Time Value of

Money
Energizer
BUZZ!

Everyone takes turns saying a number

starting with 1, 2, 3 and so on. Of course,
there is a catch. At every number with a 4 in it
or a multiple of 4, that person needs to say
BUZZ instead of the number. The next person
just continues the series as normal.
 Section 1
Basic Ideas of Time Value
of Money Concept

4
 The Core Question of
Finance
Congratulations!!!
You have won a cash prize!
There are two optional payment
schedules:
A - receive $100,000 now
B - receive $100,000 in five years.
Which option would you choose?

5
 Time Value of Money
Concept
In simple terms the
concept implies that
money today is always
better than money
tomorrow.

6
 Why Time Value of Money
Exists?
Risk and Uncertainty - future always involves some risk, especially in

respect to cash inflows of company as they are highly uncontrollable;

Inflation – in an inflationary economy a dollar today has always

 more purchasing power in compared to a dollar some point in
future;

Consumption Preference - individuals generally prefer current


consumption to a future one;

Investment Opportunities - an investor can profitably use money


received today by investing it immediately

7
Allows investors to adjust cash
flows for the passage of time;

It’s an integral part of Capital

Budgeting Processes;

 Applied in present and future

value calculations;

8
 Section 2
Present Value vs Future
Value

9
Valuation Concepts

10
 Future Value

The value at some future time of a present

amount of money, or a series of payments
evaluated at a given interest rate;

The interest earned on the initial principal

amount becomes a part of the principal at
the end of the compounding period;
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 Future Value Example
Problem
Suppose you invest $1000 for three years in a saving account that pays 10 %
interest per year. If you let your interest income be reinvested, your investment
will grow as follows:
First year : Principal at the beginning $1000
Interest for the year ($1,000 × 0.10) $100
Principal at the end $1,100
Second year : Principal at the beginning $1,100
Interest for the year ($1,100 × 0.10) $110
Principal at the end $1,210
Third year : Principal at the beginning $1,210
Interest for the year ($1210 × 0.10) $121
Principal at the end $1,331

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Formula
FV = P0(1+i)n

FV: Future Value

P0: Deposit today (t=0)
i: Interest Rate per Period
n: Number of Time Periods
In the previous example
FV=1000(1+0.1)3=1,331 13
 Double Your Money!
We will use
the“Rule-of-72”

Quick! How long

does it take to
double $5,000 at a
compound rate of
12% per year
(approx.)?
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 The “Rule-of-72”

Quick! How long does it take to

double $5,000 at a compound rate
of 12% per year (approx.)?

Approx. Years to Double = 72 / i%

72 / 12% = 6 Years
[Actual Time is 6.12 Years]
15
 Present Value
Which one would you prefer assuming that
the rate is 8%?
a) $1000 today or,
b) $2000 10 years later?
To answer this question we have to
express $2000 in today’s money.
PV=FV/(1+i)n
$926=2000/(1+0.08)10
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 Future Value of an Annuity

Ordinary Annuity: A series of consecutive

payments or receipts of equal amount at the
end of each period for a specified number of
periods.
Example: Suppose you invest $100 at the end
of each year for the next 3 years and earn 8%
per year on your investments. How much
would you be worth at the end of the 3rd
year?
 Types of Annuities

 An Annuity represents a series of equal

payments (or receipts) occurring over a
specified number of equidistant periods.
• Ordinary Annuity: Payments or receipts
occur at the end of each period(coupon);
• Annuity Due: Payments or receipts occur at
the beginning of each period(rent);

18
 T1 T2 T3
$100 $100 $100

Compounds for 0 years:

$100(1.08)0 = $100.00

Compounds for 1 year:

$100(1.08)1 = $108.00

Compounds for 2 years:

$100(1.08)2 = $116.64
______

Future Value of the Annuity $324.64

 FV3 = $100(1.08)2 + $100(1.08)1 +$100(1.08)0
= $100[(1.08)2 + (1.08)1 + (1.08)0]
= $100[Future value of an annuity of $1
factor for i = 8% and n = 3.]
(See Appendix C)
= $100(3.246)
= $324.60

FV of an annuity of $1 factor in general terms:

(1  i) n  1
(useful when using a non - financial calculator )
i
 Future Value of an Annuity
(Example)

If you invest $1,000 at the end of each year for the

next 12 years and earn 14% per year, how much
would you have at the end of 12 years?

FV12 = $1000(27.271) given i  14% and n  12

= $27,271
 Present Value of an Annuity

Suppose you can invest in a project that

will return $100 at the end of each year for
the next 3 years. How much should you be
willing to invest today, given you wish to
earn an 8% annual rate of return on your
investment?
 T0 T1 T2 T3
$100 $100 $100

Discounted back 1 year:

$100[1/(1.08)1] = $92.59
Discounted back 2 years:
$100[1/(1.08)2] = $85.73
Discounted back 3 years:
$100[1/(1.08)3] = $79.38
PV of the Annuity = $257.70
PV  $100[1 /(1.08)1 ]  $100[1 /(1.08) 2 ]  $100[1 /(1.08) 3 ]
= $100[1 /(1.08)1  1 /(1.08) 2  1 /(1.08) 3 ]
= $100[Prese nt value of an annuity of $1 factor for i  8% and n  3]
(See Appendix D.)
 $100(2.577)
 $257.70

PV of an annuity of $1 factor in general terms :

1
1
(1  i ) n
(useful with non - financial calculator s)
i
 Present Value of an Annuity
(An Example)

Suppose you won a state lottery in the amount of

$10,000,000 to be paid in 20 equal annual payments
commencing at the end of next year. What is the
present value (ignoring taxes) of this annuity if the
discount rate is 9%?

PV = $500,000(9.129) given i  9% and n  20

= $4,564,500
TVM Problems:

- What is the balance in an account at the

end of 10 years if P 2,500 is deposited
today and the account earns 4% interest,
compounded annually? quarterly?

- How long does it take for your money to

grow to ten times its original value if the
interest rate of 5% per year?
Thank You