Hoa Sen University: Faculty of Banking and Finance

HOA SEN UNIVERSITY
FACULTY OF BANKING AND FINANCE
1
CORPORATE FINANCE
CHAPTER 2
THE TIME VALUE OF MONEY
2
Chapter 2: THE TIME VALUE OF
MONEY
• Main Contents:
1. Future values and Compound interest
2. Present values
3. Multiple cash flow
4. Level cash flow: Perpetuities and
Annuities
5. Inflation and the time value of money
6. Effective annual interest rate
3
• Option 1: Have $ 1,000 in 2021 (today)
• Option 2: Have $ 1,000 in 2026 (after 5 years)
Which option will you select?
“A dollar today is worth more than a dollar
tomorrow”
4
IMPORTANT TERMINOLOGIES
* Interest (r) - return earned by someone who has “rented”
money out or, amount paid by someone who has “rented” the
money from another party
* Principal- amount borrowed or invested
* Future value (FV): The amount of an investment is worth
after one or more periods.
* Present value (PV): the current value of a future sum of
money or stream of cash flows given a specified rate of return
* Compounding (compound interest): Earning interest on
interest
* Simple interest: Earning interest on original investment
5
• Cash Flows (Inflows and Outflows)

• Rate of Return ($ return earned by an investor) : is the
net gain or loss of an investment over a specified time
period, expressed as a percentage of the investment’s
initial cost. Alternatively it is also the cost of capital for a
project
• Time Value of Money (Money has time value because of
interest rate, risk, expected inflation)
6
• Four Important Cash Flow Patterns

1) Single Sum or Lump Sum Cash Flow
2) Mixed Stream or Multiple Cash Flow
3) Annuities
4) Perpetuities
• Financial Mathematics requires work (practice).
7
SINGLE SUM (LUMP SUM)
CASH FLOW PATTERNS
8
I. Future values and Compound
interest
EX: You have $100 invested in a bank account.
Suppose banks are currently paying an interest rate of
6% per year on deposits.
How much money can you gain after 3 years?
Note: $100: initial investment (principal)
6%: interest rate
9
I. Future values and Compound interest
1st year $100+$100x6% = $100 x (1+6%) = $ 106
2nd year $ 106 x (1+6%) = $100 x (1+6%)2 = $112.36
3rd year $112.36 x (1+6%) =$100 x (1+6%)3 = $119.10
10
+ $6 + $6.36 + $6.74
r = 6% $106 $112.36 $119.10
0 1 2 3
Interest
After the 1st year = 6% x $100 = $6
After the 2nd year = ($100 + $6) x 6% = $6.36
After the 3rd year = ($100 + $6.36) x 6% = $6.74
r = 6% +$6 +$6 +$6
1 2 3
+ $6 + $6.36 + $6.74
r = 6% $106 $112.36 $119.10
0 1 2 3
Compound Interest Simple interest

After the 1st year = 6% x $100 = $6 = 6% x $100 = $6
After the 2nd year = ($100 + $6) x 6% = $6.36 = 6% x $100 = $6
After the 3rd year = ($100 +$6 + $6.36) x 6% = $6.74 = 6% x $100 = $6
Total interest after = $6 + $6.36 + $6.74 = = $6+ $6+ $6
3 years $19.10 = $18
+ $6 + $6.36 + $6.74
r = 6% $106 $112.36 $119.10
0 1 2 3
Saving
Present value
Why do the interest after each year higher
than the previous ones ? Future value
…because interests are calculated based on original

investment and its interest of previous years
I. Future values and Compound interest (cont’d)
Compound interest …earning interest on interest
Accumulated
Original interest
Interest investment over
= + periods
x
Simple interest … earning interest on original investment
Accumulated
Original interest
Interest investment over
= + periods
x
14
“A dollar today is worth more than a dollar tomorrow”
Interest = interest rate x initial investment
Capital after the 1st year = initial investment x (1 + interest rate)
Capital after the 2nd year = capital after the 1st year x (1 + interest rate)
= initial investment x (1 + interest rate)2
Capital after the t year = initial investment x (1 + interest rate)t
Present value
Future value
Future value after the t year = Present value x (1 + interest rate)t

