Module 2 Special Topics in Financial Management

Republic of the Philippines
Laguna State Polytechnic University

Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredited
LSPU Self-Paced Learning Module (SLM)
Course Special Topics in Financial Management

Sem/AY Second Semester/2023-2024
Module No. 2
Lesson Title TIME VALUE OF MONEY
Week
6-10
Duration
Date March 6 - April 7, 2023
Description This module covers the future value, intra-year
of the compounding, future and present value of an annuity,
Lesson present value at compounded interest, applications of
present and future values and amortized loans.
Learning Outcomes
Intended Students should be able to meet the following intended

Learning learning outcomes:
Outcomes  Understand the concept of time value of money.
Targets/ At the end of the lesson, students should be able to:
Objectives  Compute the time value of money in various
situations.
 Explain the importance of the time value of money
in the decision making process.
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Student Learning Strategies
Online Activities A. Online Discussion via Google Meet

(Synchronous/ You will be directed to attend in a One Hour
Asynchronous) class discussion on the nature and types of
educational technologies. To have access to
the Online Discussion, refer to this link:
https://meet.google.com/vkk-rmwm-chu
The online discussion will happen on March 4 to
April 5, 2024, from 1:00 pm to 4:00 pm.
(For further instructions, refer to your Google
Classroom and see the schedule of activities
for this module)
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Lesson 3:
Time Value of Money
In business, finance managers rely on the concept of time value of money

which states that the amount of money today is different from what it will be in the
future. Because of this difference, a finance manager makes computations carefully
before arriving at a decision. For instance, an insurance company that pays
P500,000 after 20 years to a policyholder receives a premium payment of P12,500 a
year. For 20 years, the premium payment made by the policyholder will amount to a
sum of up to P250,000 only. Why is the insurance company willing to sacrifice the
other P250,000? The answer to the question is simple, i.e., the insurance company
believes that it can do much more using the P12,500 that it actually receives every
year. The firm believes that the expected return will exceed what it is willing to pay
the policyholder.
The time value of money is a critical consideration in financial and investment
decisions. It helps individuals and firms determine how much money must be placed
today to accumulate a future sum given an interest rate for a given period. Thus, the
placement may be in either lump-sum or regular intervals, and at the beginning or at
the end of the period. Likewise, the time value of money helps determine how much
interest money will earn if placed today at a certain rate for a certain period.
The compounding of interest determines the future amount of money earned
if an investment is made at the present. It is also used to ascertain how much money
should be invested to acquire a target amount in the future, e.g., pension funds for
retiring employees, sinking funds for long-term obligations, etc. Discounting, the
opposite of compounding, is used to evaluate future cash flows associated with
capital budgeting projects and the valuation of bonds and stocks.
Future Value
A peso actually received today is worth more than a peso to be received
tomorrow. This valuation holds true because of the interest money can earn after
having been invested. Compounding interest means that the interest not withdrawn
also earns interest, i.e., the interest itself also earns interest. Knowing how much
interest is earned on the money placed in the present helps individuals decide
whether or not to look for other investment opportunities.
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For a better understanding of the concept of compounding, the following

symbols are defined:
FV = future value (present + interest) or the amount of money at

year end
PV = principal value
r = rate
i = annual interest rate
n = number of periods
If the amount PV at year 0 is placed at a rate i, then

