By: Ashraf Khan

 Time Lines of cashflow

 Future Values, Present Values
 Finding the Interest Rate
 Annuities
 FV and PV of an Annuities
 Uneven cash flows
 Comparison of Interest rates

2
 The ultimate principle suggests that a
certain amount of money today has
different buying power than the same
amount of money in the future.
 This notion exists both because there is
an opportunity to earn interest on the
money and because inflation will drive
prices up, thus changing the "value" of
the money.
 The time value of money is the central
concept in finance theory 3
Which would you prefer to get -- $10,000
today or $10,000 in 5 years?
Definitely today……

Which would you prefer to pay -- $10,000

today or $10,000 in 5 years?
Definitely in 5 years ……

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 What will you prefer to take……
 Option A: $10,000 today
 Option B: $12,000 after a year.
 Decision depends on a lot of factors…..
• Interest rates
• Inflation rate
• Investment opportunities.

In another words, if the $10,000 invested today gives less

than $12,000 after a year, you will choose option B,
otherwise you will stay with option A.
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 Option A: 10,000 today
 Option B: 12,000 after a year.

 The decision depends on a lot of factors like

• Inflation
• Interest rates
• Rate of return on other investment options.

If you are able to invest 10,000 and earn an amount

greater than 12,000 in 1 year you will prefer Option B
as you can keep the extra amount as profit.
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How to come to these decisions through
numerical examples and working is
something that we shall learn in this
lecture.

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Future Value is the value at some future time of a
present amount of money, evaluated at a given
interest rate.(eg: Value of Rs. 100 in 5 years @ 5% ,
20%, 15% interest rate)
Present Value is the current value of a future amount
of money, evaluated at a given interest rate.
(eg: Value today of Rs. 100 that you will receive 4 years
later if the interest rate is 5%, 20% etc.)
Compounding is the process of calculating the future
value from a given present value
Discounting is the process of calculating the present
value from a given future value
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Simple Interest
Interest paid (earned) on only the original amount, or
principal, borrowed (lent).
The interest earned is not added back to the principal, rather
it is taken out.
Compound Interest
Interest paid (earned) on any previous interest earned, as
well as on the principal borrowed (lent).
The interest earned is added back to principal and
subsequent interest is earned on (Principal + Interest)
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Assume that you deposit $1,000 in
an account earning 7% for 2 years.
What is the future value at the end
of the 2nd year…
• if compound interest is earned??
• if simple interest is earned??

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1st Year= 1000 x 7/100= 70
2nd Year= 1000 x 7/100= 70

So Total Interest= 70+70= 140

Total Amount= 1000+140= 1140
 P(1+i)n
P=Principal Amount
i= Interest Rate
N= No. of time periods
1000(1+0.07)2=1144.9
 There are many types of TVM calculations
 The basic types that we will cover are:
 Present value of a lump sum amount
 Future value of a lump sum amount
 Present and future value of uneven cash flow streams
 Present and future value of annuities

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First of all we need to learn how to make a
time line!

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 A timeline is a diagram used to identify
the timing of the cash flows for an
investment

 Each tick represents one time period

PV FV

0 1 2 3 4 5
Today
 0 1 2 3
i% = ??

CF0 CF1 CF2 CF3

Tick marks the end of a time period and the

beginning of another, so 0 represents today and
beginning of period 1; 1 represents the end of
Period 1 and beginning of Period 2.
The intervals from 0 to 1, 1 to 2, and 2
to 3 are time periods.
Could be years, semi-annual periods,
Quarters, months, days.

Interest rate needs to correspond to the period.

12% annual interest rate means
6% semi-annually
3% quarterly
1% monthly.
• The amount to which a cash flow or series
of cash flows will grow over a given period
of time when compounded at a given
interest rate.

You plan to deposit $100 in a bank that pays a

guaranteed 5% interest each year. How much
would you have at the end of Year 3?
19
Four different procedures to solve time value
problems.
 Use the highlighted row of
keys for solving any of the FV,
PV
N: Number of periods
I/Y: Interest rate per period
PV: Present value
PMT: Payment per period
FV: Future value
CLR TVM: Clears all of the inputs
into the above TVM keys

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How much money will you have in 5
years if you invest $100 today at a
10% rate of return?
1. Draw a timeline

$100 i = 10%
?

0 1 2 3 4 5
 FindFV (Future Value) of Rs. 100 at the end
of year 5 if the interest rate is 10%
 FV=PV(1+i)n
 FV=100(1.10)5
 =161.05

 Q. Find FV of Rs. 500 at end of 3 years if

interest rate is 5%
 =578.8
 500(1.1576)=578.8
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 Check the FVIF(Future Value Interest Factor)
for the previous question, where
 i = 10%
n = 5

 FVIF = 1.6105
 So the FV=100(FVIF),N=5, I=10%
 FV=100(1.6105)
 FV= 161.05
(Same as in previous slide)
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 Thevalue today of a future cash flow or
series of cash flows.

