Chapter 6

Accounting and time value of

money

Time value of money

$1 today > $1 in the future
Simple interest vs. compound interest
Variables
p=principal
i=interest rate
Per period

n=number of periods

 Find factor for

Future value of 1
Table 1
Present value of 1
Table 2
Future value of ordinary annuity of 1
Table 3
Future value of annuity due of 1
Table 3 * (1+i)
Present Value of ordinary annuity of 1
Table 4
Present value of annuity due of 1
Table 5

Compound interest
Compounding can substantially affect the rate of
return. A 9% annual interest compounded daily
provides a 9.42% yield.
How compounding affects Effective Yield for a $10,000 investment.

Single Sum
Future value
FV = PV * FVF (Future Value Factor)
Use table 6-1

Present value
PV = FV * PVF (Present Value Factor)
Use table 6-2

Future Value of a Single Sum

Steve Allen invested $10,000 today in a
fund that earns 8% compounded
annually. To what amount will the
investment grow in 3 years?
P=10,000, n=3, i=8%

Table 6-1
Number
of
Periods

2%

1
2
3
4
5

1.02000
1.04040
1.06121
1.08243
1.10408

Discount Rate
4%
6%
8%
1.04000
1.08160
1.12486
1.16986
1.21665

1.06000
1.12360
1.19102
1.26248
1.33823

1.08000
1.16640
1.25971
1.36049
1.46933

10%
1.10000
1.21000
1.33100
1.46410
1.61051

What factor do we use?

7

Table 6-1
Number
of
Periods

2%

1
2
3
4
5

1.02000
1.04040
1.06121
1.08243
1.10408

$10,000
Present Value

Discount Rate
4%
6%
8%

1.04000
1.08160
1.12486
1.16986
1.21665

1.06000
1.12360
1.19102
1.26248
1.33823

1.25971
Factor

1.08000
1.16640
1.25971
1.36049
1.46933

10%
1.10000
1.21000
1.33100
1.46410
1.61051

$12,597
Future Value
8

Future Value of a Single Sum

Steve Allen invested $10,000 today in a
fund that earns 8% compounded
semiannually. To what amount will the
investment grow in 3 years?
P=10,000, n=6, i=4%

Table 6-1
Number
of
Periods

2%

1
2
3
4
5
6

1.02000
1.04040
1.06121
1.08243
1.10408
1.12616

Discount Rate
4%
6%
8%
1.04000
1.08160
1.12486
1.16986
1.21665
1.26532

What factor do we use?

1.06000
1.12360
1.19102
1.26248
1.33823
1.41852

1.08000
1.16640
1.25971
1.36049
1.46933
1.58687

10%
1.10000
1.21000
1.33100
1.46410
1.61051
1.77156

6 compounding periods
4% interest per period
10

Table 6-1
Number
of
Periods

2%

1
2
3
4
5
6

1.02000
1.04040
1.06121
1.08243
1.10408
1.12616

$10,000
Present Value

Discount Rate
4%
6%
8%

1.04000
1.08160
1.12486
1.16986
1.21665
1.26532

1.06000
1.12360
1.19102
1.26248
1.33823
1.41852

1.26532
Factor

1.08000
1.16640
1.25971
1.36049
1.46933
1.58687

10%
1.10000
1.21000
1.33100
1.46410
1.61051
1.77156

$12,653
Future Value
11

Present Value of a Single Sum

Itzak Perlman needs $20,000 in 4 years.

What amount must he invest today if his
investment earns 12% compounded
annually?

P=20,000, n=4, i=12%

12

Table 6-2
Number
of
Periods

4%

.92456

.89000

.85734

.82645

.79719

.85480

.79209

.73503

.68301

.63552

.79031

.70496

.63017

.56447

.50663

.73069

.62741

.54027

.46651

.40388

Discount Rate
6%
8%
10%

12%

What factor do we use?

13

Table 6-2
Number
of
Periods

4%

.92456

.89000

.85734

.82645

.79719

.85480

.79209

.73503

.68301

.63552

.79031

.70496

.63017

.56447

.50663

.73069

.62741

.54027

.46651

.40388

$20,000
Future Value

Discount Rate
6%
8%
10%

.63552
Factor

12%

$12,710
Present Value
14

Present Value of a single sum

Itzak Perlman needs $20,000 in 4
years. What amount must he invest
today if his investment earns 12%
compounded quarterly?
P=20,000, n=16, i=3%

15

Table 6-2
Number
of
Periods

3%

0.88849

0.85480

0.79209

0.70843

0.63552

0.78941

0.73069

0.62741

0.50187

0.40388

12

0.70138

0.62460

0.49697

0.35554

0.25668

16

0.62317

0.53391

0.39365

0.25187

0.16312

Discount Rate
4%
6%
9%

12%

What factor do we use?

16

Table 6-2
Number
of
Periods

3%

0.88849

0.85480

0.79209

0.70843

0.63552

0.78941

0.73069

0.62741

0.50187

0.40388

12

0.70138

0.62460

0.49697

0.35554

0.25668

16

0.62317

0.53391

0.39365

0.25187

0.16312

$20,000
Future Value

Discount Rate
4%
6%
9%

.62317
Factor

12%

$12,463
Present Value
17

Please Keep in Mind

You can use either table 1 or table 2 to find
PV or FV, but make sure to use the right
factor
PV = PVF (present value factor) * FV
FV = FVF (future value factor) * PV
The left side determine factor on right

Itzak Perlman needs $20,000 in 4 years. What amount

must he invest today if his investment earns 12%
compounded annually?
18

P=20,000, n=4, i=12%

X = PV factor * 20,000

Use table 2

X = 0.63552*20,000=12,710.4

20,000 = FV factor * x

Use table 1

X = 20,000/1.57352=12,710.4
19

Annuities multiple sums

What
Periodic payments or receipts of the same
amount
The same-length interval in between
Compounding of interest once each interval
Find n, i and r.

