Future Value and

Present Value of
Money
One day, the Master was going on a trip and decided to entrust his wealth
to three of his most trusted servants. The wealth shall be given to
each servant based on the Master’s assessment of their talents. To his
first servant, he entrusted PHP500,000. To his second servant, believing
that he can make wise choices as well, he also gave an amount of
PHP500,000. Finally, he called on his third servant and gave him
PHP500,000. The Master then went on his journey and told the servants
he will not be back for a long time. Since the first servant was a very
smart person, he decided to invest the PHP500,000 given to him. He
was very pleased that he was quoted a long- term investment for 5
years at 8% per annum compounded annually, and decided to invest the
money in that institution. The second servant saw what the first servant
did and also decided to invest the money. However, when given the choice
by the investment firm, he did not understand simple and compound
interest. In the end, he accepted the quote at 8% per annum simple
interest. The third servant saw them and thought that they were being
too much of a risk-taker and decided just to keep the money locked in
a vault in his home. The Master returned after 5 years. He then called on
the servants and asked them what has become of the wealth he had
entrusted them. The first servant presented his PHP500,000 plus the
interest he earned worth PHP500,000 x (1.08)5 – 500,000 = 234,664.04 .
In your own opinion,
which servant will
make the Master
most pleased? Why?
 PRESENT VALUE
“A bird in the hand is worth two in the bush”
By: Miguel Cervantes
This story shows how money grows overtime. Its worth in the future is dependent on the
amount invested today.

Which is more valuable to you, to receive PHP1, 000 today or receive PHP1, 000
next year?

PRESENT VALUE FUTURE VALUE

10
₱ 1,000 % ₱ 1,100

Example: You get 10% interest on your money

So PHP1, 000 now can earn (1,000×10%) =PHP100 in
a year. Your PHP1, 000 now can become PHP1, 100 a
year from now.

PRESENT FUTURE

We say the Present Value of PHP1, 100 next year is PHP1,000

 There are two methods used for ascertaining the
worth of money at different points of time, namely,
compounding and discounting.
 Compounding method is used to know the future
value of present money.

 Discounting method is a way to compute the

present value of future money.

Take a look this comparison chart between

compounding and discounting chart

C o m p a ris o n C h a rt

BASIS FOR
COMPOUNDING DISCOUNTING
COMPARISON

M e a n in g T h e m e th o d u s e d to d e te rm in e
th e fu tu re v a lu e o f p re s e n t
in v e s tm e n t is k n o w n a s
C o m p o u n d in g .
C oncept If w e in v e s t s o m e m o n e y
to d a y , w h a t w ill b e th e a m o u n t
w e g e t a t a fu tu re d a te .
U s e of C o m p o u n d in te re s t ra te .
T h e m e th o d u s e d to
d e te rm in e th e p re s e n t
v a lu e o f fu tu re c a s h
flo w s is k n o w n a s
D is c o u n tin g .
W h a t s h o u ld b e th e
a m o u n t w e n e e d to
in v e s t to d a y , to g e t
a s p e cific a m o u n t
in fu tu re .
D is c o u n t ra te

K now n P re s e n t V a lu e F u tu re V a lu e

F a c to r F u tu r e V a lu e F a c to r o r P re s e n t V a lu e F a c to r o r
C o m p o u n d in g F a c to r D is c o u n tin g F a c to r

F o rm u la F V = P V (1 + r)^ n P V = F V / (1 + r)^ n
How to compute Future Value
• Let’s understand the future values calculation with the help of an
example. Let’s say that we have ₱ 1000 today and we have
calculated that our cost of capital is 10%. This 10% reflects both the
expectation of inflation i.e. fall in the real value of money
as well as the risk involved in this investment. Let’s consider that we
have to invest this money for a period of 3 years.
• The formula for calculating the future values is as follows:
• Future Value = Present Value (1 + (cost of capital / 100)
number of years