15
16
Picture: How an investment of $100 grows with compound interest at different interest rates
17
The higher the rate of interest, the faster your savings will grow
Compound Interest
•Interest is received on accumulated interest from
previous periods as well as on the principal; that is,
interest generates further interest
•The sum (FVt) accumulated at rate r after t periods
is:
where r = interest rate per period

t = number of periods 18
Do you know ???
MANHATTAN Island
1626, bou
ght with 2 $
4
Peter Minuit
??? How much equivalent in 2021 value ?
The average standard of interest rate is 3.5%

outstanding
24(1+3.5%)395 = 19,127,112 USD successful deal!!!
19
20
Future Value - Example 1

Suppose that you deposit $1,000 in an account
today that pays interest of 5% pa, compounded
annually. What will be the balance in the account at
the end of four years?
Future Value - Example 2

Suppose you invest $10,000 in an account that
earns interest of 6% pa, compounded annually. How
much will that investment be worth in 5 years? 10
years?
Given: PV = 10,000, r = 0.06, t = 5, 10
21
II. Present Values
Now!!!! At the
offered year-end!!
$100,000 offered
$100,000
•A dollar today is worth
more than 1 dollar tomorrow
Time value of money
Time
0 1 2 3 4 5 t
22
II. Present Values (cont’d)
Original
Receiving
investment
value
(Present
(Future
Value) Int 1 Int 2 Int 3 Value)
+ + +
Time
0 1 2 3 t
FV  PV 1  r  t
FV
PV 
1  r t 23
Discount factor
1
PV  FV
(1  r )t
Discount rate
Discount factor To measure the PV of $1 received

in year n
Future value Future value after t periods
24
• Discounted cash flow: method of
calculating present value by
discounting future cash flow
• Discount rate: interest rate used to
compute present values of future cash
flow
25
•How much do we need to invest now in order

to produce $106 at the end of the year with
interest rate of 6% ?
26
We have $100 invested for 1 year at 6% will grow to a future value

of 100 × 1.06 = $106. Let’s turn this around: How much do we
need to invest now in order to produce $106 at the end of the year?
In other words, what is the present value (PV) of the $106 payoff?
1
FV  100 * (1  6%)  $106 PV  $106
(1  6%)1
 $100
27
Discount factor
EXAMPLE
28
Discount factor
EXAMPLE
1
PV 1000
(1  1.01) 3
3-year discount factor
PV = €970.59
29
$3,000
$2,600 Strategy 1:
Save money in 1 year, interest rate 8%
Strategy 2:
•Which strategy should he select ?
Save money in 2 year, interest rate 8%
•Calculate PV of each strategy, and compare with his 30

suggestion
available fund If PV < available fund: select the strategy
EX 2: you need $3,000 next year to buy a new

computer. The interest rate is 8% per year. How
much money must you set aside now in order to
pay for the purchase? If Save money in 1 year,
interest rate 8% or Save money in 2 year,
interest rate 8%
31
* Present value of $3,000 in a year
* Present value of $3,000 in 2 years
you need to invest $2,778 today to provide $3,000 in 1 year but

only $2,572 to provide the same $3,000 in 2 years 32
The longer the time before you must make a payment, the less you need to invest 33
today
Finding the value of free credit
$20,000
•Down payment: $8,000
•The 2nd pay out: $12,000 No free credit provided

Free credit provider
Discount $1,000
•Which company should you select ?
34
Toyota is offering free credit on a $20,000 car.
You pay $8,000 down and then the balance at
the end of 2 years.
CM does not offer free credit but will give you
$1,000 off the list price. If the interest rate is
10%
Which company is offering the better deal?
35
Toyota: The first payment $8,000, takes place today. The second
payment, $12,000, takes place at the end of 2 years. The total
present value of the payments:
GM: + no free credit provide

+ discount $1,000
PV = 20,000 – 1,000 = $19,000
36
Finding the value of free credit
$20,000
•The 2nd pay out: $12,000 No free credit provided

Free credit provider
Discount $1,000
•Which company should you select ?
•PV = 20,000 – 1,000

