VAIUATION USING TIME VALUE OF MONEY

Finance people usually anticipates determing investment into:

1 Determine the future value of an investment made today.
2 Determine the present value of cash to be received at a future date.
3 Find the return on an investment
4 Calculate how long it takes for an investment to reach a desired value.

TIME time value of money refers to A FUND/INVESTMENT in hand today is worth more
VALUE than a FUND/INVESTMENT promised at some time in the future.
OF
MONEY

FUTURE Is like asking a question what is the investment growth if it earns a certain percentage for a
VALUE period of number of years.

Simply says that an investment/deposit/revenue are projected shall receive a value double
or increase in multitude depending on the rate use to anticipate projection

Formula Future value= P1 (1+r)n

If the company projected an increase in revenue for next 25 year at a rate of 5% from the
current year sales/revenue of P100,000

What is the growth? This is known the FUTURE VAUE (FV) of the P100,000 current revenue.

FV 100,000 (1+5%)25 years

100,000 (3.38635) Using scientific calculator with y raise x
P338,635.49 function enter 1.05, then enter
function y raise x funtion, then
enter 25= the value is 3.38635
or using the Excel financial calculator
FV= Rate 5%
Nper 25 Term
Pmt Not required for loan purposes only
PV -100000 Why negative, normally negative represent cash outflow
and positive for cash inflow. Since PV is the value given
up today it has to be written as
negative for cash inflow later.

Type (0 beg, 1
1 end)

Application FV(5%,25,0,-100000
FV 338,635.49 Pesos

SIMPLE Referring to interest on investment is called simple interest, simple interest

INTEREST plus principal roll over for number of years is called compound interest
AND
COMPOUND Example: The company venture to a P400,000 investment at the interest of
INTEREST 12% for 3 years. How much is the simple interest? The compound
interest? And the compound value?

Compound value = P400,000 x (1.12)3

P400,000 x (1.404928)
P561,971.20
Simple interest= 144,000.00 (400,000x.12 x 3)
Compound interest-
P561,971.20 compound value
P400,000.00 Principal
P161,971.20 Interest earned
P 144,000.00 Simple interest
P 21,971.20 Compound interest

PRESENT VALUE Simply the invested value today (PV) to earn a P1 at certain interest. Future
AND DISCOUNTING value is known, but what the investor interest is to know how much the value
of the investment today to size up if it is worth to invest. This process is considered
by the investor to be helpful to compare the value of discount particulary investing
to a real estate property that require installment payment vs cash payment. Likewise
this is the valuation use for company who are no longer fit to continue the business
as a GOING CONCERN thus require liquidation, selling property assets without
market value, the difference commonly known as goodwill.

This valuation is the reverse of FUTURE VALUE computed as follows:

PV= P1 (1/1.r)n
Hence the Future value of P1 at 10% in one yearis P1.10, whereas the Present value
is P1 (1/1.10)n or P.909

With the attributes of discounting the future value of investment to current period
this valuation is know as DISCOUNTED CASH FLOW VALUaTION

Example: Mr BongTulfo plan to buy a car he has now P2,500,000. The car is
worth P3,425,000. With the money available he will be able to earn at
a rate of 10% in 2 years. Question is the money available enough
to be able to buy that Car assuming no change in price for one year?
Ans Yes? Prove the answer, if not how much?_____________________

Excel Formula = PV(rate,nper,pmt,fv)

FUTURE VALUE AND Valuation that could prove the effectiveness of value invested vs the proposal to
PRESENT VALUE sell or dispose a property and determine the value of money on hand vs the
MIX ANALYSIS value of money needed to earn at an interest considered a discount rate

Situation: In Pesos
Proposal to buy an asset 335,000
 To sell an asset in 3 years 400,000
Option to invest at 10%

Required: Is the future value and net present value will prove to be worth
in buying the asset, and selling the asset? Show computation

Answer_____________________________________________

DISCOUNT RATE We usually ask how much is the discount rate given in an investment. It doesn’t
IMPLICIT IN AN mean that if the rate is not given, it is a none bearing interest. There is an implicit
INVESTMENT interest recorded or rate of return from the future value and the present
value considered in investment.