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Make a time line showing a period of 5 years, with cash flows
as follows

Yr 1 Rs. 100 PV=100/1.1=

Yr 2 Rs. 200 PV=200/(1.1)2
Yr 3 Rs 0
Yr 4 Rs, 500 PV=500/(1.1)4
Yr 5 Rs. 100 PV=100/(1.1)5
Final answer= 659.8
i= 10%

1062.61/1.15=659.8
Choice 1 : 700 today or
Choice 2: 1062.61 after 5 years, provides interest rate is 10%

Calculate the Present value of these cash flows at the end of

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year 5.
Future Value Formula:
FVn = P0 (1+i)n
or FVn = P0 (FVIFi,n) -- See FVIF Table

Present Value Formula:

PV0 = FVn / (1+i)n
or PV0 = FVn (PVIFi,n) -- See PVIF Table

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 How much would $100 received five years from now
be worth today if the current interest rate is 10%?
1. Draw a timeline
The arrow represents the flow of money and the
numbers under the timeline represent the time
period.
Note that time period zero is today
i = 10%
? $100

0 1 2 3 4 5
 Find the Present value of 100 due in 5 years,
if the interest rate is 10%?
 PV=FV/(1+i)n
 PV=100/(1.10)5
 PV= 62.09
 100(0.6209) = 62.09

 Present value of Rs. 500 due in 10 years if

interest rate is 3%.
 PV=500/(1.03)10= 372.05
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32
 Applying the PVIF(Present Value Interest
Factor) table to the previous PV question.
 Find PVIF where n=5, i=10%
 PVIF = 0.6209
 PV=100(0.6209)
 PV=62.09
(same as above)
Present value of Rs. 500 due in 10 years if
interest rate is 3%.
PV=500(0.7441)
=372.05
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Ordinary Annuity: Payments or receipts occur at
the end of each period.

Annuity Due: Payments or receipts occur at the

beginning of each period.
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Future Value of annuity Formula:
FVAn = PMT * (((1+i)n -1)/i)
or FVAn = PMT (FVIFAi,n) -- See FVIFA Table
FVA(DUE)= = PMT * (((1+i)n -1)/i) (1+i)
Present Value Formula:
PVA0 = PMT * ((1- (1/(1+i)n))/i)
or PVA0 = PMT (PVIFAi,n) -- See PVIFA Table
 PVA(DUE)= = PMT * ((1- (1/(1+i)n))/i) (1+i)

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 Q. A potential buyer offers to
purchase a coin from you in exchange
for a series of three annual payments
of $50 starting one year from today.
What is the current value of the offer if
the prevailing rate of interest is 7%
compounded annually?
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1. Draw a timeline
2. Discount back each payment
3. PV of Annuity= Sum PVs of all PMTs

6-37
THE PRESENT VALUE OF AN ORDINARY
ANNUITY (CONT.) - FORMULA

• Here:
 annual interest rate = .07,
 number of years = 3
 m (compounding period of interest
rate)=1
 PMT= $50
 PV= 131.22
6-38
THE PRESENT VALUE OF AN ORDINARY
ANNUITY (CONT.) - TABLE
1. Periods= Years x compounding period= 3 x 1

2. Interest Rate= 7%
3. Annuity Factor from Table= 2.6243
4. PVA(ord)= Annuity Factor x PMT= 2.6243 x 50 =131.22
Q. Find the PV of an annuity of Rs. 300 for 4 years if the interest
rate is 12%.
PVA= 300(3.0373)= 911.19
Q. Suppose you are putting Rs. 1000 in a bank every quarter for 1
year. Bank is offering you an interest of 12%. What is the PVA.
Pmt=1000, i=12/4=3%, n=4
1000(3.7171)=3717.1
6-39
 Q. A potential buyer offers to
purchase a coin from you in exchange
for a series of three annual payments
of $50 starting today. What is the
current value of the offer if the
prevailing rate of interest is 7%
compounded annually?
40
1. Draw a timeline
2. Discount back each payment
3. PV of Annuity= Sum PVs of all PMTs

6-41
THE PRESENT VALUE OF AN ANNUITY DUE
(CONT.) - FORMULA

x (1+annual interest rate/m)

• Here:
 annual interest rate = .07,
 number of years = 3
 m (compounding period of interest
rate)=1
 PMT= $50
 PV= 140.40
6-42
THE PRESENT VALUE OF AN ANNUITY DUE
(CONT.) - TABLE
1. Periods= Years x compounding period= 3 x 1
2. Interest Rate= 7%

3. Annuity Factor from Table=

4. PVA(DUE)= Annuity Factor x PMT=2.80802 x 50 = 140.40
Q. YOU HAVE TO MAKE MONTHLY PAYMENTS OF RS. 14000 AGAINST A LOAN
THAT YOU HAV TAKEN FOR NEXT 2 YEARS. THE FIRST PAYMENT THAT YOU HAVE
TO MAKE IS TODAY. THE INTEREST RATE THAT THE BANK IS CHARGING IS 15%.
WHAT IS THE PRESENT VALUE OF THIS ANNUITY STREAM?
PMT=14000, I=15/12=1.25%, N=2*12=24
=292348.5
6-43
 Calculate the PV of a 3 year annuity of Rs.
200 if the interest rate is 5%.