= $19,000
Choose Toyota
for cheaper
purchasing 37
Finding the interest rate
issue
•Repay $1,000
•How much is the interest rate ?
1 •…paid at the end of 25 years
PV  FV
(1  r )t •Price of IOU: $129.20
 r  ...
38
Finding the interest rate
39
Finding the number of period
40
MIXED STREAM (MULTIPLE)
CASH FLOW PATTERNS
41
III. Multiple Cash Flow
A single cash flow
FV  PV 1  r t
FV
Single CF2 PV 
Multiple CF
Single CF1
1  r t
Single CF3
Single CF4
Multiple CF is sum cash revenue and expenditures over a period of time
Now, we calculate the FV, PV of a Multiple Cash Flow… 42

III. Multiple Cash Flow
Future Value of multiple cash flow
It is sum of future value of each cash flow.

Each cash flow must be computed to the same
point in the future
FV  PV 1  r 
t
43
III. Multiple Cash Flow (cont’d)
2 years later
•Year 0: deposit $1,200

•Year 1: deposit $1,400
•r = 8%
•How much will he spend

44
on a laptop after 2 years ?
Instead of putting aside one sum in the bank to

finance the purchase, you plan to save some
amount of money each year.
You put $1,200 in the bank now, and another
$1,400 in 1 year at an 8% rate of interest
How much will you spend on a computer in 2
years?
45
Picture: Draw time line can help to calculate the future value of your savings
46
Suppose that the computer purchase can be put

off for an additional year and that you can make
a third deposit of $1,000 at the end of the second
year.
How much will be available to spend 3 years
from now?
47
48
Present Value of multiple cash flow
It is sum of present value of each individual

cash flow
Each cash flow must be discounted to the
same point in time (normally to start date)
FV
PV 
1  r t
49
2
drawing 2 strategies
Installment plan
$16,000 •Year 1: $4,000

1
•Year 2: $4,000
Pay $15,500 at once
(deducted $500)
r = 8%
•Which strategy should be chosen ?
50
Option 1: paying $15,500 for a used car now

Option 2: paying $8,000 down today and make
payments of $4,000 in each of the next 2 years.
Which is the better deal?
51
Present Value of multiple cash flow (cont’d)
< $15,500
The strategy 2 of installment plan should be chosen 52

Characteristics of PV of a stream of future cash flows
…is the amount that needs to be invested today to generate the stream of
future cash flows.
Total future cash flow: - $16,000
Available cash: $15,133.06
Don’t worry
Total of PV of future cash flow = 53
available cash = $15,133.06
The installment plan’s present value is the amount that you would need
to invest now to cover the three payments.
Let’s check
54
…to prove this:
55
Example: FV of Multiple Cash Flows

You deposit $1,000 now, $1,500 in year one, $2,000 in year
two and $2,500 in year three in an account paying 10%
interest per annum.
How much do you have in the account at the end of the third
year?
56
Example: FV of Multiple Cash Flows

You deposit $1,000 now, $1,500 in year one, $2,000 in year
two and $2,500 in year three in an account paying 10%
interest per annum.
How much do you have in the account at the end of the third
year? $2,500
$1,000 $1,500 $2,000
0 1 2 3
57
Example: PV of Multiple Cash Flows
You deposit $1,500 in one year, $2,000 in two years
and $2,500 in three years in an account paying 10%
interest per annum.
What is the present value of these cash flows?
58
Example: PV of Multiple Cash Flows
You deposit $1,500 in one year, $2,000 in two years
and $2,500 in three years in an account paying 10%
interest per annum.
What is the present value of these cash flows?
$2,500
$1,000 $1,500 $2,000
0 1 2 3
59
What is the value at the end of Year 3 of the

following CF stream if the quoted interest rate is
10% pa, compounded semi-annually?
60
62
63
64
IV. Level Cash flows: Perpetuity
and Annuity
Iphone5
$x $x $x $x
0 1 2 3 4
Annuity
$x $x $x $x ….
0 1 2 3 4 ….
Perpetuity 65
PERPETUITIES
AND ANNUITY
66
IV. Level Cash flows: Perpetuity and Annuity
(cont’d)
What is an annuity and a perpetuity ?
Annuity
…sequence (level stream) of equal cash payment made at

equal period (regular intervals) with a finite maturity
Perpetuity
…sequence of equal cash payment that never ends
67
(cont’d)
Present value- perpetuity (cont’d)
Endow in finance
$100,000 per year, forever

