RELOSA, DANILO

 BSBA – Financial Management

 Dr. Filemon C. Aguilar Memorial College of Las pinas
 Inventory Audit Supervisor
Time Value of Money
ADVANCE FINANCIAL MANAGEMENT

REFERENCE: FINANCIAL MANAGEMENT 13TH

EDITION BY: EUGENE F. BRIGHAM
Time Lines

 Help you to visualize what’s happening in the particular problem.

Time
Interest Rate

FV FV
=? =?

End of one Period

Step-by-step Approach

 The time line itself can be modified and used to find the FV of $100 compounded
for 3 years at 5%, as shown below:

FV1 = PV + INT FV2 = PV + INT FV3 = PV + INT

= PV (1+i) = PV (1+i) = PV (1+i)
= $100 (1.05) = $105 (1.05) = $110.25 (1.05)
= $105 = $110.25 = $115.76
Future Values

 Future Value or Ending Amount, in the account after N periods after interest
earned has been added to the Account.
 From PV to FV is what we called Compounding.
 PV = Present Value, or beginning amount.
 FVN = Future Value, or ending amount.

I = Interest rate earned per year.

 INT = Dollars of Interest earned during the year
N = Number of Period involved in the analysis.
Formula Approach

 FVN = PV(1+i)N

FV2 = PV (1+i)2 FV3 = PV (1+i)3

= $100 (1.05)2 = $100 (1.05)3
= $110.25 = $115.76
Financial Calculators

 Were designed specifically to solve time value problems.

 Note that financial calculators have five keys that correspond to the five variables
in the basic time value equations.

PMT = 0
PMT = 10
Spreadsheet

End of period

Beginning of the period

Simple Interest Vs. Compound Interest

Interest is earned on the

Interest is earned only
interest earned in prior
in the principal.
periods.

Simple Compound
Interest Interest

FV = PV + FV3 = PV
PV(I)(N) (1+i)3
Sample Question
 Supposed you currently have $2,000 and plan to purchase a 3 year certificate of deposit (CD) that
pays 4% interest, compounded annually. How much will you have when the CD matures?

Answer: $ 2,249.73
Sample Question
 A company’s sales in 2009 were $100 million. If sales grow by 8% annually, what will they be 10
years later? What would they be if they decline by 8% per year for 10 years?

Answer: $ 215,892,499.73 Answer: $ 43,438,845.42

Present Values

 Present sum of money.

 Finding the Future Value is what we called Compounding. On the other hand,
finding the present value is Discounting.
Step-by-step Approach

 The time line itself can be modified and used to find the PV of $115.76
discounted for 3 years at 5%, as shown below:

PV1 = FV + INT PV2 = FV + INT PV3 = FV + INT

= FV / (1+i) = FV / (1+i) = FV / (1+i)
= $105 / (1.05) = $110.25 / (1.05) = $115.76 / (1.05)
= $100 = $105 = $110.247 or $110.25
Formula, Financial Calculator &
Spreadsheet
Finding the Interest Rate

 FV = PV (1+i)N
Sample Problem
 A given security has a cost of $100 and it will return $150 after 10 years. Find the rate of
return if we buy the security.
 FV = PV (1+i)N
 $150 = $100 (1+i)10
 $150 / $100 = (1+i)10
 (1+i)10 = 1.5
 (1+i) = 1.5 (1/10)
 1+i = 1.0414
 I = 1.0414 – 1
 I = 0.0414 = 4.14 %
Types of Interest Rates

 Nominal Annual Rates, given the symbol INOM

 Periodic Rates, denoted as IPER
 Effective Annual Rates, given the symbol EAR or EFF%
Nominal Rate, INOM

 This is the rate quoted by banks, brokers, and other financial institutions.
 Nominal rates works according to the simple interest and does not take into
account the compounding periods.
 Note that the nominal rate is never shown on a time line, and it is never used as an
input in a financial calculator. If more frequent compounding occurs, you must
use periodic rates.
Periodic Rate, IPER

 This is the rate charged by a lender or paid by a borrower each period.

