 Discount – calculation of the present

FINANCIAL MARKETS
Time Value of Money
value of some future amount.
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 Discount Rate – rate used to calculate the
Overview of the Handouts: present value of future cash flows. P
I.
II.
Definition of Terms
Formulas
 Discounted Cash Flow Valuation –
calculating the present value of future
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Time value of money is the concept that money
cash flow to determine its value today.
- process of valuing an investment
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by discounting its future cash flows.
you have now is worth more than the identical
sum in the future due to its potential earning
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capacity.
II. Formulas
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I. Definition of Terms

 Lump Sum Payment – A single cash

I. Present Value
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payment or flow is received or occurs at
PV of 1 = (1+r)-n * PMT
the start and end of an investment horizon
1-(1+r)-n
with no other cash flows exchanged. PV of ordinary annuity = * PMT
r
o Present Value of a Lump Sum
o Future Value of a Lump Sum 1-(1+r)-n
PV of annuity due = * (1+r) * PMT
r
 Annuity Payment – Series of equal cash 1-(1+r)-n
PV of deferred annuity = * (1+r)-d * PMT
flows received at fixed intervals over the r
entire investment horizon.
o Present Value of an Annuity II. Future Value
o Future Value of an Annuity
FV of 1 = (1+r)n * PMT
 Future Value – also known as “compound
(1+r)n-1
value. It is the value of an investment after FV of ordinary annuity = * PMT
r
one or more periods of time.
(1+r)n-1
FV of annuity due = * (1+r) * PMT
 Compounding – The accumulation of r
interest in an investment over time in (1+r)n-1
FV of deferred annuity = * (1+r)d * PMT
order to earn more interest. r

 Interest on interest – interest gained on III. Perpetuity

prior interest payments reinvested
Cash flow
Perpetuity =
 Simple Interest – interest earned only on Interest rate
the original principal amount invested.
IV. Interpolation
 Compound Interest – interest generated
on both the original principle and interest PVr - PVLR
r = LR + * (HR-LR)
reinvested from previous periods. PVHR - PVLR

 Present Value – current value of future Legend:

cash flows discounted at the appropriate
discount rate. r = rate
n = number of periods
PMT = annuity payment

Junior Philippine Institute of Accountants and Auditors – United

d = number of periods deferred
PVr = PV factor of the missing rate
PVHR = PV factor of higher rate
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PVLR = PV factor of lower rate
HR = higher rate P
LR = lower rate
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Junior Philippine Institute of Accountants and Auditors – United