Generous man r= 10%
How much is the amount that the man must set aside today ?
68
(cont’d)
Present value- perpetuity (cont’d)
69
(cont’d)
70
(cont’d)
71
(cont’d)
The expected dividend next year is $0.3 and dividends are

expected to grow at 5% per annum forever. If the discount
rate is 10%, what is the value of this promised dividend
stream?
Given: C = $0.3, g = 5%, r = 10%,
72
(cont’d)
With an 8 percent interest rate, calculate the present

value of the following streams of beginning-of-year
payments:
[a] $1,000 per year forever
[b] $500 per year forever, with the first payment two
years from today
[c] $2,420 per year forever, with the first payment
due three years from today
73
(cont’d)
Solution
74
(cont’d)
Solution
75
(cont’d)
76
(cont’d)
Present value of annuities
An annuity is a cash flow stream of equal amounts,

equally spaced in time for a finite period of time
In other words, a cash flow pattern where the owner

receives a regular (FIXED) payment, at a regular
(FIXED) point in time for a known (FIXED) period of
time.
77
(cont’d)
• ORDINARY ANNUITY (Annuity in arrears)

Pays a constant amount at the END of each period for a
finite number of periods.
• ANNUITY DUE (Annuity in advance) Pays a

constant amount at the BEGINNING of
Each period for a finite number of periods.
78
(cont’d)
IMPORTANT
Always assume the ORDINARY.
If nothing is said about the timing of cash flows.
ALWAYS assume the cash flow occurs at the
END of the period
79
(cont’d)
• The first C occurs at the end of the first time period
• The time period from the date of valuation to the date of

the first C is equal to the time period between each
subsequent C
• Also known as an annuity in arrears
80
(cont’d)
Present value of Ordinary annuity (cont’d)
Kangaroo Autos offer a payment scheme of $8,000 a year

at the end of each of the next 3 years, r = 10%.
What is present value of this installment plan?
81
(cont’d)
Kangaroo Autos offer a payment scheme of $8,000 a year at the end

of each of the next 3 years, r = 10%
$4,000 $4,000 $4,000
0 1 2 3
82
(cont’d)
Present value of Ordinary annuity Present Value

Ordinary Annuity Formula
1 1 
PV  C   t  Annuity factor
 r r (1  r ) 
1  (1  r )t 
 PV  C   83
 r 
(cont’d)
Annuity in Arrears (Ordinary Annuity)
r% $C $C $C $C
0 1 2 3 n
1 1 
PV  C   t 
 r r (1  r )  Annuity factor
1  (1  r ) t 
 PV  C  
 r 
84
(cont’d)
Present value of Ordinary annuity (cont’d) Present Value
Ordinary Annuity Formula
85
(cont’d)
Present value of annuity due (cont’d)
Kangaroo Autos offer a payment scheme of $8,000 a year

at the beginning of each of the next 3 years, r = 10%.
What is present value of this installment plan?
86
(cont’d)
Present value of annuity due (cont’d)
87
IV. Level Cash flows: Perpetuity and Annuity (cont’d)
88
(cont’d)
Present value of Annuity Due (cont’d)

Annuity in Advance (Annuity Due)
$C r% $C $C $C $C
0 1 2 3 n
1 1 
PV  C   t 
(1  r )
 r r (1  r )  Annuity factor
1  (1  r ) t 
 PV  C   (1  r )
 r 
89
(cont’d)
1 1  1 1 
PV  C   PV  C   t 
(1  r )
t 
 r r (1  r )  r r (1  r ) 
1  (1  r ) t  1  (1  r ) t 
 PV  C   (1  r )
 PV  C    r 
 r 
90
PV of Ordinary Annuity PV of Annuity Due
(cont’d)
Present value of annuity (cont’d)
•Receive equally installments each

year: $10.35 mio.
•Total year: 30.
•Interest rate: 3.2%
Lottery winner of $310.5 mio
$10.35 $10.35 … $10.35
0 1 2 … 30
Does he accept the proposal ? Why ?

