Philippine Christian University

Dasmarinas Campus

TIME VALUE OF MONEY

A Research Paper Presented in Partial Fulfillment

of the Requirements for the Course
Financial Management

Submitted by:

Name
PRIMITIVO MACALINDONG DAYANDAYAN
(MMPA TRECE 1B7)

Date Submitted
March 05, 2023
 TABLE OF CONTENTS

CHAPTER Page
I. Introduction 1
II. What Is the Time Value of Money? 3
III. Future Value 4
IV. Present Value Single Amount 5
V. Computation Tools for Time Value of Money 6
VI. Factors Affecting Time Value of Money 9
VIII. How Else Is Time Value of Money Used? 11
VII. Insights what you have learned about the topics 12

Reference 13
 I. INTRODUCTION:

A dollar today is worth more than a future dollar received because

today’s dollar can be invested to earn interest while the future dollar is
held in the control of another. This paper introduces the key concepts of
the Time Value of Money (TVM), tools used for computation and some
practical applications for the use of time value of money formulas. TVM
is a key factor in business and economic decisions. The use of TVM in
business is essential for assisting people in making investment decisions
and evaluating alternatives that have fluctuating cash flow patterns over
time. For example, compound interest (or rate of return) calculations are
used to determine a financial institutions annual percentage rate (APR)
for disclosure to account holders and banking regulators or discounting,
which is inversely related to compounding, used in the valuation of
stocks, bonds, business ventures, real estate, and capital expenditure
projects.
There are plenty of applications of time value of money in finance. The
Time Value of Money is related to the concept of opportunity cost in
economics.
The cost of any decision includes the cost of the alternative opportunity
choices declined. The time value of money is an essential concept in
financial markets. The idea that money is worth more in the future
requires an understanding of future value and compounding interest
rates over different terms.

The time value of money is a financial principle that states the value of
a dollar today is worth more than the value of a dollar in the future. This
philosophy holds true because money today can be invested and
potentially grow into a larger amount in the future.

The present value of a future cash flow is calculated by dividing the

future cash flow by a discount factor that incorporates the amount of time
that will pass and expected interest rates.
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The future value of a sum of money today is calculated by multiplying
the amount of cash by a function of the expected rate of return over the
expected time period.

The time value of money is used to make strategic, long-term financial

decisions such as whether to invest in a project or which cash flow
sequence is most favorable.

Time value of money often ignores detrimental impacts to finance such

as negative interest rates or capital losses. In situations where losses
are known and unavoidable, negative growth rates can be used.

Keywords:

Annuity: money paid at regular intervals each year

Cash Flow: amount of cash collected and paid over a specified period
of time.
Compound: to pay interest based on principal plus previously accrued
interest
Discount: extracting of interest from a future amount to reduce to today’s
dollars
Interest: “rent” paid for the use of money for a period of time.

The following variables are used in calculating the Time Value of Money:
i = interest rate (rate of return)
I = Amount invested at the start of the period
t = specified period of time
n = number of time periods
PMT = payment
CF = Cash flow (the subscripts t and 0 mean at time t and at time zero,
respectively)
PV = present value (PVA = present value of an annuity)
FV = future value of the invested amount (FVA = future value of an
annuity)
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 II. WHAT IS THE TIME VALUE OF MONEY

The basic concept of the time value of money is that cash received
later is not equal to the same amount of cash which is currently on hand.
The cash on hand has earning power and can be invested for growth.
Time value of money is the math of finance with four basic approaches:
future value (FV) of a single amount, future value of annuity (FVA),
present value (PV) of a single amount, and present value of annuity
(PVA). (Griffin, 2009) The Time Value of Money mathematics quantifies
the value of a dollar through time depending on the interest rate or rate
of return earned on the investment and is used in many areas of finance
such as computing compounding interest on a savings account,
calculating annual rate of return on a mutual fund, evaluating long term
bonds, loan amortization or leases, evaluating future cash flows from a
capital project, etc. The Time Value of Money concepts are grouped into
two areas: Future Value and Present Value. Future Value describes the
process of finding what an investment today will grow to in the future.
Present Value describes the process of determining what a cash flow to
be received in the future is worth in today's dollars. (Mathis, 2001)

Since money has a time value, we must take this time value of money
into consideration when we are making financial decisions. We do this
by restating money values through time with Time Value of Money
Calculations. Time value of money calculations are used to shift dollar
values through time. They can be used to state future dollar flows in
present value terms or to restate present value amounts into future dollar
values. The calculations are the most powerful tool available for making
financial and business decisions. Once the methods of restating money
values through time is mastered, they can be used for restating cash
flows in such a way as to make them comparable in the financial
decision-making process. The calculation of present values is the
foundation for many financial decisions facing both individuals and
managers in all types of firms. The process allows numerous
calculations related to the earning of interest, the earning of non-interest
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returns on investments, loan related problems, capital budgeting
decision processes, insurance programming problems, and almost any
business asset purchase or investment decision. They also provide the
foundation for some of the most widely used valuation concepts and
valuation models employed in finance.

