The Time Value

of Money
 The Time Value of Money

Compounding and
Discounting Single Sums
We know that receiving Rs.1 today is
worth more than Rs.1 in the future.
This is due to opportunity costs.
The opportunity cost of receiving Rs.1 in
the future is the interest we could have
earned if we had received the Rs.1
sooner.
Today Future
If we can measure this opportunity cost,
we can:
 If we can measure this opportunity cost,
we can:
• Translate Rs.1 today into its equivalent in the
future (compounding).
 If we can measure this opportunity cost,
we can:
• Translate Rs.1 today into its equivalent in the
future (compounding).
Today Future

?
 If we can measure this opportunity cost,
we can:
• Translate Rs.1 today into its equivalent in the
future (compounding).
Today Future

?
• Translate Rs.1 in the future into its equivalent
today (discounting).
 If we can measure this opportunity cost,
we can:
• Translate Rs.1 today into its equivalent in the
future (compounding).
Today Future

?
• Translate Rs.1 in the future into its equivalent
today (discounting).
Today Future

?
Future Value
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 1 year?
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 1 year?

PV = FV =

0 1
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 1 year?

PV = -100 FV =

0 1

Calculator Solution:
P/Y = 1 I=6
N=1 PV = -100
FV = Rs.106
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 1 year?

PV = -100 FV = 106

0 1

Calculator Solution:
P/Y = 1 I=6
N=1 PV = -100
FV = Rs.106
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 1 year?

PV = -100 FV = 106

0 1
Mathematical Solution:
FV = PV (FVIF i, n )
FV = 100 (FVIF .06, 1 ) (use FVIF table, or)
FV = PV (1 + i)n
FV = 100 (1.06)1 = Rs.106
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 5 years?
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 5 years?

PV = FV =

0 5
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 5 years?

PV = -100 FV =

0 5

Calculator Solution:
P/Y = 1 I=6
N=5 PV = -100
FV = Rs.133.82
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 5 years?

PV = -100 FV = 133.82

0 5

Calculator Solution:
P/Y = 1 I=6
N=5 PV = -100
FV = Rs.133.82
 Future Value - single sums
If you deposit Rs.100 in an account earning 6%, how
much would you have in the account after 5 years?

PV = -100 FV = 133.82

0 5
Mathematical Solution:
FV = PV (FVIF i, n )
FV = 100 (FVIF .06, 5 ) (use FVIF table, or)
FV = PV (1 + i)n
FV = 100 (1.06)5 = Rs.133.82
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
quarterly compounding, how much would you have
in the account after 5 years?
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
quarterly compounding, how much would you have
in the account after 5 years?
PV = FV =

0 ?
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
quarterly compounding, how much would you have
in the account after 5 years?
PV = -100 FV =

0 20

Calculator Solution:
P/Y = 4 I=6
N = 20 PV = -100
FV = Rs.134.68
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
quarterly compounding, how much would you have
in the account after 5 years?
PV = -100 FV = 134.68

0 20

Calculator Solution:
P/Y = 4 I=6
N = 20 PV = -100
FV = Rs.134.68
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
quarterly compounding, how much would you have
in the account after 5 years?
PV = -100 FV = 134.68

0 20
Mathematical Solution:
FV = PV (FVIF i, n )
FV = 100 (FVIF .015, 20 ) (can’t use FVIF table)
FV = PV (1 + i/m) m x n
FV = 100 (1.015)20 = Rs.134.68
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
monthly compounding, how much would you have
in the account after 5 years?
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
monthly compounding, how much would you have
in the account after 5 years?
PV = FV =

0 ?
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
monthly compounding, how much would you have
in the account after 5 years?
PV = -100 FV =

0 60

Calculator Solution:
P/Y = 12 I=6
N = 60 PV = -100
FV = Rs.134.89
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
monthly compounding, how much would you have
in the account after 5 years?
PV = -100 FV = 134.89

0 60

Calculator Solution:
P/Y = 12 I=6
N = 60 PV = -100
FV = Rs.134.89
 Future Value - single sums
If you deposit Rs.100 in an account earning 6% with
monthly compounding, how much would you have
in the account after 5 years?
PV = -100 FV = 134.89

0 60
Mathematical Solution:
FV = PV (FVIF i, n )
FV = 100 (FVIF .005, 60 ) (can’t use FVIF table)
FV = PV (1 + i/m) m x n
FV = 100 (1.005)60 = Rs.134.89
Present Value
 Present Value - single sums
If you receive Rs.100 one year from now, what is the
PV of that Rs.100 if your opportunity cost is 6%?
 Present Value - single sums
If you receive Rs.100 one year from now, what is the
PV of that Rs.100 if your opportunity cost is 6%?