It is a fair trade ?
91
What is a solution ?
(cont’d)
Suppose: A man buy Powerball lottery ticket and
win $310.5 million. That sum is to be paid in 30
equal annual installments of $10.35 million each.
If the first payment occurred at the end of 1 year,
interest rate of 3.2%
1. What was the present value of the prize?
2. Does he accept the proposal of receive payment
of $10.35 million each year in 30 years? Why?
3. Is it fair trade?
4. What is solution? 92
(cont’d)
Q1:
PV = $10.35 x 19.1033 = $197.7 million
93
(cont’d)
* Q2:
He will not accept this proposal because
PV= $197.7 million < $310.5 (value of the prize)
* Q3: It is not fair
* Q4: He should receive $197.7 million up front
94
(cont’d)
Future value of an Annuity
r= 8%
$13,000
$3,000 $3,000 $3,000 $3,000
0 1 2 3 4
Can you buy this red car at the end of year 4 ?
95
(cont’d)
Calculating the future value of an ordinary annuity of $3,000 a year for 4 year (interest rate =8%)
96
Future value of an annuity

Future value of an ordinary annuity
. FV of an ordinary annuities = PV of an ordinary annuity x (1+r)t
1 1  t
FV of an ordinary annuities = C 
 r r (1  r ) t  x (1  r )
 
 (1  r )t  1
FV of an ordinary annuities = C  
 r 
Future value of an annuity due

1 1  t
C 
FV of an annuity due =  r r (1  r ) t  (1  r ) x (1  r )
 
97
Future value of an annuity (cont’d)
98
99
(cont’d)

…in 50 more years
$500,000
r= 10%
…will be retired
How much could she save each year from this year ?
100
(cont’d)
C = FV/annuity factor C = $500,000/1163.908 = $429,58
101
(cont’d)
Annuities due  (1  r )t  1
FV of an annuities due = C   (1  r )
 r 
…in 50 more years
$500,000
r= 10%
…will be retired
If she save the money at the beginning of each year, how much should she deposit ?
Compare outcome with the previous FV annuity,

102
C = ???
any conclusion about this?
C = FV/annuity factor C = $500,000/1046.517 = $477.77
103
IV. Level Cash flows: Perpetuity and
Annuity (cont’d)
104
V. EFFECTIVE ANNUAL INTEREST RATE
Effective annual interest rate
Interest rate that is annualized using compound interest.
Borrow $100
Interest 1% per month
Putting off the

payment up to 1 year Total payment after 1 year:
100(1+1%)12= $112.68
105
(cont’d)
0 1
$100 $112.68
How much is the equivalent interest rate? •12.68%
Effective annual interest rate
106
Nominal and effective annual interest rate
FV= 100(1+12%/12)12 FV=100(1+12.68%)1x1

= $112.68 = $112.68
Nominal interest rate Effective annual interest rate
1 + effective annual interest rate = (1 + i/n)n
i: interest rate per compounding period
n: number of compounding periods

107
(cont’d)
Method to convert to effective annual interest rate from an annual

percentage rates (APRs)
•APRs: annualized by multiplying the rate per period by the number of period in a year.
Steps to convert to effective annual interest rate
1 Take the quoted APR divided by the number of compounded

period in a year
•Monthly interest: APR / 12

•Quarterly interest: APR / 4
•Semi-annually interest: APR / 2
108
(cont’d)
Steps to convert to effective annual interest rate (cont’d)
2 Convert to effective annual interest rate
1 + effective annual interest rate = (1 + monthly rate)12
1 + effective annual interest rate = (1 + quarterly rate)4
1 + effective annual interest rate = (1 + semi-annually rate)2
109
(cont’d)
Why do we use the effective annual interest rate ?
•To measure the actual income of the depositors or expense of the borrowers
LAST SELF TEST