There are five key components in TVM calculations. These are:

present value, future value, the number of periods, the interest rate, and
a payment principal sum. Providing you know four of these values, you
can rearrange the TVM formulae to calculate the fifth. (Time Value of
Money) A simple example takes the amount of $20,000 invested at 10%.
At the end of a year, that $20,000 is worth $22,000 (the original $20,000
plus the $2,000 earned in interest). The $20,000 held today can be
referred to as the present value of $22,000 which will be received a year
from today.

III. FUTURE VALUE

For dollar amounts at some point in the future, we use the term "Future
Value" or the initials "FV". Money can increase in value over time
because of interest or other types of returns (i.e. dividends or price
depreciation). Practical applications of future value of a single amount
include estimating the value of a 401K on the day you retire or 529 plans
when a child starts college, the amount that a U.S. savings bond will be
worth in 10 years, and the estimated value of your home five years from
now.
Under compound interest, interest is earned not only on the initial
principal but also on the accumulated interest. Interest begins to be
earned on the accumulated interest as soon as it is paid, which occurs
at the end of each compounding period. This contrasts with simple
interest, under which interest is only earned on the initial principal.
(Mathis, 2001)
An annuity is a series of equal cash flows for a definite period of time.
A fixed-rate home mortgage is an annuity.

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IV. PRESENT VALUE SINGLE AMOUNT

For dollar amounts in the present, we use the term "Present Value"
or the initials "PV". Present Value describes the process of
determining what a cash flow to be received in the future is worth in
today's dollars. Therefore, the Present Value of a future cash flow
represents the amount of money today which, if invested at a specific
interest rate, will grow to the amount of the future cash flow at that
time in the future.

The process of finding present values is called Discounting and the

interest rate used to calculate present values is called the discount
rate. For example, the Present Value of $100 to be received one year
from now is $90.91 if the discount rate is 10% compounded annually.
(Present Value) The calculation of present values is the foundation
for many financial decision-making processes including the area of
capital budgeting decisions and other business investments.

All business investment decisions should be based on Discounted

Cash Flow (DCF) decision tools such as Net Present Value (NPV).
Once the incremental after-tax cash flows associated with an
investment project are identified, the process of calculating the NPV
is nothing more than a series of PV$ and PV of Annuity calculations
that help answer the following questions:

Does the project have a positive Net Present Value?

Does the project have a percentage return that is greater than our
cost of capital?
If we undertake this project, will we increase the economic value of
our firm?
Are the incremental benefits of the project greater than the
incremental costs?

All automobile loans, equipment loans, home mortgage loans, and

credit card loans that require a periodic payment (such as a monthly
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payment) that contains both interest due and a payment on the loan
principal are often called loan amortization problems. They are
nothing more than PV of an Annuity problem.

V. COMPUTATION TOOLS FOR TIME VALUE OF MONEY

Several computational tools can be used to calculate future value,

present values, annuities, and rates of return. The long, more difficult
method is manual calculations using the formulas as shown in Figure
1. The most basic are financial tables located in the back of the
textbook (Excerpt of FV shown in Table 1). Spreadsheet functions,
like Microsoft Excel are easiest to use (Microsoft Excel Object shown
in Table 2). There are also financial calculators that can help
compute time value of money, such as the Hewlett Packard HP-12C
which is a standard handheld calculator in use for more than 25 years.

TVM Calculation Tools

Table 1. Excerpt of FV Financial Table

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Table 2. Excel Spreadsheet to calculate TVM. Double click to open
worksheet and type information in yellow highlighted cells to
calculate value for table above and amount.

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 Interest # of time
TVM Formula Amount
Rate (i) periods (n)
PV=1/(1+i)n $ 20,000 10% 1
0.90909
$ 18,181.82

FV=1*(1+i)n $ 20,000 10% 1

$ 1.10000
$ 22,000.00

$ 8,000 8% 5
PVA=1-(1/(1+i)n)/i 3.99271
$ 31,941.68

$1,760,000 9% 5
FVA=(1+i)n-1/i 5.98471
$10,533,091

$ 1,760,000 9% 5

PVAD=PVA*(1+i) 4.23972
$ 7,461,906.98

$ 1,760,000 9% 5
FVAD=FVA*(1+i) 6.52333
$ 11,481,068.83
Figures

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 Figure 1.
Summary of Time Value Money Concepts (Spiceland, Sepe, & Nelson,
2013)

VI. FACTORS AFFECTING TIME VALUE OF MONEY

The time value of money is one of the most important concepts of

finance. It is very crucial to understand and implement to make wise
investment decisions. It states that having money in hand right now
is more valuable than getting the same amount of money in the future.
Therefore, from an investment or business perspective, the money
can be used to invest or expand the business to generate more
money. Thus, money holds the potential to generate income in the
future.

