The Time Value of Money

9
Chapter

Anwar Zahid
Independent University, Bangladesh

© 2003 McGraw-Hill Ryerson Limited

The Interest Rate

Which would you prefer -- $10,000

today or $10,000 in 5 years?
years

Obviously, $10,000 today.

today

There is TIME VALUE TO MONEY!!

MONEY

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Why TIME?

Why is TIME such an important

element in your decision?

TIME allows you the opportunity to

postpone consumption and earn
INTEREST.
INTEREST

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Time Value of Money
 The
basic idea behind the concept of time value of
money is:
 $1 received today is worth more than $1 in the future
OR
 $1 received in the future is worth less than $1 today

Why?
 because interest can be earned on the money

 Theconnecting link between present (today) and

future is the interest or discount rate
© 2003 McGraw-Hill Ryerson Limited
Future Value and Present Value

 FutureValue (FV) is what money today will be

worth at some point in the future

 PresentValue (PV) is what money at some point in

the future is worth today

© 2003 McGraw-Hill Ryerson Limited

Types of Interest

 Simple Interest
Interest paid (earned) on only the original amount,
or principal.
 Compound Interest
Interest paid (earned) on any previous interest
earned, as well as on the principal.

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Future value

Formula
FVsi: Future Value based on Simple Interest
i: Interest Rate per Period
n: Number of Time Periods

© 2003 McGraw-Hill Ryerson Limited

Simple Interest Example

 Assume that you deposit $1,000 in an

account earning 7% simple interest for 2
years. What is the future value of the deposit
at the end of the 2nd year?

= $ 1145 Ans

Future Value is the value at some future time of a present

amount of money
© 2003 McGraw-Hill Ryerson Limited
Present Value Single Amount
 The present value is the exact opposite of the future value.
 For example, let us reverse the previous problem – what
would be the Present Value (PV) of $1,464 received four years
into the future, with a 10% interest rate (also known as
discount rate)?

© 2003 McGraw-Hill Ryerson Limited

Chapter 09
Practice

© 2003 McGraw-Hill Ryerson Limited

Random: You will receive $6,800 six years from now. The
discount rate is 10 percent. What is the present value of
your future return?
Time line

PV? 0 1 2 3 ………… 6, FV
6,800

GIVEN,

FV= 6,800
i = 10%
n=6
PV = ?

© 2003 McGraw-Hill Ryerson Limited

 Pg, 275,pdf;7: Your uncle offers you a choice of $105,000
in 10 years or $47,000 today. If money is discounted at 9
percent, which should
Time line you choose?

PV? 0 1 2 3 4 5 ……………….. 10, FV

1,05,000

GIVEN,
44,353 is lower than
FV= 1,05,000 today’s 47,000.
i = 9%
n = 10 So, you should select
PV = ? 47,000 today.

© 2003 McGraw-Hill Ryerson Limited

Pg, 275,pdf-5: If you invest $9,000 today, how much will
you have a. In 7 years at 12 percent?
Time line

PV 0 1 2 3 4 5 6 7 FV ?
9,000

GIVEN,

PV= 9,000
i = 12%
n=7
FV = ?

© 2003 McGraw-Hill Ryerson Limited

** Pg, 276,pdf-12: You invest a single amount of $10,000 for 5
years at 10 percent. At the end of 5 years you take the proceeds
and invest them for 12 years at 15 percent. How much will you
have after 17 years? Time line

PV 0 1 2 3 4 5 6 7 8 9 10 11 ……….… 17
FV ?
10,000 16,105
FV ?

GIVEN,

PV=10,000
i = 10%
n=5 FV= 16,105
FV = ?
FV= 16,105 (1.15)^12

FV= 86,166 Ans

© 2003 McGraw-Hill Ryerson Limited

 Pg, 276,pdf;16: Carrie Tune will receive $190,500 after 20 years
as a payment for a new song she has written. If a 10 percent rate is
applied, should she be willing to sell out her future rights now for
$160,000? Time line

PV? 0 1 2 3 4 5 ……………….. 20, FV

190,500

GIVEN,
She should sell out her
FV= 190,500 future rights now for
i = 10% 1,60,000 instead of
n = 20 190,500 after20 years.
PV = ?

H.W ; 14
© 2003 McGraw-Hill Ryerson Limited
 Pg, 275, pdf; 10: How much would you have to invest today to
receive A. $15,000 in 8 years at 10 percent?
Time line

PV? 0 1 2 3 4 5 ……………….. 8, FV
15,000

GIVEN, A)

FV=15,000
i = 10%
n=8
PV = ?

© 2003 McGraw-Hill Ryerson Limited

 Pg, 275, pdf ; 10: How much would you have to invest today to
receive
C. $ 6,000 each year for 10 years at 9 percent?
Time line
H.W ;
10; B & D
PV? 0 1 2 3 4 5 ……………….. 10, FV
PV? 0 6000 6000 6000 6000 6000 ……………….. 6000 FV

GIVEN, Annuity (A) = A series of

B) equal payment.
A = 6,000
Key words
i=9%
Annuity (A) = Each
n = 10 year / Per year /
PVA = ? yearly installment /
per annum / etc.