FV = PV (1 + i)"
In this case, if PV = P1,000, i = 12%, and n = 4, the result is:
FV = P1,000 (1.12)4
The (1.12)4 is equal to 1.573 which is obtained by multiplying 1.12 four times
by itself. The interest table for the future value of 1 may also be used for convenience.
Example:
Mario Orio placed P1,000 in a savings account earning 7% interest
compounded annually. How much money will he accumulate after 5 years?
FV = PV (1 + i)n
= P1,000 (1.07)5
= P1,000 (1.403)
= P1,403
Note: The value 1.403 may also be found in the interest table using the future
value of 1.
Example:
Lackie Tyan invested a large sum of money in ZZZ Corporation. The
company pays a P3 dividend per share. The dividends are expected to increase by
15% per year for the next 3 years. Lackie wants to project the dividends from years 1
to 3.
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Answer:
FV = PV (1 + i)"
At year 1
FV = P3 (1.15)1
= P3 (1.15)
= P3.45
At year 2
FV = P3 (1.15)2
= P3 (1.322)
= P3.97
At year 3
FV = P3 (1.15)3
= P3 (1.521)
= P4.56
Intra-year Compounding
Interest is often compounded more than once a year. Banks and other
financial institutions accepting placements compound interest quarterly, daily, or
even continuously. If interest is compounded many times a year, the general formula
for solving the future value is:
FV = PV (1+i/m)t x m
The number of conversion periods for 1 year is denoted by m while the total
number of conversion periods for the whole investment term is denoted by n.
Conversion periods are usually expressed by any convenient length of time and
usually taken as an exact division of the year, e.g., monthly, quarterly, semi- annually,
and annually. When the conversion periods are:
Annually m = 1
Semi-annually m = 2
Quarterly m = 4
Monthly m = 12
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The total number of conversion periods for the whole term n can be found
from the relation:
n = time x number of conversion periods per year m
n=txm
Thus, the term 5 years compounded:
Annually 5 x 1 n=5
Semi-annually 5 x 2 n = 10
Quarterly 5 x 4 n = 20
Monthly 5 x 12 n = 60
The interest rate is usually expressed as an annual or yearly rate, and must
be changed to the interest rate per conversion period or periodic rate i and can be
found from the relation:
Thus, the interest rate at 9% compounded:
Annually 9% / 1 i = 9.00%
Semi-annually 9% / 2 i = 4.50%
Quarterly 9% / 4 i = 2.25%
Monthly 9% / 12 i = 0.75%
The formula reflects a more frequent compounding (t x m) at a smaller

interest rate per period (i / m). The future value increases as m increases. Thus,
continuous compounding results in the maximum possible future value at the end of
n periods for a given rate of interest.
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Future Value of an Annuity

An annuity is defined as a series of equal payments (or receipts) made at
fixed intervals for a specified number of periods. If the payment occurs at the end of
the period, it is called an ordinary annuity. Examples are mortgages on housing, car
loans, and bank loans. If the payment occurs at the beginning of each period, the
annuity is called an annuity due. Life and car insurance premiums and rental
payments are some examples of an annuity due. Between the two types of annuities,
the ordinary annuity is more common in practice.
Example:
Aiza wants to determine the sum of money she will have in her savings
account at the end of 5 years by depositing P1,000 at the end of each year for the
next 5 years. The annual interest rate is 8%.
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Answer:
Each deposit is made at the end of the year and compounded at the end of
the period n. The sum of the compounded deposits is the future value of an annuity.
Another way of solving this problem is by using the future value of an annuity
formula. Assume the following:
However, the formula can only be used if the cash payments or receipts are
even; otherwise, each payment or receipt is computed individually using the present
value. Based on the previous example:
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Example:
Aiza wants to determine the sum of money she will have in her savings
account at the end of 5 years by depositing P1,000 at the beginning of each year for
the next 5 years. The annual interest rate is 8%.
Since the deposits started at the beginning of each year, more interest is
earned as compared to deposits made at the end of the year. Another way of solving
this problem is by using the future value of an annuity formula. Again, the formula to
be given will only be useful if it has an equal cash flow. The formula is as follows:
Because of an earlier deposit or payment, the future value of an ordinary

annuity has been compounded for one additional period. Thus, applying the formula:
Present Value at Compounded Interest

The present value of a future sum is the amount that must be invested today
at a compound interest to reach a desired sum in the future. The process of
calculating present values, or discounting, is usually the opposite of finding the
compounded future value. In connection with present value calculations, the interest
rate is called the discount rate.
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Example:
Roval Toro is given the opportunity to receive P50,000 10 years from now. If
he can earn 15% on his investment compounded annually, what is the most he
should pay to benefit from this opportunity?
Roval Toro should invest at the maximum amount of P12,350 earning at 15%
to accumulate a future amount of P50,000.
Present Value of an Annuity

Interest received from bonds, pension funds, and insurance obligations all
involve annuities. To compare these financial instruments, the present value of each
must be known.
The present value of an annuity can be found using the following equation:
Example:
Martha Fobre is offered the opportunity to receive the following equal cash
flow over the next 3 years:
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If she must earn a minimum of 8% on her investment, what is the most she
should pay today? The present value of the equal cash flow is as follows:
Martha Fobre has to deposit P25,770.97 to receive a yearly amount of

P10,000 for three years. Another way of solving this problem is by using the present
value of an annuity formula. The formula to be given is only useful if it has an equal
cash flow. The formula is as follows:
Present Value of Unequal Cash Flows