TIP: MUST BE PRESENT VALUE AND FUTURE VALUE IS KNOWN

Then apply the formula to solve for "r" the rate of return
PV- FV/(1+r)n or transpose
(l+r)n- FV/PV

Excel Formula= Rate(nper,pmt,pv,fv)

Example: The estimated investment is needed at P80,000, if the company has

P35,000 now what rate is required to mee the goal in 8 yrs. Or If you can
earn 20% per year will the company make it.

using excel
Answer______________________
Rule of thumb-using 72= 72/8= 9%
if invest to earn 20% 35,000(1.20)8
in 8 years
35,000 (4.29981)
= P150,493.35

PERIOD OF TIME This aid the management to assess the time to prepare the timetable of
procuring an asset given the investment required with present value and
future value known at a given dicounted rate

Fomula: (1+r)n= FV/PV

ExcelFormula NPER(rate,pmt,pv,fv)

Example: The company is saving for buying a company with the total cost of
P10 Millio. With the current available fund of P2.3 Million the company
can earn 5% how long will the company to wait to reach the goal in
buying the company, at 16% how long will the company to wait

Answer_______________________________________

FUTURE VALUE This valuation favor the determination of the future cash flows involving multiple
WITH MULTIPLE cash flows that usually happen when the company opt to invest based on the
CASH FLOW availabilitiy of funds on hand. Scarce financial requirements with the economic
downtrend tend to come with the option of doing it on installment base.

Theory on single cash flows apply the same to this valuation. Importantly needed
is knowing the timeline to understand how the cash flow is program and how much
it earn on the year it is invested.

Example: Assume that the following funds are invested for a period of 3 years
with the cash flow done on installment at the rate of 5%
year amount # of yrs rate factor Future
to target Rate value
1 100,000.00 2 (1.05)2 1.1025 110,250.00
2 200,000.00 1 (1.05)1 1.05 210,000.00
3 300,000.00 0 300,000.00
3 years 620,250.00
What if it extend to additional 2 years without additional
fund invested
add 2 years 620,250.00 2 (1.05)2 1.1025 683,825.63
making it 5 years
or 1 100,000.00 2 (1.05)4 1.2155 121,550.00
2 200,000.00 1 (1.05)3 1.1576 231,520.00
3 300,000.00 2 (1.05)2 1.1025 330,750.00
5 years 683,820.00
Difference
rounding off

PRESENT VALUE Discounting the future value to the value at present with multiple cash flow follows
WITH MULTIPLE the same concept discussed on the single cash flow
CASH FLOW
Example: Proposed investment offered to Y Company with three P50,000
payment. 1st payment shall be made 4 years from today, 2nd 5 years,
and 3rd 6th years. If it earns 11%. What is the investmen worth it
today

50000 (1/1.11)4 5000/1.5181 3293.59

50000 (1/1.11)5 5000/1.6851 2967.18
50000 (1/1.11)6 5000/1.8704 2,673.22
8933.99

Hint: time period in assumed to be paid at the end of each period unless otherwise
stipulated as paid beginning of each period

Hint: if compounding frequency is required, ie: Yearly/semi-annual/quarter/monthly

Example: What is the end of year value of invested at annual percentage rate (APR)
of 24% compounded monthly

P1 (1+r/m)mxt= Compounded annual investment

 Compounded annual investment - 1 = Effective annual rate

Compounding frequency
Application
P1(1+.24/12)12x1
P1(1+.24/12)12x1
P1(1+.02)12x1
P1(1.02)12x1
P1(1.2682)x1=
P1.2682 annual compounded investment
What is the Effective Annual Rate= Annual rate of 1.2682 less 1
or EAR 1.2682-1= .2682 or 26.82%

Compounding interest is monthly- M=12

Compounding interest is quarterly- M=4
Compounding interest is sem-annual- M=2
Compounding interest is daily- M=365
Compounding interest is yearly- M=1
With the given data compute the compounded investment with APR of 24%
at Quarter Answer _________________________ 1.4185
at Semi-annual Answer _________________________ 1.2544
at days Answer _________________________ 1.291

What if in the given example APR 24% is compounded monthly for 3 years
compute for the compounded investment

P1(1+.24/12)12x3
P1(1+.02)12x3
P1(1.02)12x3
P1(1.02)12x3
P1(2.0399)
P2.0399

PERPITUITY In finance investment are taken with extra concern where the amount of cash
flow are continiously given for an infinite period,though the Philippine setting
do not practice such, but other countries do.