Two types

Ordinary annuity

payment occur at the end of each period.

Annuity Due

payment occur at the beginning of each period.

20

Multiple sums -annuity

Ordinary annuity (end of period)
FV = R * FVF ord (ordinary annuity)
PV = R * PVF ord (ordinary annuity)

table 6-3
table 6-4

Annuity due (beg. of period)

FV = R * FVF (due) = R * FVF ord * (1+i)
table 6-3 *(1+i)

PV = R PVF (due)

table 6-5

21

You rent a copier for 12 years

Your rent is $2,000 per year

Rent is due at the end of each year
Your lease is for 12 years
Interest rate is 5%
How much is the total amount of rent you
would have paid at the end of 12 years?

22

An ordinary annuity
Future Value

$2,000

2,000

2,000

2,000

2,000

2,000

10

11

12

23

 Ordinary annuity
Future value
Table 6-3

N=12, i=5%, r=$2,000

Factor =15.91713
FV=2,000 @ Factor(ord)
FV=2,000@15.91713=31,834.26
24

Your rent is $2,000 per year

Rent is due at the end of each year
Your lease is for 12 years
Interest rate is 5%
How much is the total amount of rent you
would have paid today?

25

An ordinary annuity
Present Value

$2,000

2,000

2,000

2,000

2,000

2,000

10

11

12

26

 Ordinary annuity
Present value
Table 6-4

N=12, i=5%, r=$2,000

Factor =8.86325
PV=2,000 @ PVF (ord)
PV=2,000@8.86325=17,726.5
27

Future Value of an Annuity Due

Rents occur at the beginning of each period.
Interest will accumulate during 1st period.
Annuity Due has one more interest period than
Ordinary Annuity.
Factor = multiply future value of an ordinary
annuity factor by 1 plus the interest rate.
=Factor *(1+i)
$2,000

2,000

2,000

2,000

Future
Value
2,000

2,000

2,000

2,000

10

11

12
28

Your rent is $2,000 per year

Rent is due at the beginning of each year
Your lease is for 12 years
Interest rate is 5%
How much is the total amount of rent at
the end of 12 years?

29

Future value of an annuity due

Future Value
2,000

$2,000

2,000

2,000

2,000

2,000

10

11

12

30

 Annuity due
Future value
Table 6-3

N=12, i=5%, r=$2,000

Factor =15.91713
FV=2,000 @ FVF (ord)(1+5%)
FV=2,000@15.91713*1.05=33,425.97
31

Your rent is $2,000 per year

Rent is due at the beginning of each year
Your lease is for 12 years
Interest rate is 5%
How much is the total amount of rent
worth today?

32

Future value of an annuity due

Present Value
2,000

$2,000

2,000

2,000

2,000

2,000

10

11

12

33

 Annuity due
Present value
Table 6-5

N=12, i=5%, r=$2,000

PVF due =9.30641
PV=2,000 @ PVF due
PV=2,000@9.30641=18,61.82
34

Present Value
$100,000

100,000

100,000

100,000

100,000

100,000

.....
0

19

20

Jaime Yuen wins $2,000,000 in the state lottery. She

will be paid $100,000 at the end of each year for the
next 20 years. How much has she actually won?
Assume an appropriate interest rate of 8%.

What table do we use?

35

Table 6-4
Number
of
Periods

4%

6%

1
5
10
15
20

0.96154
4.45183
8.11090
11.11839
13.59033

0.94340
4.21236
7.36009
9.71225
11.46992

Discount Rate
8%
0.92593
3.99271
6.71008
8.55948
9.81815

10%
0.90900
3.79079
6.14457
7.60608
8.51356

12%
0.89286
3.60478
5.65022
6.81086
7.46944

What factor do we use?

36

Table 6-4
Number
of
Periods

4%

6%

1
5
10
15
20

0.96154
4.45183
8.11090
11.11839
13.59033

0.94340
4.21236
7.36009
9.71225
11.46992

$100,000
Receipt

Discount Rate
8%
0.92593
3.99271
6.71008
8.55948
9.81815

9.81815
Factor

10%
0.90900
3.79079
6.14457
7.60608
8.51356

12%
0.89286
3.60478
5.65022
6.81086
7.46944

$981,815
Present Value
37

Present Value
$100,000 100,000

100,000

100,000

100,000

100,000

.....
0

19

20

Jaime Yuen wins $2,000,000 in the state lottery. She

will be paid $100,000 at the beginning of each year for
the next 20 years. How much has she actually won?
Assume an appropriate interest rate of 8%.

What table do we use?

38

Table 6-5
Number
of
Periods

4%

6%

1
5
10
15
20

1.00000
4.62990
8.43533
11.56312
14.13394

1.00000
4.46511
7.80169
10.29498
12.15812

Discount Rate
8%
1.00000
4.31213
7.24689
9.24424
10.60360

10%
1.00000
4.16986
6.75902
8.36669
9.36492

12%
1.00000
4.03735
6.32825
7.62817
8.36578

What factor do we use?

39

Table 6-5
Number
of
Periods

4%

6%

1
5
10
15
20

1.00000
4.62990
8.43533
11.56312
14.13394

1.00000
4.46511
7.80169
10.29498
12.15812

$100,000
Receipt

Discount Rate
8%
1.00000
4.31213
7.24689
9.24424
10.60360

10.60360
Factor

10%
1.00000
4.16986
6.75902
8.36669
9.36492

12%
1.00000
4.03735
6.32825
7.62817
8.36578

$1,060,360
Present Value
40

 E6-12
E6-14

41