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1. Consumption Preference

If the amount of satisfaction is the same, people choose to consume

now rather than later. Most people are willing to forgo their current
consumption if they discover they will be able to consume more in
the future. Their decision to forgo current spending is mostly driven
by a higher rate of return that is greater than the required rates of
return. Even though they are not concerned about the benefits of the
future, some people believe that since the future is unclear, it is best
to consume now.

2. Future Uncertainty
Future events are never guaranteed. What will occur in the future is
unknown and no one can predict future events accurately. The
financial environment of an economy goes through major changes
over time. Therefore, if the present consumption rate is higher, it is
preferable to consume now rather than in the future. People prefer to
offset uncertain future financial flow with reliable cash flow.

3. Inflation in Economy
Inflation and money’s purchasing power are related. Money loses
some of its purchasing power over time. Every economy experience
inflation, yet the rate varies from one country to the next. If there is
higher inflation, then the required rates of return of investors are
higher. For a higher inflationary economy, consumers prefer current
consumption rather than future consumption. Hence, the time value
of money has a negative relationship with inflation. The value of the
currency goes down when the general price level rises, which means
consumers’ purchasing power declines and the future value of a sum
of money falls.

4. Investment Opportunity
Reinvestment is a concept that the time value of money takes into
account. If an investment produces a regular cash flow, the periodic
return can be reinvested to provide an even higher return. Whatever
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the current cash flow may be, if it arrives now, it can be invested to
produce future cash flow. The projected cash flow exceeds the cash
flow at present.

VII. HOW ELSE IS TIME VALUE OF MONEY USED?

The time value of money can also be used to make decisions about
retirement planning, mortgage payments, and insurance.

Retirement planning

The time value of money is important in retirement planning because

it can help you decide how much money to save now in order to have
the same amount of money when you retire. For instance, if you plan
on building a retirement fund of PHP 5,000,000 in 20 years, you need
to invest PHP 2,512,815.21 in a vehicle that earns 3.5% annually.

Loan payments

The time value of money is also important in making loan payments.

This is because the sooner you pay off your loan, the less interest
you will have to pay.

Inflation

The time value of money also affects our purchasing habits. The time
value of money helps us understand how inflation affects the
purchasing power of money. Inflation is when a unit of currency today
can buy more goods and services than the same unit of currency in
the future. This is because, as prices rise over time, the money you
need to pay for the item or service must also go up. For instance, if
in 2000, you only needed P100 to buy a large cup of coffee. But
because of inflation, by 2010, you now need P150 to buy the same
amount of coffee. This means that P100 no longer has the same
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purchasing power in 2010 as it did in 2000.

VIII. INSIGHTS WHAT YOU HAVE LEARNED ABOUT THE

TOPICS

The principles I have learned to this topic it the fact that Php1
received today is not the same as Php1 received at some time in
the future. Faced with a choice between receiving Php1 today or
Php1 in one year’s time, we would not be indifferent, because
while money received today has value, it will more likely than not
have greater value in the future - provided we were to receive
interest on money that was not received today but deposited for
receipt later. This is the concept of time value of money, a fact of
life that means that the promise of a receipt of funds in the future
is acceptable, provided we are compensated for not receiving it
today. And we quantify the time value of money by quoting a rate
of interest on the money in question.

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REFERENCES:

Griffin, M. P. (2009). MBA Fundamentals Accounting and Finance.

New York: Kaplan.

Mathis, R. (2001). The Time Value of Money. (Prentice-Hall, Inc.)

Retrieved Jun 18, 2013, from Corporate Finance Live by Rock Mathis:
http://www.prenhall.com/divisions/bp/app/cfl/TVM/TimeValueOfMoney.h
tml

Present Value. (n.d.). Retrieved Jun 18, 2013, from Business Finance
Online:
http://www.zenwealth.com/BusinessFinanceOnline/TVM/PresentValue.ht
ml

Spiceland, D., Sepe, J., & Nelson, M. (2013). Intermediate Accounting

(7th ed.). New York, NY, US: McGraw-Hill Irwin.

Time Value of Money. (n.d.). Retrieved Jun 27, 2013, from

QFinance.com:
http://www.qfinance.com/contentFiles/QF02/g1xtn5q6/13/1/time-value-of-
money.pdf

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