Formula PV (Peso amount of continous cash flow)/rate

Example The company receives perpituity cash 10,000 every year for a rate of
8% the perpituity value yearly is
PV (10,000/.08)
PV=P125,000 yearly

FACT: What is the relevance of the Present value Perpetuity? This is the value
of the money that the company has now. If he had more, he could spend
more basing on the pattern of the yearly perpetuity investment he had,
if had less the company will run of fund as he has to spend the perpetuity
 investment in a year.

GROWING The Present Value of perpituity rises in a year from the time now, meaning zero
PERPITUITY day to the time the rate applies . This is true to lease agreements where the lease
increases per year as agreed
FORMULA
PV(Amount of perpetuity (1+ growth rate)/ Discount rate - Growth rate

EXAMPLE: Assume that the landlord of the building received a net cash flow
of P100,000 next year and shall rise by 5% every year at a discount rate
of 11%.

Since the value of the net cash flow is done once to start next year
the growth rate in the formula does not apply as part of numerator
hence: PV (100,000/.11-.05)= P1,666.666.66

FACTS Same facts as mention in the preceeding lesson applies

Assume: What if the value of perpituity involve continuity and rises evey year?
like for instance the payment of dividend which is practice by most of
the corporation.

Example The company is about to pay a dividend of P3 and 6% increase is expected

forever with a discount rate of 11%. What is the price of the stock
today

PV=3+ 3(1.06)/.11-.06
PV=3 +63.6
PV=66.60

WHAT IF THERE This valuation cover the annual payments usually practice in insurance, loan
ARE CASH FLOW TO availment that require long period of payments we call it Annuity Present value of 1
BE PAID IN ANNUITY Pension plan, lease also fall in this valuation.

The previous topic discussed is referred to an Ordinary Present Value of 1

that cover a lump sum investment

Formula PV= C X 1- (1/(1+r)t/r this valuation cover the annual (annuity)

payments, hence the present value of 1
is deducted to the present value interest
factor . Once the investment cover annual
payment the annuity valuation process follows

Example: A man won a lottery paying P50,000 a year for 20 years. At the time the
interest rate is 8%. A trick most of the advertiser will consider a bluff
should we know not the value of the present value. The first payment
shall be be made a year after (Meaning not now or zero date)
 P50,000x 1- (1/1.08)20/r
P50,000x 1-(.21455)/.08
P50,000x 9.818125
P490,906.25
A bluff as advertiser convincingly believe people that they shall received
P1,000,000.

What if we want to get a PV of a future value where annuity payment is required

FORMULA PV=C (1+r)t-1/r
Example: Suppose An employee invest for a P3000 yearly to an insurance company
with a 6% interest. How much the employee get when he retires in
30 years

PV= P3000 x(1.06)30 -1/.06

PV=P3000 x(79.0582)
PV=P237,174.56

CONCERN There is investment that payments are delayed that would require
#1 span of time not exactly paid at present time.
Example An investment to be paid in 4 years amounting to P5,000 shall be paid
BEGINNING OF 6TH YEAR at 10% interest. How much is the present value
at day zero

PV=5000 x 1-(1/(1+.10)4/.10
PV=5000 x 1-(1/(1+.10)4/.10
PV=5000 x (.3170/.10)
PV=5000 x (3.1699)
PV=15,849.32 Note beginning of 6th year meaning the PV is for the
5th year
To bring to date zero which is beginning of day 1
PV=15,849.32/(1.10)5
PV= 15849.32/(1.6105)
PV=P9,841.24
Illustrative time frame of above problem
Time cover
0 P9,841.24
1
2 Bring back the PV to Date 0 which
3 is the beginning of Day 1
4
5 P15,849.32
6 5000 Beginning of payment means the 5th year
7 5000 4 year payment
8 5000 Compute the PV Annuity for the 4 period
9 5000 as per above computation
10

Be careful on the transaction that gives you the hint of the time
 like a payment made a year after…this means day 1
Beginning of year ??? Same as what we have discussed above