 It can be a rate per year, per 6 months (semiannually), per quarter, per month, per
day, or per any other time interval.
Effective (or Equivalent) Annual Rate
(EAR or EFF%)
 This is the annual rate that produces the same final result as compounding at the
periodic rate for M times per year.
Annuities

 A series of payments made at equal intervals.

 Ordinary (or deferred) annuity if payments occur at the end of each period.
 Annuity due if payments are made at the beginning of each period.
Future Value of an Ordinary Annuity
Future Value of an Ordinary Annuity

 FVAN= 100 x [ (1+ .05)3/.05 – 1/.05 ]

= 100 x [1.157625 / .05 – 1/.05]
= 100 x [23.1525 – 20]
= 100 x [3.1525]
= $ 315.25
Future Value of an Ordinary Annuity
Future Value of an Annuity Due

$ 100 $ 100 $ 100

0 1 2 3
105
110.25
115.7625

$331.01
Future Value of an Annuity Due

 FVAN= 315.25(1+.05)
= $ 331.01

Note: The reason the values are higher in Annuity Due is that
payments made at the beginning of the period have more time to
earned interest.
PRESENT VALUES OF ORDINARY
ANNUITIES AND ANNUITY DUES

Ordinary
Annuity

$100.00

$285.94 Annuity Due

PRESENT VALUE OF ORDINARY
ANNUITY & Annuity Due
Ordinary Annuity Annuity Due

 PVAN= PMT X (1/.05 – 1 / .05(1+.05)3

 = 100 X (20 – 1 / .05788125)
 = 100 X (20 – 17.27675)
 = 100 X 2.72325
 = $ 272.32
Sample Question

 Mr. Khalid will receive $8,500.00 a year for the next 15 years from his trust. If a
7% interest rate is applied, what is the current value of the future payments if first
receipt occurs today?

82,836.48
Sample Question

 What is the present value of an annuity due that makes 5 annual payments of
$200.00 each if the discount rate is 12% ?
Sample Question

 Find the present value of due annuity with periodic payments of $2,000, for a
period of 10 years at an interest rate of 6%, discounted semiannually?

 Note: using Financial Calculator divide the I/Y into 2 then multiply the number of years into 2.
Perpetuities
 A consol, or perpetuity, is simply an annuity whose promised payments extend out forever.
 This type of bonds guarantees holders continuous annual payments.
Finding PV of Perpetuities

 Bank will promised to pay you $10 yearly for the rest of your life and there is
available investment earning 10% interest rate annually. What is the present value
of your perpetuity?

 PV = C (cash flow) /R (interest rate)

 PV = $10 / 0.1
 PV = $100
UNEVEN, OR IRREGULAR, CASH
FLOWS
 When a cash flow stream is uneven, the present value (PV) and/or future value
(FV) of the stream are calculated by finding the PV or FV of each individual cash
flow and adding them up.
PV OF UNEVEN, OR IRREGULAR,
CASH FLOWS

=100/(1+.12)1 =300/(1+.12)2 =300/(1+.12)3 =300/(1+.12)4 =500/(1+.12)5

=89.285 =239.158 =213.534 =190.655 =283.713
FV OF UNEVEN, OR IRREGULAR,
CASH FLOWS
FV OF UNEVEN, OR IRREGULAR,
CASH FLOWS

 FV = CF0(1+I)N+ CF1(1+I)N-1+ CF2(1+I)N-2+ CF3(1+I)N-3+ CF4(1+I)N-4+ CF5(1+I)N-5

 FV = CF1(1+1.2)5-1+ CF2(1+1.2)5-2+ CF3(1+1.2)5-3+ CF4(1+1.2)5-4+ CF5(1+1.2)5-5
 FV = 100(1+1.2)5-1+ 300(1+1.2)5-2+ 300(1+1.2)5-3+ 300(1+1.2)5-4+ 500(1+1.2)5-5
 FV = 157.35 + 421.48 + 376.32 + 336 + 500
 FV = $1,791.15
Amortized Loans

 A loan that is to be repaid in equal amounts on a monthly, quarterly, or annual

basis is called an amortized loan.

Example:
 Suppose a company borrows $100,000, with the loan to be repaid in 5 equal payments at the end
of each of the next 5 years. The lender charges 6% on the balance at the beginning of each year.
THANK YOU!!!