The Time Value of Money

Since money has the ability to earn interest, its value increases with time.
For instance, P100 today is equivalent to

F = P 100(1+0.07)5 = 140.26,

five years from now if the interest rate is 7% per year, compounded annually. We
say that the Future Worth of P100 is P140.26, if i = 7% (per year) and n = 5
(year)

Since money increases in value as we move from the present to the future, it
must decrease in value as we move from the future to the present.
Thus, the present worth is P140.26 is P100 if i = 7% (per year) and n = 5 (years)

Example:
A student who will inherit P5000 in three years has a savings account that pays 5
½ % per year compounded annually. What is the present worth of the student’s
inheritance?
Solution:

P = F/(1+i)n = 5000 /(1+0.055)3 = P4258.07

The present worth of P5000 is P4248.07 if i = 5 ½%, compounded annually, and

n = 3.

INFLATION

FC = PC(1+λ)n

Where:
λ = annual inflation rate (expressed as a decimal)
n = number of years

Example:
An economy is experiencing inflation at the rate of 6% per year. An item
presently costs P100. If the 6% inflation rate continues, what will be the price of
this item in five years?
Solution:

FC = 100(1+0.06)5 = P133.82
In an inflationary economy, the value (buying power) of money decreases as
costs increase. Thus,

𝐹 𝑃𝐶 1
= =
𝑃 𝐹𝐶 (1 + 𝜆)!

𝑃
𝐹=
(1 + 𝜆)!

where:
F = future worth
P = present amount

Example:
An economy is experiencing inflation at an annual rate of 6%. If this continues,
what will P100 be worth five years from now?
100
𝐹= = 𝑃74.73
(1 + 0.06)!

Thus P100 in five years will be worth P74.73 in terms. Stated differently, in five
years P100 will be required to purchase the same commodity that can now be
purchased for P74.73.

If interest is being compounded at the same time that inflation is occurring, then
the future worth can be determined by :

!(!!!)! !!! !
𝐹= (!!!)!
=𝑃 !!!

or

𝑭 = 𝑷(𝟏 + 𝜽)𝒏

where :
!!!
𝜃 = !!!, as composite interest rate. observe that θ may be negative.

Example:
An engineer has received P100000 from his employer for a patent disclosure. He
has decided to invest the money in a 15-year savings certificate that pays 8% per
year, compounded annually. What will be the final value of his investment, if
inflation continues at the rate of 6% per year?

Solution:

!!!.!" !"
𝐹 = 100000 !!!.!"
= 𝑷𝟏𝟑𝟐𝟑𝟔𝟑. 𝟓𝟑 ---Answer

OR using composite interest rate:

𝑖−𝜆 0.08 − 0.06
𝜃= =     = 0.0189
1+𝜆 1 + 0.06

𝑭 = 𝑷(𝟏 + 𝜽)𝒏 = 𝟏𝟎𝟎𝟎𝟎𝟎(𝟏 + 𝟎. 𝟎𝟏𝟖𝟖𝟔𝟕𝟗𝟐𝟒)𝟏𝟓

𝑭 = 𝑷𝟏𝟑𝟐𝟑𝟔𝟑. 𝟓𝟑

TAXES

composite interest rate is redefined:

Example:
Refer to the previous problem, suppose the engineer is in the 32% tax bracket,
and is likely to remain there throughout the lifetime of the certificate. If the
inflation continues at the rate of 6% per year, what will be the value of his
investment, when certificate matures?

(1 − 𝑡)𝑖 − 𝜆 (1 − 0.32)(0.08) − 0.06

𝜃= = = −00528
1+𝜆 1 + 0.06

𝑭 = 𝑷(𝟏 + 𝜽)𝒏 = 𝟏𝟎𝟎𝟎𝟎𝟎(𝟏 − 𝟎. 𝟎𝟎𝟓𝟐𝟖)𝟏𝟓 = 𝑷𝟗𝟐𝟑𝟔𝟔. 𝟏𝟑

pay taxes on the original P100000, substantially reducing the amount of money
available.)
TASK: Due on Wednesday, Oct 19,2022, 5pm
Copy and Answer. Show COMPLETE Solution. Enclose the final answer

1. What is more desirable: investing P2000 at 6% per year compound

interest for three years, or investing P2000 at 7% per year simple interest
for three years? Support your answer using concept and formulas
(computation).
2. How many years will be required for an investment of P3000 to increase to
P4081.47 at an interest rate of 8% per yea, compounded annually?
3. Suppose that a man lends P1000 for four years at 12% per year simple
interest. At the end of the four years, he invests the entire amount which
he then has for 10 years at 8% ineterst per year, compounded annually.
How much money will he have at the end of the 14-year period?
4. Let the inflation rate be 6% per year. If a person deposits P50000 in a ban
account of 9% per annum smple interest for 10 years, will this effectively
protect the purchasing power of the original principal? ? Support your
answer using concept and formulas (computation).
5. Rework Problem 4, which is changed as follows: the individual is in the
35% tax bracket and pays taxes on all the interest received; the P50000 is
invested at 9% per year, compounded annually.