CONCERN What to do if the Annuity investment is received date zero as most of

#2 the problem in PV require proper time to get the correct valuation
Example We use the same problem- of the lottery
A man won a lottery paying P50,000 a year for 20 years. At the time the
interest rate is 8%. A trick most of the advertiser will consider a bluff
should we know not the value of the present value. The first payment
shall be be made a year after (Meaning not now or zero date)

What if the payment start at once at day zero how many years shall
be considered to equal it to 20 years

0 P50,000 Include day 0 and compute PV for

1 PV at Annuity 19 years only since day 0 is included
2 for 19 years
3 Computation below
…forward to
20

Day 0 P50,000
P50,000x 1- (1/1.08)29/r
P50,000x 1-(.23171)/.08
P50,000x 9.603625
P480,181.25 480,181.25
P530,181.25

CONCERN What if investment shall be paid with infrequent annuity, say every 2 years
#3 or every 4 years etc for a span of specific date. Ie: if 20 years the
investment shall be divided into 2 if every 2 years making it 10 years.
what we do is get the interest rate for 2 years and use it in the
computation. DO NOT DEVIDE THE THE PV OF ANNUITY using the
formula for full time date as 20 years

Example An annuity investment is received for P4,500 to be paid every 2 years, 1st
payment received 2 years from now, for a span of 20 years at annual
interest of 6%

to compute 2 years interest= (1.06 x 1.06)-1= 12.26%

P4500 x -1 (1/(1.1236)10/.1236
P4500 x -1 (1/(1.1236)10/.1236
P4500 x (.68820/.1236)
P4500 x(5.5679)
P25,055.65
 CONCERN What if 2 annuities are to value, this is usually the case of saving for
#4 the future cash flows, like education where expenses are shouldered
without any aid of insurance plan, and that a projected expenses are
known. Unlike with education insurance a coverage is going to be paid
and invested based on the policy and premium to pay

Example The parents of Nash and Young is saving for the education of their
children that by the age of 18 the expenses in college full semester
amount to P120,000 be sustain. At the rate of 14% how much deposit
per year the parents shall do for a 4 year course?

Graphical presentation to show the 2 annuity to value

Age
0 P37,691.68 Divide the Value by the PVInterest
1 factor to get the yearly deposit. c/
Preparation/saving time and deposit
Bring the PV to date 0 b/

17 P349,645.48 /(1.14)17 a/
18 120,000 Compute the PV annuity interest factor
19 120,000 for 4 years. Beginning of 18th year payment
20 120,000 start for the 4 year course
21 120,000

P120,000 x 1- (1/(1.14)4/.14
P120,000 x 2.9137
P349,645.48 a/
P349,645.48/(1.14)7= b/
P37,691.68
P37,691.68/(1-(1/(1.14)17/.14
P37,691.68/6.3729
P5,914.40 c/ Yearly deposit of P5,914.40 made
at the end of each first 17 years
invested at 14% provide enough
money to sustain tuition payment

GROWING ANNUITY Like valuation in pepetuity, annuity shall grow that salary package, lease, dividends
etc.

FORMULA PV= C x [1-(1+g)/(1+r)t]/(r-g)

c-payment to make
g-growth rate
r-rate
t-time

Example Mr Colorado is anticipating a salary increase of 9% every year upon

completion of the graduate studies and law with a salary of P660,000
 until his retirement at the age of 60. With the interest of 20%. The
salary is his first and to be paid exactly one year from now…meaning
day 1, and his salary will be paid at annual installment . How much is
the value of his lifetime salary

PV= C x [1-(1+g)/(1+r)t]/(r-g)

PV=P660,000 x [1-(1.09/1.20)60]/.20-.09
PV=P660,000 x 9.0625
PV=5,981,255.82

It will happen that the projection to increase the yearly cash flow/investment
thus it require to compute the effect of increase yearly. Will consider the example
of the tuition fees that the parents prepare for the college expenses at P120,000
for full SY for 4 years

Example The parents of Nash and Young is saving for the education of their
children that by the age of 18 the expenses in college full semester
amount to P120,000 be sustain. At the rate of 14% how much deposit
per year the parents shall do for a 4 year course?

the parents plan to increase the yearly deposit till the 17th year by
4%. How much would the PV of the yearly deposit with the 4% increase.

