TIME VALUE OF MONEY

CHAPTER 3
INFLATION
CONSUMPTION PREFERENCE
A REAL RETURN
ASSUMPTIONS
Free Cash
Frictionless money market: Lending & Borrowing Rate Equal
Risk-free
No borrowing or lending limit
Cash flows at fixed time intervals

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 2
FORMS OF CASH FLOW
Single Amount (Lump Sum)
Annuity (Series of equal amount)
Equal amount to Perpetuity
Unequal Cash Flows
Constantly growing amount to Perpetuity

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 3
VALUE ADDITIVITY
Calculations can be done in parts without affecting the total value

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 4
THE INPUT VARIABLES
Seek out
 Present Value (PV) (Amount at the beginning of a time line)
 Future Vale (FV) (Amount at the end of a time line)
 Payment (PMT) (Amount of Annuity)
 Interest/Discount/Reinvestment Rate (I)
 Length of time period (N)
In this chapter, you will need 4 input values. If you know 3, you can find the 4 th
variable.

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 5
 FUTURE VALUE OF SINGLE AMOUNT

FVn = PV (1 + i)n
Time Line
The Input Variables on the Time Line
Fv1 = Pv * (1+i)n = 1* (1+.10)1 = Tk 1.10 
Fv2 = Pv * (1+i)n = 1* (1+.10)2= Tk 1.21
Fv3 = Pv * (1+i)n = 1* (1+.10)3 = Tk 1.331
Fv4 = Pv * (1+i)n = 1* (1+.10)4 = Tk 1.4641

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 6
FVIF VALUES
FVIF Table: Gives You The Future Value of Taka 1 for Given I and N.
FVIF on Finance Calculator

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 7
 FVIF VALUES ON A GRAPH

Figure 1: FVIF: Future Value Interest Factor of Taka 1

7
6
5 Compounding Rate 5%
4
FVIF

3 Compounding Rate
2 10%
1 Compounding Rate
0 15%
Compounding Rate
20%
Time
FVIF Increases with Time and Rate

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 8
THE NATURE OF FVIF VALUES
What happens as time gets longer?
What happens as interest rate (compounding Rate) rises?
How long does it take to double an initial amount?
Rule of 70 ( or 69 or 71 or 72)
How much will you pay for a cup of tea when you will be 70 years old?

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 9
FUTURE VALUE OF AN ANNUITY
FVAi,n= Pmt(1+i)n-1+ Pmt(1+i)n-2+
Pmt(1+i)n-3………+Pmt(1+i)0
n-1

  FVIFAi,n = ∑ (1+i)t
T =0
Using the FVIFA table
Future Value of a Series

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 10
NATURE OF THE FVIFA VALUES
What happens as i increases?
What happens as time gets longer?
 What pattern do you see relative to n?
 Can you build the FVIFA Table using the FVIF Table
Why there will be no FVA if payment goes on forever.

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 11
HOW LONG DOES IT TAKE TO ACCUMULATE TAKA 1 CRORE

You and your spouse will save Tk 1,000 each per month and deposit the amount at
the end of the year in an account that credits you with 12% interest.
 How much will you have if you do this for 35 years?
 How much will you have if you do this for 30 years?

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 12
FUTURE VALUE WITH UNEQUAL CASH FLOW
Find The Future Value of Each Flow
Sum the Future Values

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 13
FREQUENCY OF COMPOUNDING
Semi-annual
Quarterly
Monthly
Daily
Continuously

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 14
PRESENT VALUE OF A SINGLE AMOUNT
Rearrange The FVi,n Equation
PV = FVi,n / (1+i)n = FVi,n * (1/(1+i)n)

PVIF = (1/(1+i)n) = 1/FVIFi,n

Using the PVIF Table

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 15
NATURE OF THE PVIF TABLE
What happens as time lengthens
What happens as i increases
(Page 39)

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 16
 PVIF ON A GRAPH

Figure 2: PVIF: Present Value of Taka 1

1.2
1 Discount Rate
0.8 5%
PVIF

0.6
0.4 Discount Rate
0.2 10%
0
Discount Rate
15%
Discount Rate
20%
Time

PVIF Gets Smaller for Distant Amounts and

SHAHigher
R I F N U Rates
RUL AHKAM, EMB 660, SUMMER 2017,
N O RT H S O U T H U N I V E R S I T Y 17
PRESENT VALUE OF AN ANNUITY
Present Value of An Annuity of Taka 1
PVAi,n = 1(1/(1+i)1) + 1(1/(1+i)2)+ ………… + 1(1/(1+i)n)
n n
= PVAi,n = 1* ∑ (1/(1+i)t) = ∑ (1/(1+i)t)

t=1 t =1

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 18
USING THE PVIFA TABLE
What happens as time gets longer?
What happens as interest rate (compounding Rate) rises?
What is the relationship between n and PVIFA?

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 19
AMORTIZATION
Paying off a loan in Equal Annual Installments
 Interest and Balance Due declines as time elapses
 Payment of Principal Portion increases with Time.

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 21
PRESENT VALUE OF UNEQUAL CASH FLOWS
Find Individual Present Values
Sum the Present Values
What about simply using the CF function of your calculator?
Finding FV of Unequal Flows by converting The PV of Unequal Flows to A FV.

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 22
PRESENT VALUE OF A PERPETUITY
∞
PV = ∑ Pft / (1+i)t

t=1
PV = Pf / i

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 23
CHOOSE BETWEEN AN PERPETUITY AND PRESENT AMOUNT

Do you remember the assumptions?

At 12% discount/interest rate, choose between
 Taka 100,000 now
 Taka 12,000 per year for ever

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 24
MORE FREQUENT DISCOUNTING
Semi-Annual
Quarterly
Monthly
Daily
Continuously

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 25
SOLVING FOR RATE
What Rate makes the Present Value (Single flow) equal to the Future Value (single
flow)?
What Rate makes the Present Value(or Future Value ) of Annuity (Single flow) equal
to the payment stream?
Solve for Payment
Amortization table.

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 26
EFFECTIVE ANNUAL RATES
Periodic Compounding
 EAR = (1+i/m)m -1
 m =1 for annual compounding
 m =2 for semi-annual compounding
 m =4 for quarterly compounding
 m =12 for monthly compounding
 m =360 (365) for daily compounding
Continuous Compounding
 EAR = ei-1

SHARIF NURUL AHKAM, EMB 660, SUMMER 2017,

N O RT H S O U T H U N I V E R S I T Y 27