A car loan requiring quarterly payments carries an annual
percentage rates (APRs)
ARP of 8 percent.
What is the effective annual rate of interest ?
110
VI. INFLATION AND THE TIME VALUE OF
MONEY
Investment return Inflation

6% 10%
…value of money is eroded 111

MONEY
Real versus Nominal Cash flow
Inflation: Rate at which prices as a whole are increasing
What can be used for measuring the inflation rate ?
…CPI (Consumer price index) used for measuring the inflation rate.
112
CPI measures the number of dollars needed to buy a specified basket of goods and service
that is supposed to represent the typical family’s purchases
MONEY
Real versus Nominal Cash flow (cont’d)
Example:
In 2010, price of one shirt: $1
In 2020, price of one shirt: $2
If a dollar bought one shirt, the same dollar this
year buys only a half of one shirt
>> The increase in the price means that
purchasing power of money is eroded
113
MONEY
114
MONEY
What is the nominal dollar ?
…refer to the actual number of dollars
What is the real dollar ?
…refer to the amount of purchasing power
115
MONEY
buy
In 1990
pr
ov
id
e
Pay monthly lo
an Year CPI
$800 for 30 years
1990 133.8
2011 190.3
??? What is the real monthly payment of 2011 compared with real 1990 dollar ? 116
MONEY
Suppose you took out a 30-year house

mortgage in 1990. The monthly payment
was $800. It was still $800 in 2011
What’s the monthly payment for 2011 expressed in
real 1990 dollars?
What do you think the real amount paid in 2011
with that in 1990 ?
117
VI. INFLATION AND THE TIME VALUE OF MONEY
(cont’d)
??? What is the real monthly payment of 2011 compared with real 1990 dollar ?
CPI increased (1990/2011): …………
Real payment of 2011 compared with 1990:……
What do you think the real amount paid in 2011 with that in 1990 ?
118
(cont’d)
CPI increased by a factor of 190.3/133.8 = 1.42 over

those years
Real monthly payment of 2011 compared with
real 1990 dollar Year CPI
$800/1.42 = $562.48 1990 133.8
2011 190.3
The real burden of paying the mortgage was much

less in 2011 than in 1990.
119
(cont’d)
120
(cont’d)
Inflation and interest rate
investment (1  nominal interest rate)
Real FV of investment 
1  inflation rate
1  nominal interest rate

1  Real interest rate 
1  inflation rate
What is the nominal interest rate ?
…rate at which money invested growths
…interest rate board of commercial banks
What is the real interest rate ?
…rate at which purchasing power of an investment increases
121
MONEY (cont’d)
• A nominal interest rate refers to the interest
rate before taking inflation into account
• Real interest rate is an interest rate that has
been adjusted to remove the effects of inflation
to reflect the real cost of funds to borrowers and
the real yield to the lender or to an investor
122
(cont’d)
Inflation and interest rate (cont’d)
…invest to earn interest rate: 6%
…simultaneously, reduce the income

with inflation rate of 2%
…how much is the real interest rate ?
123
(cont’d)
Inflation and interest rate (cont’d)
Attention!!!
In reality, if nominal interest rate and inflation rate are small, the real interest rate will be…
Real interest rate = nominal interest rate – inflation rate
124
(cont’d)
Valuing real cash payments
Suppose that the nominal interest rate is 10%. How much do you need to
invest now to produce $100 in a year’s time
…compare the nominal and real values of investment under the inflation rate of 7% and
nominal interest rate of 10%
Nominal Real
Interest rate 10% 2.8%
FV (after 1 year) $100 $93.46
PV $90.91 $90.91
Nominal PV and Real PV are equal to each other 125

(cont’d)
Valuing real cash payments
Nominal Real
Interest rate 10% =1.10/1.07-1

=2.8%
FV (after 1 year) $100 = $100/1.07
= $93.46
PV
Real future payment after 1 year compared with now
126
(cont’d)
Valuing real cash payments (cont’d)
Note
Current dollar cash flows must be discounted by the nominal
interest rate; real cash flows must be discounted by the real
interest rate
127
(cont’d)
Nominal Real
Interest rate 8% =1.08/1.05-1
=2.857%
FV (after 1 year) $5000 = $5000/1.05

= $4,761.9
PV
Real future payment after 1 year compared with now
128
(cont’d)
His total assets: $79 bio.
Spend $5.7 bio per year, in 30 years

•Interest rate = 6%
•Inflation rate = 3%
I would like to
ensure the same
power of
purchasing of
2045 as in 2015
129
(cont’d)
I would like to
ensure the same
power of
purchasing of
2042 as in 2012
Solution
Spend less in 2012 and then increase expenditure in line with inflation
•Real interest rate: …………….