PV = FV =

0 ?
 Present Value - single sums
If you receive Rs.100 one year from now, what is the
PV of that Rs.100 if your opportunity cost is 6%?

PV = FV = 100

0 1

Calculator Solution:
P/Y = 1 I=6
N=1 FV = 100
PV = -94.34
 Present Value - single sums
If you receive Rs.100 one year from now, what is the
PV of that Rs.100 if your opportunity cost is 6%?

PV = -94.34 FV = 100

0 1

Calculator Solution:
P/Y = 1 I=6
N=1 FV = 100
PV = -94.34
 Present Value - single sums
If you receive Rs.100 one year from now, what is the
PV of that Rs.100 if your opportunity cost is 6%?

PV = -94.34 FV = 100

0 1
Mathematical Solution:
PV = FV (PVIF i, n )
PV = 100 (PVIF .06, 1 ) (use PVIF table, or)
PV = FV / (1 + i)n
PV = 100 / (1.06)1 = Rs.94.34
 Present Value - single sums
If you receive Rs.100 five years from now, what is
the PV of that Rs.100 if your opportunity cost is 6%?
 Present Value - single sums
If you receive Rs.100 five years from now, what is
the PV of that Rs.100 if your opportunity cost is 6%?

PV = FV =

0 ?
 Present Value - single sums
If you receive Rs.100 five years from now, what is
the PV of that Rs.100 if your opportunity cost is 6%?

PV = FV = 100

0 5

Calculator Solution:
P/Y = 1 I=6
N=5 FV = 100
PV = -74.73
 Present Value - single sums
If you receive Rs.100 five years from now, what is
the PV of that Rs.100 if your opportunity cost is 6%?

PV = -74.73 FV = 100

0 5

Calculator Solution:
P/Y = 1 I=6
N=5 FV = 100
PV = -74.73
 Present Value - single sums
If you receive Rs.100 five years from now, what is
the PV of that Rs.100 if your opportunity cost is 6%?

PV = -74.73 FV = 100

0 5
Mathematical Solution:
PV = FV (PVIF i, n )
PV = 100 (PVIF .06, 5 ) (use PVIF table, or)
PV = FV / (1 + i)n
PV = 100 / (1.06)5 = Rs.74.73
 Present Value - single sums
What is the PV of Rs.1,000 to be received 15 years
from now if your opportunity cost is 7%?
 Present Value - single sums
What is the PV of Rs.1,000 to be received 15 years
from now if your opportunity cost is 7%?

PV = FV =

0 15
 Present Value - single sums
What is the PV of Rs.1,000 to be received 15 years
from now if your opportunity cost is 7%?

PV = FV = 1000

0 15

Calculator Solution:
P/Y = 1 I=7
N = 15 FV = 1,000
PV = -362.45
 Present Value - single sums
What is the PV of Rs.1,000 to be received 15 years
from now if your opportunity cost is 7%?

PV = -362.45 FV = 1000

0 15

Calculator Solution:
P/Y = 1 I=7
N = 15 FV = 1,000
PV = -362.45
 Present Value - single sums
What is the PV of Rs.1,000 to be received 15 years
from now if your opportunity cost is 7%?

PV = -362.45 FV = 1000

0 15
Mathematical Solution:
PV = FV (PVIF i, n )
PV = 100 (PVIF .07, 15 ) (use PVIF table, or)
PV = FV / (1 + i)n
PV = 100 / (1.07)15 = Rs.362.45
 Present Value - single sums
If you sold land for Rs.11,933 that you bought 5
years ago for Rs.5,000, what is your annual rate of
return?
 Present Value - single sums
If you sold land for Rs.11,933 that you bought 5
years ago for Rs.5,000, what is your annual rate of
return?

PV = FV =

0 5
 Present Value - single sums
If you sold land for Rs.11,933 that you bought 5
years ago for Rs.5,000, what is your annual rate of
return?

PV = -5000 FV = 11,933

0 5

Calculator Solution:
P/Y = 1 N=5
PV = -5,000 FV = 11,933
I = 19%
 Present Value - single sums
If you sold land for Rs.11,933 that you bought 5
years ago for Rs.5,000, what is your annual rate of
return?
Mathematical Solution:
PV = FV (PVIF i, n )
5,000 = 11,933 (PVIF ?, 5 )
PV = FV / (1 + i)n
5,000 = 11,933 / (1+ i)5
.419 = ((1/ (1+i)5)
2.3866 = (1+i)5
(2.3866)1/5 = (1+i) i = .19
 Present Value - single sums
Suppose you placed Rs.100 in an account that pays
9.6% interest, compounded monthly. How long will
it take for your account to grow to Rs.500?