© 2003 McGraw-Hill Ryerson Limited

 Pg, 276, pdf; 15: Sherwin Williams will receive $18,500 a year for the
next 25 years as a result of a picture he has painted. If a discount rate
of12 percent is applied, should he be willing to sell out his future rights
now for $165,000? Time line

PV? 0 1 2 3 4 .…..…………….. 19, FV

PV? 0 18500 18500 18500 18500 18,500 FV

HW 17

GIVEN,

A = 18,500 PVA = 18500 * 7.84

i = 12 %
n = 25
PVA = $ 145,040 ans
PVA = ?

© 2003 McGraw-Hill Ryerson Limited

 Pg:, 276/ 19: Al Rosen invests $25,000 in a mint condition 1952
Mickey Mantle Topps baseball card. He expects the card to increase in
value 12% per year for the next 10 years. How much will his card be
worth after 10 years?
Time line

PV? 0 1 2 3 4 5 …………….... 10
25,000, PV……………………………………………....... FV ?

GIVEN,

PV = 25,000
i = 12%
n = 10
FV = ?

Note: This is not a annuity math even per year is

given.
© 2003 McGraw-Hill Ryerson Limited
Pg 276/ Pdf 23.Jcak Hammer invests in a stock that will pay dividends of $2.00
at the end of the first year, $2.20 at the end of the second year, and $2.40 at the
end of the third year. Also, he believes that at the end of the third year he will
be able to sell the stock for $33. What is the present value of all three benefits
if a discount rate of 11% is applied? Time line

PV 0 1 2 3
2.0 2.20 2.40 + [ 33]

Assume, current share price of

this share is $19, will you buy ?
Pg 277/ 26:Determine the amount of money in a savings account at the end of
10 years, given an initial deposit of $5,500 and a 12 percent annual interest rate
when interest is compounded (a) annually, (b) semiannually, and (c) quarterly.

A) Annually
PV= 5,500
i = 12%
n = 10
FV = ?

B) Semiannually

i = 12% / 2 = 6%
n = 10* 2= 20 times
 C) Quarterly

i = 12% / 4 = 3%
n = 10* 4= 40 t

Fv= 17,941

Check List
Daily= 365 times
Weekly=52 t
Monthly= 12 t
Quarterly = 4 t
Semiannual = 2 t
Pg,277/ 29 Your grandfather has offered you a choice of one of the three following
alternatives: $7,500 now; $2,200 a year for nine years; or $31,000 at the end of the
nine years. Which alternative should you choose? Assuming you could earn 10%
annually. If you could earn11% annually would you still choose the same alternative
Time line

PV? 0 1 2 3 4 5 ……………................. 9
7,500, 2,200 2,200 2,200 ……………………............31,000

Alternative 1: $7,500 now, PV

Alternative 2: $2,200 a year for nine
years.
Alternative 3: $31,000 end of nine years.

A -3 Must be taken
RANDOM MATH: Presume, you invest in a project at tk. 9,500 end of
every year for next 14 years. Assume discount rate is 26%. So, what
is the future value of your project?

A= 9,500
i = 26%
n = 14
FVA= ?
Pg,277/ 30 You need $28,974 at the end of 10 years, and your only investment
outlet is an 8 percent long-term certificate of deposit (compounded annually). With
the certificate of deposit, you make an initial investment at the beginning of the first
year. A) What single payment could be made at the beginning of the first year to
achieve this objective?
B) What amount could you pay at the end of each year annually for 10 years to
achieve this same objective?Time line

0 1 24 3
5 ……………................. 10
PV? ……………………..…………………….............. 28,974

FV =
28,974 13,421 = A * 6.71
i = 8%
n = 10 A = 13,421 / 6.71
PV = ?
A = $ 2,000 ans
Pg,277/ 38 Del Monty will receive the following payments at the end of the next
three years: $2,000, $3,500, and $4,500. Then from the end of the 4th year through
the end of the 10th year, he will receive an annuity of $5,000 per year. At a discount
rate of 9 percent, what is the present value of all three future benefits?
Assume he (Monty) is offered $30,000Timetoline
cancel the contract, should she do it?

n=7
n=0 1 2 3 4 5 6 …………... 10
PV? ……2,000 3,500 4,500………. 5,000......5,000……5,000……......10
25,150

19,420

PV= 27,674 Ans

Decision?
HW. 39
Pg,278/ 36 Morgan Jennings, a geography professor, invests $50,000
in a parcel of land that is expected to increase in value by 12 percent
per year for the next five years. He will take the proceeds and provide
himself with a 10-year annuity.Time
Assuming
line a 12 percent interest rate,
how much will this annuity be?

PV 0 1 2 3 4 5 6 7 8 9 10 .……….…….. 15 FV ?
50,000 88,117
FV ?

GIVEN,

PV= 50,000
i = 12 %
n=5
FV = ? FV= $ 88,117
The End of Chapter 9

© 2003 McGraw-Hill Ryerson Limited