•Annual spending in 2012:………………….
130
(cont’d)
An interest rate of 6% Bill Gates could, if he wished, turn his $79 billion
wealth into a 30-year annuity of $5.7 billion per year of luxury and
excitement (L&E). Unfortunately, L&E expenses inflate just like gasoline
and groceries. Thus Mr. Gates would find the purchasing power of that $5.7
billion steadily declining.
If he wants the same luxuries in 2045 as in 2015, he’ll have to spend less in
2015 and then increase expenditures in line with inflation.
How much should he spend in 2015? Assume the long-run inflation rate is
3%.
131
(cont’d)
Calculate real interest rate
PV = annual spending x 30-year annuity factor

$ 79,000,000,000 (PV) = annual spending x 30-year annuity factor at 2.9%
$ 79,000,000,000 (PV) = annual spending x19.8562
Annual spending =3,979,000,000
132
VI. INFLATION AND THE TIME VALUE OF MONEY (cont’d)
133
Thank you for your attention !
134

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Hoa Sen University: Faculty of Banking and Finance

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HOA SEN UNIVERSITY

FACULTY OF BANKING AND FINANCE

• Cash Flows (Inflows and Outflows)

• Four Important Cash Flow Patterns

• Financial Mathematics requires work (practice).

1st year $100+$100x6% = $100 x (1+6%) = $ 106

2nd year $ 106 x (1+6%) = $100 x (1+6%)2 = $112.36

3rd year $112.36 x (1+6%) =$100 x (1+6%)3 = $119.10

Compound Interest Simple interest

…because interests are calculated based on original

Compound interest …earning interest on interest

Simple interest … earning interest on original investment

Capital after the 1st year = initial investment x (1 + interest rate)

Capital after the t year = initial investment x (1 + interest rate)t

Future value after the t year = Present value x (1 + interest rate)t

where r = interest rate per period

Do you know ???

??? How much equivalent in 2021 value ?

The average standard of interest rate is 3.5%

Future Value - Example 1

Future Value - Example 2

Time value of money

Discount factor To measure the PV of $1 received

Future value Future value after t periods

•How much do we need to invest now in order

We have $100 invested for 1 year at 6% will grow to a future value

3-year discount factor

•Calculate PV of each strategy, and compare with his 30

EX 2: you need $3,000 next year to buy a new

* Present value of $3,000 in 2 years

you need to invest $2,778 today to provide $3,000 in 1 year but

Finding the value of free credit

•The 2nd pay out: $12,000 No free credit provided

•Which company should you select ?

GM: + no free credit provide

Finding the value of free credit

•The 2nd pay out: $12,000 No free credit provided

•PV = 20,000 – 1,000

Finding the interest rate

A single cash flow

Multiple CF is sum cash revenue and expenditures over a period of time

Now, we calculate the FV, PV of a Multiple Cash Flow… 42

It is sum of future value of each cash flow.

•Year 0: deposit $1,200

•How much will he spend

Instead of putting aside one sum in the bank to

Suppose that the computer purchase can be put

It is sum of present value of each individual

•Down payment: $8,000

$16,000 •Year 1: $4,000

•Which strategy should be chosen ?

Option 1: paying $15,500 for a used car now

Which is the better deal?

The strategy 2 of installment plan should be chosen 52

Characteristics of PV of a stream of future cash flows

Total future cash flow: - $16,000

Available cash: $15,133.06

…to prove this:

Example: FV of Multiple Cash Flows

Example: FV of Multiple Cash Flows

What is the value at the end of Year 3 of the

What is an annuity and a perpetuity ?

…sequence (level stream) of equal cash payment made at