Fatema Afreen, Faculty Member

Department of Business Administration

Premier University, Chattogram.

 Definition of Time Value of Money

Money has a time value associated with it i.e., the value of a unit of money is
different in different time periods, therefore, an amount received today is worth
more than an amount to be received in the future.

The value of an amount of money changes over time.

TVM is based on the belief that a dollar today is worth more than a dollar that will
be received at some future date.

 Reasons of Time Preference for Money

 Uncertainty

 Consumption

 Inflation

 Investment opportunity

 Required rate of return

 Importance of Time Value of money

Financial decision making

Measuring and facing the risk and return

Project evaluation and selection

Valuation of securities

To evaluate, compare and combine cash flows occurring at different period of

time

Fund planning

Determination of growth rate

Ascertaining the lease payment and debt payment

 Fatema Afreen, Faculty Member
Department of Business Administration
Premier University, Chattogram.

 Basic Patterns of Cash Flow

It may be three types:

 Single Amount

 Annuity

 Mixed Stream

 Single Amount:

A lump sum amount either currently held or expected at some future date. More
precisely, single amount refers to the cash flow that occurs once in the whole project
life.

For example:

Tk. 800 invested today would increased to Tk. 1,070 at the end of 5 years at the rate of
6% interest or,

to get Tk. 1,070 at the end of 5 years at a rate of 6% one should invest Tk. 800 today.

 Annuity:

A series or streams of equal cash flows at equal interval of time period. These cash
flows can be periodic inflows (equal) of returns earned on investments or periodic
outflows (equal) of funds invested to earn future returns.

An Annuity may be of three forms-

 Ordinary Annuity &

 Annuity Due.

 Perpetuity
 Fatema Afreen, Faculty Member
Department of Business Administration
Premier University, Chattogram.

 Ordinary Annuity:

An annuity for which the cash flow occurs at the end of each period.

 Annuity Due:

An annuity for which the cash flow occurs at the beginning of each period

 Perpetuity:

An annuity with an infinite life is called perpetuity. In other words, an annuity that
never stops providing its holder with a cash flow of each year, called perpetuity.

For example:

An individual is offered a bond that pays coupon payments of $10 per year and
continues for an infinite amount of time.

 Mixed stream:

Any series of cash flows that doesn’t confirm to the definition of an annuity is
considered to be an uneven cash flow stream or, mixed stream

For example:

a series of cash flow such as $100, $100, $200, $300, $300, $200 would be considered
an uneven cash flow stream.
 Fatema Afreen, Faculty Member
Department of Business Administration
Premier University, Chattogram.

 Time Line
A time line on which time zero appears at left most and future periods are marked
from left to right; can be used to depict investment cash flows.

Year

0 2015 2017 2919 2020

 Approaches of Time Value of Money

 Future vs. Present Value

Future Value is cash you will receive at a given future date.

Present Value is the equivalent of cash on hand today.

Since financial managers make decisions at time zero, they tend to rely on present
value techniques.

PV vs. FV and Compounding vs. Discounting

 Continuous compounding means compounding of interest an infinite number of

times per year at intervals of micro seconds.
 Fatema Afreen, Faculty Member
Department of Business Administration
Premier University, Chattogram.

• Nominal Annual Rate & Effective Annual Rate (EAR) of Interest

Nominal annual rate is a contractual annual rate of interest charged by a lender

or promised by a borrower.

• EAR/Equivalent annual rate(EFF) is the annual rate of interest actually being

paid or earned. It is the percentage rate that is actually being earned, taking the
total compounding effect in to account.

• Loan Amortization:
Loan amortization means computation of equal periodic loan payments. These
payments provide a lender with a specified interest return and repay the loan principal
over a specified period. The loan amortization process involves finding the future
payments, over the term of the loan, whose present value at the loan interest rates
equal the amount of initial principal borrowed.

 Equations for Future Value:

If Compounded annually , FV = PV (1+r)n

More frequently than annually,

FV = PV (1+r/m) n(m)

For Continuous compounding, FV = PV (e)r(n)

(where, e= 2.71828 or, 2.7183 app.)

 Equations for Present Value:

If Discounted annually, PV = FV (1+r)-n

More frequently than annually,

 Fatema Afreen, Faculty Member
Department of Business Administration
Premier University, Chattogram.

PV = FV (1+r/m) –n(m)

For Continuous discounting, PV = FV ( e)-r(n)

 Mixed Stream:
Equations for Future Value:

 Equations for Present Value:

 EAR/Equivalent annual rate(EFF)

 Fatema Afreen, Faculty Member
Department of Business Administration
Premier University, Chattogram.

Present Value of Annuity:

 Fatema Afreen, Faculty Member
Department of Business Administration
Premier University, Chattogram.

Future Value of Annuity:

 According to Formula:
 Fatema Afreen, Faculty Member
Department of Business Administration
Premier University, Chattogram.

 FV =Future value

 PV = Present value

 r = Rate of interest (i/k/r)

 n = Number of years(n/t)

 m = number of times per year interest is compounded/ no. of conversion period

 c = Each periodic payment

Financial Table:

 Terms for using financial table:

 PVIF= present value interest factors for $1

 FVIF= future value interest factors for $1

 PVIFA=present value interest factors for $1 annuity

 FVIFA=future value interest factors for $1 annuity