PAPUA NEW GUINEA UNIVERISTY OF TECHNOLOGY

MINING ENGINEERING DEPARTMENT

PRIVATE MAIL BAG, TARAKA CAMPUS,
LAE 411, MOROBE PROVINCE, PNG
Ph: 4734671:

COURSE FACILITATOR
DR KAEPAE KEN AIL (PHD)

LECTURE 4
TIME VALUE OF MONEY

9TH MARCH 2023

TIME VALUE OF
MONEY
MONEY GROWS ON TIME
 PRINCIPLES OF TIME VALUE OF MONEY
Use of interest rates in evaluation of time value of money

a) Compounding a present value (Pv) to the future (Fv)

b) Discounting a future cash flow (Fv) to present value (Pv) or [P/F,i,n)

c) Annuities or techniques of dealing with annual cash flows and annual payments.
The four common annuities are:

(i) Uniform series annuity (A), where future value (F) is calculated given uniform series of annual cash
flows or payments, or [F/A,i,n]

(ii) Uniform series present worth where present value (P) is calculated given uniform annual CFs or
payments (A), [P/A,i,n]

(iii) Sinking fund is a type of annuity where given future value (F), uniform annual deposits or payments
(A) are calculated, [A/F,i,n]

(iv) Capital recovery is used to calculate annual equal payments (A), given present sum of loan or
payments, [A/P,i,n]
There are three ways to compute time value of money problems:

 1. The algebraic (or formula) method

 2. Use of Table of Factors
 3. Spreadsheet Excel (used for discounted cash flow modeling

The following equations are used for uniform investments or payments.

(1) Future Worth (Value) – FV

The future value is calculated by two methods (1) formula and (2) use of time series interest
factors Table. The formula is called uniform series future worth compound equation.

Formula: Fv = P*(1 + i)n where P = present value at time zero

i = interest rate
n = number of years
Fv = Future worth
 Example 1: A one-off K10, 000 cash is deposited in an interest-bearing account at minimum
rate of return of 15% for 10 years. What will be the compounded future value in 10 years
from now?

Data: Pv = K10, 000, i = 15%, n = 10 years, Fv = ?

Pv=K10,000 Fv =?
==K1000000
000
0 1 2 3 4 5 6 7 8 9 10

Fv = (P*(1+i)n = K10,000*(1+0.15)10 = K40,455.58 in 10 years time

This assumes the investor expects to receive K40,455.58 in 10 years time for investing
K10,000 at an interest rate of 15% compounded annually.
2. Present Value (PV)

Present Value (PV) is the value in today's dollars of a sum of money to be received in the future. It
is the inverse of compounding. It answers the question: What is the benefit now/today in terms of
the future?

Present value is an important measure of investment decision making because people lean towards
having cash or benefits now than future. Thus present value is magnified when the opportunity
cost of having to wait for future consumption is factored into the amount to be received in the future.
Present value is obtained by discounting a sum of money to be received in the future.

Present value of a sum of money to be received in the future can be determined with the following
equation. This equation is called the single payment present worth equation.

Pv = Fv * 1 . wWhere i = interest rate, Fv = Future value and i = interest rate

(1+i)

Example 2: A company wants to make $20, 000 in 10 years’ time. What one-off deposit should be
made now at 8% minimum rate of return?
 Pv = ? Fv = $20,000
==K1000000
000
0 1 2 3 4 5 6 7 8 9 10

Pv = Fv* i = $20,000*1 = $9,263.87

(1 + i)n (1+0.08)10
(0.4632)

The future value $20,000 is in present terms (present value) $9,263.87 at an interest
rate of 8% discounted over 10 years.

Present value of a future sum of money is inversely related to the number of years until
the payment will be received and the opportunity rate. This implies that at certain rate of
interest (discount rate), the future value is geometrically reduced, and difference
$10,736.13 ($20,000-$9,263.87). The difference is the opportunity cost of capital
forgone by making a decision to invest, spend or consume now.
 UNIFORM SERIES OF ANNUAL PAYMENTS/INVESTMENTS

Annuity

An annuity deals with annual payments within a specified period, e.g. 10 years. There are four
types of annuities as explained below.

1. Uniform Series Annuity

Uniform series annuity is a series of uniform, annual payments for a specified number of years.
The formula below is best known as uniform series compound factor formula because it
compounds annual cash flows to the future. This is represented by the following equation.

Pv = A (1 + i) – 1 Where A = equal (uniform) annual payments (deposits)

i
Example: If you make K1000 annual deposits for 10 years in an interest bearing
deposit at 10% interest, how much will it worth in 10 years time?