Time-value-of-money problems may revolve around a series of payments or
cash receipts. However, not every situation involves a single amount of annuity. A
problem may involve an unequal cash flow each period for a certain number of years.
The present value of unequal cash flows is the sum of the present values of each
unequal cash flow.
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Example:
Xenetea Trias was offered the opportunity to receive the following unequal
cash flows over the next 3 years:
If she must earn a minimum of 8% on her investment, what amount should

she pay today? The present value of unequal cash flows of revenue is as follows:
Applications of Future and Present Values

Future and present values have numerous applications in financial and
investment decisions. They are useful in decision-making whether for personal
reasons (e.g., how much deposit must be made to acquire a certain amount of
money, amortize a loan, or pay off a sinking fund?) or corporate reasons (e.g., capital
budgeting, bond and stock valuation, and right financing mix).
An individual may want to know the annual deposit (or payment) necessary to
accumulate a future sum. To determine this future amount, the formula in computing
the future value of annuity can be used.
Example:
Ziram Ilamu is interested to know the equal annual, end-of-year deposits
required to accumulate P15,000 at the end of 10 years when her son enters college.
The interest rate is 12%. The annual deposits are as follows:
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If Ziram Ilamu deposits P854.75 at the end of every year for 10 years at 12%
interest, she will accumulate P15,000 at the end of the fifth year.
Amortized Loans
Payments of obligations are made in equal installments which may be
monthly, quarterly, semi-annually, or annually. Amortized loans include housing loans
and auto loans. Other loans are classified as long-term loans. The periodic payment
can be computed using the present value of an annuity of 1:
Example:
Ferlie Shells has a 60-month auto loan of P650,000 at a 12% annual interest
rate. She wants to find out how much the monthly payment should be.
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To repay the principal and interest on a P650,000, 12%, 60-month auto loan,
Ferlie Shells has to pay P14,458.90 a month for the next 60 months.
Example:
Assume that a firm borrows P120,000 to be repaid annually for the next 5
years. The creditor-bank stipulated a 12% interest. Compute the amount of each
payment.
Each loan payment made is distributed partly to the interest and partly to the
principal. The breakdown is often displayed in a loan amortization schedule. The
interest component is largest in the first period and subsequently declines, whereas
the principal portion is smallest in the first period and increases thereafter.
Example:
Using the same data in Example 10, the amortization schedule is as follows:
Annual Percentage Rate (APR)

The different types of financial instruments use various compounding periods.
Bonds, for instance, usually pay interest semi-annually; banks pay interest on
deposits quarterly; and firms offering credit cards pay interest monthly. If an investor
wants to compare financial instruments with different compounding periods, a
mathematical tool should be used to make the comparison possible. For this purpose,
the effective annual rate also known as the annual percentage rate (APR) is used.
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APR is computed as follows:
Where:
r = nominal rate
m = number of compounded period in a year
If the nominal rate is 12% compounded quarterly, the APR is:
This means that if an investment offers 12% interest compounded quarterly,

the investor is actually receiving an APR or effective annual rate of 12.55%. That is to
say, if one investment offers a 12% interest compounded quarterly while the other
one offers a 12.55% interest compounded annually, the same amount of money will
be received at the end of the year.
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Learning Resource
 Financial Management Part II, Ferdinand L. Timbang, CPA, MSCF

Module 2 Special Topics in Financial Management

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Republic of the Philippines

Laguna State Polytechnic University

LSPU Self-Paced Learning Module (SLM)

Course Special Topics in Financial Management

Intended Students should be able to meet the following intended

Student Learning Strategies

Online Activities A. Online Discussion via Google Meet

In business, finance managers rely on the concept of time value of money

For a better understanding of the concept of compounding, the following

FV = future value (present + interest) or the amount of money at

i = annual interest rate

If the amount PV at year 0 is placed at a rate i, then

Thus, the interest rate at 9% compounded:

The formula reflects a more frequent compounding (t x m) at a smaller

Future Value of an Annuity

Because of an earlier deposit or payment, the future value of an ordinary

Present Value at Compounded Interest

Present Value of an Annuity

Martha Fobre has to deposit P25,770.97 to receive a yearly amount of

Present Value of Unequal Cash Flows

If she must earn a minimum of 8% on her investment, what amount should

Applications of Future and Present Values

Annual Percentage Rate (APR)

APR is computed as follows:

If the nominal rate is 12% compounded quarterly, the APR is:

This means that if an investment offers 12% interest compounded quarterly,

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