• i.e. Future Value = ₱ 1000(1.10)3

• i.e. Future Value = ₱ 1331
• This means that the equivalent sum of money that we should expect
in 3 years, given our cost of capital is ₱ 1331. This means that we
should accept proposals where future value is more than ₱ 1331,
reject proposals where future value is less than ₱ 1331 and be
indifferent towards proposals where future value is equal to ₱
1331.
• From henceforth, we will refer to this by stating that the future value
of ₱ 1000, at our given cost of capital, for a period of 3 years is ₱
1331. Also, it must be noted that future values are nominal in nature.
 How to compute Present Values
• Present values are the exact opposite of future values. During future
values we were compounding a present value at a given rate to
reach a future value. But in present value calculations, we will
discount the future values, which are nominal in nature, at the given
cost of capital for the given period to reach the present value. Let’s
look at it with the help of an example.
• Now, we have a proposal that offers to pay us ₱ 1000, 3 years from
hence. Our given cost of capital is 10%.
• The formula for calculating the present values is as follows:
• Present Value = Future Value / (1 + (cost of capital / 100) number of years

• i.e. Present Value = ₱ 1000 / (1.10)3

• i.e. Present Value = ₱ 751.31
• This means that the equivalent sum of money that we should
expect today, given our cost of capital is ₱ 751.31. This means
that we should accept proposals where present value is more than ₱
751.31, reject proposals where present value is less than ₱
751.31 and be indifferent towards proposals where future value is
equal to ₱751.31.
W he n th e term pre sen t value is used, w e are re ferring to th e
disco unted presen t da y valu es w hich are equivale nt to nom inal fu ture
value s.

Differentiate future value and present value.

• F uture V alue - the a m ou nt to w hich a n in vestm en t w ill grow after e arn ing
inte rest. In o ur previo us exam ple s, it is the prin cipal p lu s total in te re st
earn ed o ver a sta te d period . S o the future valu e of an in ve stm e nt of
P H P 1,000 yielding an interest of 8 % for a 5 -year period co m pou nd ed
an nually is P H P 1,4 69 .33.
• Present V alu e - th e a m ount yo u ha ve to invest to day if you w ant to
ha ve a certain a m ou nt of cash flow in the future.

• T hese de finition s can better b e illustra ted in a tim eline .

0 1 2 3 4 5
Initial Investment T-0 Value of
Investment at T-5 (PV): Php 1,000 (FV): Php
1,469.33
 Figure 1: Growth of Value over 5-year period

• T h e tim e v alu e o f m o n e y a n aly sis he lp s m a n a g e rs a n d in ve s to rs

c o m p a re c a s h flow s to d a y v e rs u s c a sh flo w in th e fu tu re . It a n sw e rs
q u e stio n s su ch a s w h a t a m o u n t in th e fu ture is e q u a l to P H P 1,0 0 0 .0 0
to d a y o r w h a t a m o u n t to d a y is e q uiv a le n t to P H P 1 ,4 6 9.3 3 in th e fu tu re .
T h e fu tu re va lu e is co m p u te d u s ing c o m p o u n d in g w hile th e p re s e n t va lu e
is co m p u te d u sin g d isc o u n tin g . In p ra ctice , w h e n m a k in g in ve s tm e n t
d e cis io n s , in ve s to rs u su a lly a do p t th e p re s e n t va lu e a p proa c h
A . D iffe re n tia te th e b a sic p a tte rn s o f ca sh flo w .
• S in gle A m o un t (Lu m p S u m ) - a sin gle c a s h o u tflo w is m a d e a n d th e
to tal re c eip ts w ill b e a t a s in g le fu tu re d a te.
• A n nu ity - p e rio dic s tre a m o f e q u a l c a sh flo w a t eq u a l tim e in te rv a ls
(a n n ua lly , m o n th ly, e tc.).
F o r e xa m ple , p a ym e n t for a c ertain ite m sh a ll b e for 1 2 e q ua l m on th ly
in s ta lm e n ts o f P H P 1 ,0 0 0 .
 M ix e d S tre a m - u n e q u a l p erio d ic ca s h flo w s th a t re fle c t n o
p a rticu lar p a tte rn . F o r e x a m p le ,
p a ym e n ts m a de b y a c u s to m e r a re in 3 u n e q ua l in s ta lm e n ts.

Time Amount
Year 1 1,500
Year 2 3,000
Year 3 2,500
Table 1: Sample of Mixed Stream