 PVA(ord) = 544.64

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Q. What is the accumulated value of a
$25 payment to be made at the end of
each of the next three years if the
prevailing rate of interest is 9%
compounded annually?

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1. Draw a timeline
2. Calculate FV of each PMT
3. FV of Annuity= Sum of FVs of all PMTs

6-46
THE FUTURE VALUE OF AN ORDINARY
ANNUITY (CONT.) - FORMULA

• Here:
 annual interest rate = .09,
 Y= number of years = 3
 m (compounding period of interest
rate)=1
 PMT= $25
 FV= 81.95
6-47
THE FUTURE VALUE OF AN ORDINARY
ANNUITY (CONT.) - TABLE
1. Periods= Years x compounding period= 3 x 1
2. Interest Rate= 9%

3. Annuity Factor from Table=

4. FVA(Ord)= Annuity Factor x PMT= 3.2781 x 25 = 81.95
Q. Suppose you put Rs. 15000 in a bank every quarter for 2 year
and bank gives you interest of 20% annually. What is the FVA at
the end of year one.
15000(4.3101)=64651.5
For two years:
i=5%, n=8, PMT=15000. FVA=143236.6 6-48
Q. What is the accumulated value of a
$25 payment to be made at the start of
each of the next three years if the
prevailing rate of interest is 9%
compounded annually?

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1. Draw a timeline
2. Calculate FV of each PMT
3. FV of Annuity= Sum of FVs of all PMTs

6-50
 THE FUTURE VALUE OF AN ANNUITY DUE
(CONT.) - FORMULA

x (1+annual interest rate/m)

• Here:
 annual interest rate = .09,
 Y= number of years = 3
 m (compounding period of interest
rate)=1
 PMT= $25
 FV= 89.33
6-51
THE FUTURE VALUE OF AN ANNUITY DUE
(CONT.) - TABLE
1. Periods= Years x compounding period= 3 x 1
2. Interest Rate= 9%

3. Annuity Factor from Table=

4. FVA(DUE)= Annuity Factor x PMT= 3.5731x 25 = 89.33
5. SUPPOSE YOU ARE PUTTING 50,000 IN A BANK EVERY 6 MONTHS
FOR THE NEXT 5 YEARS. The first payment is to be made today. THE
INTEREST RATE THE BANK OFFERS YOU IS 7%. What is the
accumulated value in your account at the end of 5 years.
6. PMT=50,000, I=3.5%, N=10
7. FVA(DUE)= 607099.6
6-52
 Student Loan Payments
 Car Loan Payments
 Insurance Premiums
 Mortgage Payments
 Retirement Savings

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 PMT PMT PMT
PV    
(1  i ) (1  i ) (1  i )
1 2 3

PMT
PV 
i

Find the present value of a perpetuity of

$270 per year if the interest rate is 12%
per year??
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Amortization tables are widely used for home
mortgages, auto loans, business loans, retirement
plans, etc.
It breaks down each payment into the interest
component and the principal component.

Construct an amortization schedule for a

Rs.10,000, 10% annual rate loan with 4 equal
annual payments.
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 Suppose you want 10000 after 10 years. The
bank is offering 12% compounded quarterly.
How much should you invest today?
 You are planning to put 10,000 in bank every
year for the next 5 years. Bank is offering 12%
compounded quarterly. What will be the
accumulated amount in your account at the end
of 5 years.
 You are planning to put 10,000 in bank every
quarter for the next 5 years. Bank is offering
12% compounded quarterly. What will be the
accumulated amount in your account at the end
of 5 years. 56
 You are promised an income stream of Rs. 10000
per month for the next 5 years if you invest XXX
in the bank today. If the interest rate the bank is
offering you 15%, compounded monthly, what is
the amount you have to invest today?
 PVA=…pmt=10,000,n=12*5=60, i=15/12=1.25%
 PVA= 420325. 92
 You are planning to invest 10,000 in a bank every
year for the next 5 years. If the bank is offering
6% annually, what will be the accumulated value
at the end of 5 years.
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 You are planning to withdraw 10,000 from
the bank every year for the next 7 years.
Bank is offering 14% compounded
quarterly. What is the amount you need to
put in the bank today?

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1. Find the amount that you need to invest today to
get 140,000 at the end of 8 years if the interest
rate is 8%.
2. What is the future value of a Rs. 800 semi annual
annuity for 5 years if the rate of interest is 20%,
compounded semi-annually.
3. I can take out 50000 each year as a payment for
my car loan for the next 5 years. What is the
maximum amount of loan that I can take, if the
interest rate is 10% annually.
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 Ahmed wants to spend 50,000 a year for the next
5 years. How much amount he needs to put in a
bank today is the interest rate he is offered is
10% annually.
 What option is better? 12% qtrly compounding
or 10 % monthly compounding if you are
planning to invest for the next 20 years.
 In how much time do you expect your income to
triple if the interest rate being offered to you is
12%, semi-annual compounding.
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