Data: A = K1000, i = 10%, n = 10 years, Fv = ? Fv = ?

1000 1000 1000 1000 1000 1000 1000 1000 1000 1000
==K1000000
0 0001 2 3 4 5 6 7 8 9 10

Fv = K1000*(1+0.10)10 -1 = K15,374.246
0.10

The future value for series of equal annual payments of K1000 is worth K15,
937.246 in 10 years time.
 2. Uniform Series Present Worth

Uniform series present worth annuity is derived from a series of uniform money payments for a
specified number of years. The formula below is best known as uniform series present worth
factor formula because future annual cash flows are discounted to the present. This is
represented by the following equation.
P = A *(1+i)n - 1
i(1+i)n
Example: If you are thinking of withdrawing $1000 per year to pay school fee for your child, how
much will you deposit into a fund or account for 10 years if minimum rate of return is 12%?

Data: A = $1000, i = 12%, n = 10 years, P = ?

P = ? 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000
==K1
0 00000 1 2 3 4 5 6 7 8 9 10
P = A *(1+i)n – 1 = $1000*(1+0.12)10-1 = $5,650.20
0000

i(1+i)n 0.12*(1+0.12)10
An amount of $5, 650.20 is required now to be deposited in order to withdraw $1000 annually for a
child’s school fee over a 10 year period at 12% minimum rate of return.
3 Sinking fund

This type of annuity is called sinking fund because it calculates how much annual deposits could be
made to earn a projected amount. The sinking fund is used to calculate uniform cash flows, payments
or deposits for investments or projects with projected/targeted future values. The following formula is
applied.
A = Fv * i .
(1+ i)^n - 1

Example: In order to accumulate K1,000,000 in 10 years time at 15% minimum rate of return, what
uniform annual deposits should be made over 10 years period?
Data: A = ?, i= 15%, n = 10 years, Fv = K1,000,000 F = $1,000,000
(projected)

49T 49T 49T 49T 49T 49T 49T 49T 49T 49T
==K10
0 00000 1 2 3 4 5 6 7 8 9 10
Note: T= 000000
A = $1,000,000 * 0.15 . = K49,252.06
(1+0.15)10 - 1

The annual deposits will be K49,252.06 for an expected earnings of K1,000,000 in future
4. Capital recovery

The capital recovery is used to calculate annual equal payments given a present value. It is useful for
calculating loan or debt installment annually for long term loans. This formula is the most applied for
evaluating annual payments or incomes or for loan installments by banks. The following formula is
called capital recovery factor: n
A = P * i*(1+i ) . [ A/P, i%, n ), means given present value
n
(1+ i ) - 1 calculate annual payments]
Example: What equal amount of money is payable to repay a loan of K100, 000 at minimum
rate of return of 10%, for loan term is 10 years?
Data: P = $100, 000, i = 10%, n = 10 years, A = ?
0 16274 16274 16274 16274 16274 16274 16274 16274 16274 16274
==K10
000000
0 00 1 2 3 4 5 6 7 8 9 10
A= K100, 000*0.1 (1+0.1)10 = K16,274.54/year
(1+0.1)10 -1
First loan installment is due in the first year end and throughout the 10 years. $16, 274.54 will be paid
annually. Capital recovery factor is widely applied and useful for calculating the annual debt
installments or other sort of liability payments on annual basis
5 Perpetuities

Perpetuity is a special type of annuity with an infinite number of payments (PMT). Perpetuity is
an annuity that continues forever, that is every year from now on this investment pays the same
dollar amount. In real world perpetuities do not exist. In rare cases, example, lifetime
government bond investments do exist where one could continue to get accrued payments each
year. Also preferred stock which yields constant dividends for infinity period is good example of
perpetuity. In reality, perpetuity never exists.

Table 2.1 Discrete Cash Flow formulas and examples, illustrating the basic Time Value of
Money formulas (reference can easily be made to the Table)
To Find: Given Factor to Factor Name Functional
multiply by Symbol For single CF:

F P (1+i)N Single payment compound amount (F/P,i%,N)

. 1 .
N
P F (1+i) Single payment present worth (P/F,i%,N)

Uniform series Annuities

. (1+i)N .
F A i Uniform series compound amount (F/A,i%,N)

. (1+i)N -1 .
P A i(1+i)N Uniform series present worth (P/A,i%,N)

. i .
A F (1+i)N -1 Sinking fund (A/F,i%,N)

. i(1+i)N .
A P (1+i)N -1 Capital recovery (A/P,i%,N)