PV = FV =

0
 Present Value - single sums
Suppose you placed Rs.100 in an account that pays
9.6% interest, compounded monthly. How long will
it take for your account to grow to Rs.500?

PV = -100 FV = 500

0 ?
Calculator Solution:
• P/Y = 12 FV = 500
• I = 9.6 PV = -100
• N = 202 months
 Present Value - single sums
Suppose you placed Rs.100 in an account that pays
9.6% interest, compounded monthly. How long will
it take for your account to grow to Rs.500?
Mathematical Solution:
PV = FV / (1 + i)n
100 = 500 / (1+ .008)N
5 = (1.008)N
ln 5 = ln (1.008)N
ln 5 = N ln (1.008)
1.60944 = .007968 N N = 202 months
 Hint for single sum problems:
• In every single sum future value and
present value problem, there are 4
variables:
• FV, PV, i, and n
• When doing problems, you will be
given 3 of these variables and asked to
solve for the 4th variable.
• Keeping this in mind makes “time
value” problems much easier!
 The Time Value of Money

Compounding and Discounting

Cash Flow Streams

0 1 2 3 4
 Annuities
• Annuity: a sequence of equal cash
flows, occurring at the end of each
period.
 Annuities
• Annuity: a sequence of equal cash
flows, occurring at the end of each
period.

0 1 2 3 4
 Examples of Annuities:
• If you buy a bond, you will
receive equal semi-annual coupon
interest payments over the life of
the bond.
• If you borrow money to buy a
house or a car, you will pay a
stream of equal payments.
 Examples of Annuities:
• If you buy a bond, you will
receive equal semi-annual coupon
interest payments over the life of
the bond.
• If you borrow money to buy a
house or a car, you will pay a
stream of equal payments.
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?

0 1 2 3
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?

1000 1000 1000

0 1 2 3

Calculator Solution:
P/Y = 1 I=8 N=3
PMT = -1,000
FV = Rs.3,246.40
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?

1000 1000 1000

0 1 2 3

Calculator Solution:
P/Y = 1 I=8 N=3
PMT = -1,000
FV = Rs.3,246.40
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?
Mathematical Solution:
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?
Mathematical Solution:
FV = PMT (FVIFA i, n )
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?
Mathematical Solution:
FV = PMT (FVIFA i, n )
FV = 1,000 (FVIFA .08, 3 ) (use FVIFA table, or)
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?
Mathematical Solution:
FV = PMT (FVIFA i, n )
FV = 1,000 (FVIFA .08, 3 ) (use FVIFA table, or)

FV = PMT (1 + i)n - 1
i
 Future Value - annuity
If you invest Rs.1,000 each year at 8%, how much
would you have after 3 years?
Mathematical Solution:
FV = PMT (FVIFA i, n )
FV = 1,000 (FVIFA .08, 3 ) (use FVIFA table, or)

FV = PMT (1 + i)n - 1
i
FV = 1,000 (1.08)3 - 1 = Rs.3246.40
.08
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?

0 1 2 3
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?

1000 1000 1000

0 1 2 3

Calculator Solution:
P/Y = 1 I=8 N=3
PMT = -1,000
PV = Rs.2,577.10
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?

1000 1000 1000

0 1 2 3

Calculator Solution:
P/Y = 1 I=8 N=3
PMT = -1,000
PV = Rs.2,577.10
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?
Mathematical Solution:
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?
Mathematical Solution:
PV = PMT (PVIFA i, n )
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?
Mathematical Solution:
PV = PMT (PVIFA i, n )
PV = 1,000 (PVIFA .08, 3 ) (use PVIFA table, or)
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?
Mathematical Solution:
PV = PMT (PVIFA i, n )
PV = 1,000 (PVIFA .08, 3 ) (use PVIFA table, or)

1
PV = PMT 1 - (1 + i)n
i
 Present Value - annuity
What is the PV of Rs.1,000 at the end of each of the
next 3 years, if the opportunity cost is 8%?
Mathematical Solution:
PV = PMT (PVIFA i, n )
PV = 1,000 (PVIFA .08, 3 ) (use PVIFA table, or)

1
PV = PMT 1- (1 + i)n
i

1
PV = 1000 1 - (1.08 )3 = Rs.2,577.10
.08