the procedures- a/ and b/ except that the c/ procedure shall be

computed with the formula using

P37,691.68 The value computed back to date zero

that should be the base to compute for the
increase at 4% yearly, Unknown therefore
is the value of deposit to be made yearly
to equal the value at P37,691.68

c x (1.g/1.r)17/.14-.04= P37,691.68

P37,691.68 x .10/1-(1.04/1.14)17
P37,691.68 x .10/.7900
P4,771.09 The yearly deposit to make
P4,771.09 x 1.04%= P4,961.93 and so on….. Next year/s

ANNUAL PERCENTAGE
RATE AND EFFECTIVE
ANNUAL RATE
Discounted Cash Flow cover four (4) parts that is PV, Rate, Time, FV. Each of the
parts represent variables needed to compute the required value. Rate valuation
always raises an issue as to the term it represents. Confusion as to how it is called
to get correct interpretation of the value computed, be a Present Value or Future
value. The rate know as ANNUAL PERCENTAGE RATE (APR) & EFFECTIVE ANNUAL
RATE (EAR) shall be discussed to clear grey issue on the matter of usage

In the formula we have learned and discussed, say PV of FV annuity

FV= PV x (1+r)t - 1

APR or the stated rate must be written in terms of interest payment

made each period

Hence if the the problem state that an investment is to earn a 12% per annum
simply means that the it is 1% per month, and it does not meant that it is the same
as EFFECTIVE ANNUAL RATE
it is called the APR or stated rate. Written as:

FV= PV x (1+r)t - 1
x (1 + .01/12)12 - 1

APR

What about the EAR from the given formula? It is the Present value factor - 1
written as:

EAR= (1.01/12)12-1 or

Present Value Factor- compute using the calculator x raise to Y funtion or

y raise to X function= 1.1216 or .1216 or 12.16%

EAR
The interest rate expressed as if it
were compounded once per year.
the rate you are paying
What if the term is 18% per annum to compute fot EAR, you need to convert the
APR 18% to months say .18/12 or .015 = 1.5%, to compute for EAR
EAR = (1+.015)/12 -1 APR
=1.1956-1
= .1956 or 19.56 the rate you are actually paying

Here some tricky notes to consider. Say Your P100 today is worth P115 written
in 14 days

what is APR/ Quoted price? Find 1st the rate using the formula
FV=PV (1+r)t
115=100 (1+r)t
115/100=(1+r)t
1.15 =(1+r)t
r=-1+1.15
r=.15 or 15%
 Question is 15% the quoted price? For one year? Answer is obiously NO
15% is for 14 days, therefore the APR = (1+.15 x 365/14)

APR= 3.9107 or 391.07%

EAR= (1.15)365/14 -1
EAR=using calculator "Y raise to x" or "x raise to y" function
EAR= 38.2366 or 3,823.66%

AMORTIZATION Loan is mostly paid depending on the arrangement by the borrower and the
lender. The truth and lending act always consider payment of interest on the
diminishing balance, ie after knowing the present value of the loan to be paid
annually that includes the principal and the interest, interest must be computed
using the rate based on the principal balance to separate the principal portion of
the present value annuity payment that should be use to pay and determine the
remaining balance

Example: A loan of P500,000 for 5 years at 9%. How much is the annual payment
using the PV annuity valuation (PV factor use calculator Y raise to X or X
raise to Y)

500,000= C x [1-(1+r)5/r
500,000= C x [1-(1+.09)5/.09
500,000= C x (1- .6499)/.09]
500,000= C X ( .3501/.09)
500,000= CX (3.8897)
X= 500,000/3.8897
X= 500,000/3.8897
X=128,544.62 Annual payment

Prepare the table

Annual payt interest=9% principal Balance
of Diminish 500,000.00
balance
1 128,544.62 45,000.00 83,544.62 416,455.38
2 128,544.62 37,480.98 91,063.64 325,391.74
3 128,544.62 29,285.26 99,259.36 226,132.38
4 128,544.62 20,351.91 108,192.71 117,939.68
5 128,544.62 10,614.57 117,939.68 (0.00)
642,723.10 142,732.73 500,000.00
PV FACTOR FV PV
0.8264 3,425,000.00 2,830,420.00

No. 2,830,420.00

-₱335,000.00
 -₱532,400.00

Err:523

30.1223821456 YRS
0.51873113373 YRS
0.4185
0.2544
0.291