified number of years.

1 1 
PV of annuity = C   − t 
 r r (1 + r ) 
1 1 
where  −  is called t − year annuity factor
 r r (1 + r ) 
t
Example 4.8
Example 4.8
Future Value of an Annuity
 Future Value of an Annuity 年金終值

FV (annuity) = PV  (1 + r ) N

C  1 
= 1 −   (1 + r )
N

r  (1 + r ) N

= C 
1
r
( (1 + r ) N
− 1)
Example 4.9
Growing Cash Flows 成長型現金流量
 Growing Perpetuity 成長型永續年金
• Assume you expect the amount of your perpetual payment to
increase at a constant rate, g.

 Present Value of a Growing Perpetuity 成長型永續年金現值

C
PV (growing perpetuity) =
r − g
Example 4.10
Example 4.10 (cont’d)
 Growing Cash Flows 成長型現金流量
 Growing Annuity 成長型年金
• The present value of a growing annuity with the initial
cash flow C, growth rate g, and interest rate r is defined
as:
 Present Value of a Growing Annuity成長型年金現值

1   1 + g  
N

PV = C  1 −   
(r − g )   (1 + r )  
 
• With N = ∞ and g < r , it becomes the formula for a growing
perpetuity.
Growing Annuities
A three-year stream of cash flows that grows at the rate g is equal to the
difference between two growing perpetuities.
Example 4.11
Example 4.11
4.6 Using an Annuity Spreadsheet or Calculator
 Spreadsheets simplify the calculations of TVM (Time
Value of Money) problems
• NPER 期數
• RATE 利率
• PV 現值
• PMT 每期支付額
• FV 終值
 These functions all solve the problem:
1  1  FV
NPV = PV + PMT  1 − NPER 
+ = 0
RATE  (1 + RATE )  (1 + RATE ) NPER
Example 4.12
Example 4.12 (cont’d)
Example 4.13
Example 4.13 (cont’d)
 4.7 Non-Annual Cash Flows
 The same time value of money concepts apply if the
cash flows occur at intervals other than annually as long
as
• The interest rate and
• The number of periods
must be adjusted to reflect the new time period.

Ex : For monthly cash flow streams

1. The interest rate is specified as a monthly rate
2. The number of periods is expressed in months
Example 4.14
Example 4.14 (cont’d)
 4.8 Solving for the Cash Payments : PMT
 Sometimes we know the present value or future value, but do
not know one of the variables we have previously been given as
an input, say, a loan(貸款).
 When you take out a loan you may know the amount you would
like to borrow but may not know the loan payments that will be
required to repay it.
Example 4.15
Example 4.15 (cont’d)
4.9 The Internal Rate of Return
 In some situations, you know the present value and cash flows
of an investment opportunity but you do not know the internal
rate of return (內部報酬率，IRR), the interest rate that sets the
net present value of the cash flows equal to zero.
 IRR with 2 cash flows :
P * (1 + IRR)N = FV
IRR = (FV/P)1/N - 1
 IRR of growing perpetuity : (C/P) + g
 IRR for an annuity : Use function RATE in the spreadsheet
Example 4.16
Example 4.16 (cont’d)
Example 4.17
Example 4.17 (cont’d)