Time Value of Money

Simple Interest
It is the interest on the amount invested or borrowed at a given rate and for a
given time. It is usually associated with loans or investments which are short
term in nature.

I = (P)(r)(t)
where:
I = simple interest
P = principal amount borrowed or lent
r = interest rate per period
t = time factor
Simple Interest
Q: How much is the interest expense of a 3 month Notes Payable worth
P20,000, with a stated interest rate of 5%? How much is its Maturity
Value?
A1: 20,000 x 0.05 x 3/12 = P250 is the interest expense
A2: 20,000 + 250 = P20,250 is the Maturity Value
Future Value of a Single Payment
The future value is defined as the amount which you will receive sometime in
the future, if you would invest your money in a bank that gives a certain
amount of interest to its depositors. Stated differently, future value is the
amount to which an investment will grow after earning interest.
FV = PV(1+r)ᵗ
where:
FV = future value or maturity value
P = present value
r = rate per period
t = number of periods
Future Value of a Single Payment
Q: AMV Co. invested its excess cash worth P20,000 in a savings account
earning interest at 5% every year. What is its Future Value four years
from now?
A: FV = 20,000 x (1 + 0.05)⁴ = 24,310.13
Future Value of a Single Payment
In your manual calculator, enter the following: After typing the screen should
show the following amounts:
1+r 1.05
Press the multiplication sign “x” two times. 1.05
Press the equal sign “=“ three times. This is [4 – 1] or number of periods less 1.1025 > 1.1576 > 1.2155
1.
Multiply future value factor computed with the given present value, P20,000. 24,310.13
Present Value of a Single Payment
The present value is defined as the principal which you would have to
invest now at a given interest rate, so that it will amount to some
predetermined future some of money.
PV = FV/(1+r)ᵗ
where:
FV = future value
PV = present value
r = rate per period
t = number of periods
Present Value of a Single Payment
Q: AMV Co. intends to buy a small lot of land worth P24,310.13.
According to the owner of the land, they would only sell the lot to
prospective buyers fours years from today. How much cash does AMV
Co. needs to place in a bank today, in order to have enough cash to buy
said property? Assume that the bank can give 5% interest. Stated
differently, what is the Present Value of P24,310.13 that will be needed
4 years from now at the stated interest rate of 5%?
A: PV = 24,310.13/(1.05) ⁴ = 20,000
Present Value of a Single Payment
In your manual calculator, enter the following: After typing the screen should
show the following amounts:
1+r 1.05
Press the division sign “÷” two times. 1.05
Press the equal sign “=“ four times. This is the total number of periods. 0.95238 > 0.90702 > 0.86383 >
0.82270
Multiply the present value factor computed with the given future value, 20,000
P24,310.13.
Future Value of an Ordinary Annuity
An annuity is a sequence of equal payments made at regular intervals.
Some example of annuities are quarterly payments of a lot’s
amortization, premiums on insurance, periodic pensions, and monthly
payments on installment purchases.
An ordinary annuity is one for which the periodic payments are made
at the end of the period.
The future value of an ordinary annuity is the sum of all accumulated
value of the set of payments due at the end of the term.
FVoa = R{[(1+i)ⁿ-1]/i}
Future Value of an Ordinary Annuity
Q: JC intends to save a small portion of his salary in a bank account
every year for 3 years. The yearly amount of P10,000 will be deposited
at a bank that gives interest at 10% every year. How much will be the
amount accumulated at the bank if the first payment will be made at
the end of the first year? Stated differently, what is the Future Value of
P10,000 payments that will be made at the end of each year for 3 years
at a bank with a stated interest rate of 10%?
Future Value of an Ordinary Annuity
In your manual calculator, enter the following: After typing, the screen should
show the following amounts:
1 +r 1.10
Press the multiplication sign “x” two times. 1.10
Press the equal sign “=“ two times. This is the total number of periods less 1. 1.21 > 1.331
[3 -1]
Deduct “1” from the amount. 0.331
Divide the amount by the interest rate per period “0.10”. 3.31
Multiply the future value factor computed with the given annual payment, 33,100
P10,000.
Future Value of an Annuity Due
An annuity due is one for which the first payment occurs immediately.
It is also defined as an annuity in which payments are made at the
beginning of each period.
The future value of an annuity due is the sum of the accumulated
values of the payments at the end of the term, with the first payment
to be made at the beginning of a period.
Fvad = R({[(1+i)ⁿ⁺¹-1]/i} – 1)
Future Value of an Annuity Due
In your manual calculator, enter the following: After typing, the screen should
show the following amounts:
1 +r 1.10
Press the multiplication sign “x” two times. 1.10
Press the equal sign “=“ three times. This is the total number of periods. 1.21 > 1.331 > 1.4641
Deduct “1” from the amount. 0.4641
Divide the amount by the interest rate per period “0.10”. 4.641
Deduct “1” from the amount. 3.641
Multiply the future value factor computed with the given annual payment, 36,410
P10,000.
Present Value of an Ordinary Annuity
The present value of an ordinary annuity is the sum of all discounted
value of several payments due at the beginning of the term, with the
first payment to be made at the end of a period.
PVoa = R{[1-(1+i)⁻ⁿ]/i}
Present Value of an Ordinary Annuity
In your manual calculator, enter the following: After typing, the screen should
show the following amounts:
1 +r 1.10
Press the division sign “÷” two times. 1.10
Press the equal sign “=“ three times. This is the total number of periods. 0.90909 > 0.82644 > 0.75131
Deduct “1” from the amount. -0.24868
Divide the amount by the interest rate per period “0.10”. -2.48685
Multiply the present value factor computed with the given annual payment, 24,868.51
P10,000. Ignore the negative sign.
Present Value of an Annuity Due
The present value of an annuity due is the sum of all discounted value
of several payments due at the beginning of the term, with the firm
payment to be made at the beginning of a period.
PVad = R({[1-(1+i)⁻⁽ⁿ⁻¹⁾]/i}+1)
Present Value of an Annuity Due
In your manual calculator, enter the following: After typing, the screen should
show the following amounts:
1+r 1.10
Press the division sign “÷” two times. “1.10
Press the equal sign “=“ two times. This is the total number of periods less 1. 0.90909 > 0.82644
[3 - 1]
Deduct “1” from the amount. -0.17355
Divide the amount by the interest rate per period “0.10”. -1.73553
Remove the negative sign. 1.73553
Add 1 to said amount. 2.73553
Multiply the present value factor computed with the given annual payment, 27,355.37
P10,000. Ignore the negative sign.
Present Value of a Perpetuity
Perpetuity is more likely considered a form of annuity. Yet, the two
differs from the mode of payment since payments in perpetuity are
considered continuous forever.
Pvper = Perpetuity payment/Interest rate
Present Value of a Perpetuity
If you want to get the present value of infinite P100,000 payments
every year at a 5% interest rate, just divide 100,000 by 5 percent and
you will get P2,000,000.
Present Value of a Perpetuity
Q: A wealthy Chinese tycoon is in his deathbed. Before leaving this
world, he wants to leave a legacy. How much money does he need to
leave in a trust fund in order for 5 indigent Filipino students to study
college every year from now until forever? Annual tuition fee amounts
to P60,000 per student and the interest rate for banks is 4%.
A: The total tuition fee for 5 students would be P300,000. This is the
perpetuity payment needed. Divide this amount with the interest rate
of 4% and you will have the amount needed to be placed in an
educational trust fund.
300,000/0.04 = P7,500,000