TVM Part 2

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
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
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
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
In your manual calculator, enter the following: After typing the screen should
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}
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%?
In your manual calculator, enter the following: After typing, the screen should
1 +r 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
1 +r 1.10
Press the equal sign “=“ three times. This is the total number of periods. 1.21 > 1.331 > 1.4641
Divide the amount by the interest rate per period “0.10”. 4.641
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
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
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
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.
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
Application of Time Value of Money
Different kinds of notes receivable:
1. Single payment on interest bearing note
2. Single payment on non-interest bearing note
3. Annuity payments on non-interest bearing note
4. Annuity payments on interest bearing note with unrealistically low
stated interest rate
5. Annuity payments on interest bearing note with unrealistically high
stated interest rate
Single Payment on Interest Bearing Note
On January 1, 2010, the Company received a P200,000 interest bearing
note from a customer as payment for goods sold to them. The principal
will be paid after 4 years, while the annual interest of 7% will be paid at
the end of every year, starting December 31, 2010.
Q1: What is the present value of the note?
A: The present value of the note is P200,000. Its present value is the
same as its face value because the note is interest bearing.
Q2: What is the amount of interest income earned by the Company at
the end every year?
A: The interest income earned by the Company amounted to P14,000
every year. [200,000 x 0.07 = 14,000]. There is no effect of
compounding on the interest because it is being paid in cash at the end
of every year.
Q3: What is the total amount of interest earned by the company for the
4-year period?
A: It would amount to P56,000. [14,000 x 4 years]
Single Payment on Non-Interest Bearing
Note
On January 1, 2010, a family friend of the owner wanted to borrow cash
from the Company. The Company received a P200,000 non-interest
bearing note as assurance from that person. The principal will be paid after
4 years. The prevailing interest rate for this kind of note is 7%.
Q1: What is the present value of the note? In other words, what is the
amount of cash received by the borrower?
A: The present value of the note is P152,579.04. It is the present value of
200,000 to be received 4 years from January 1, 2010. This is also the
amount of cash proceeds to be received by the borrower. He is willing to
receive this amount even if he is required to pay P200,000 at the maturity
date.
Note
On January 1, 2010, a family friend of the owner wanted to borrow
cash from the Company. The Company received a P200,000 non-
interest bearing note as assurance from that person. The principal will
be paid after 4 years. The prevailing interest rate for this kind of note is
7%.
Q2: What is the amount of Discount on Notes Receivable?
A: The discount on notes receivable is P47,420.96 [200,000 –
152,579.04]. It is the total amount of interest that will be earned by the
company for the 4-year period. This amount will also be amortized for
the 4-year period using the effective interest method.
Note
bearing note as assurance from that person. The principal will be paid
after 4 years. The prevailing interest rate for this kind of note is 7%.
Q3: What is the amount of interest income earned by the Company at
the end every year?
A: The interest income earned by the Company every year would differ.
The company will earn higher interest income in the later years because
of the effect of compound interest. The interest income on the last year
will be adjusted in order for the carrying value to equal P200,000.
Note
Date Interest income at 7% Carrying Value
152,579.04
12/31/2010 10,680.53 163,259.57
12/31/2011 11,428.17 174,687.74
12/31/2012 12,228.14 186,915.88
12/31/2013 13,084.12 200,000
Note
On January 1, 2010, a family friend of the owner wanted to borrow
cash from the Company. The Company received a P200,000 non-
interest bearing note as assurance from that person. The principal will
be paid after 4 years. The prevailing interest rate for this kind of note is
7%.
Q4: What is the carrying value of the note at the end of every year?
A: The carrying value of the note is the sum of the carrying value at the
start of that year plus the interest income earned for that year.
Annuity Payments on Non-Interest Bearing
Note
On January 1, 2010, a family friend of the owner wanted to borrow cash from
the Company. The Company received a P200,000 non-interest bearing note
as assurance from that person. The principal will be paid with equal annual
installments at the end of every year for 4 years. The first payment will start
on 12/31/2010. The prevailing interest rate for this kind of note is 7%.
Q1: What is the present value of the note? In other words, what is the
amount of cash received by the borrower?
A: The present value of the note is P169,360.56. It is the present value of four
P50,000 payments to be received at the end of each year for 4 years, starting
from December 31, 2010. This is also the amount of cash proceeds to be
received by the borrower.
Note
bearing note as assurance from that person. The principal will be paid with
equal annual installments at the end of every year for 4 years. The first
payment will start on 12/31/2010. The prevailing interest rate for this kind
of note is 7%.
A: The discount on notes receivable is P30,639.43 [200,000 – 169,360.56].
It is the total amount of interest that will be earned by the company for the
4-year period. This amount will also be amortized for the 4-year period
using the effective interest method.
Note
Q3: What is the amount of interest income earned by the Company at the
end every year?
A: The interest income earned by the Company every year would differ. The
company will earn lower interest income in the later years because of the
effect of the year end P50,000 payments that will be made by the borrower.
Note
Date Periodic Payment Interest Income Reduction of Principal Outstanding Balance (CV)
1/1/10 169,360.56
12/31/10 50,000 11,855.24 38,144.76 131,215.80
12/31/11 50,000 9,185.11 40,814.89 90,400.91
12/31/12 50,000 6,328.06 43,671.94 46,728.97
12/31/13 50,000 3,271.03 46,728.97 0
To get the interest income, multiply the prevailing interest rate of 7% to

the carrying value for that period. The reduction of the principal is
equal to the Periodic payment less the interest income for that period.
Note
A: The carrying value of the note is the sum of the carrying value at the start
of that year plus the interest income earned for that year less the P50,000
installment payment. The 50,000 payment is first applied as payment to the
interest for that period. The remaining portion will be applied as reduction to
the principal amount.
Annuity Payments on Interest Bearing Note
with Unrealistically Low Stated Interest Rate
On January 1, 2010, a family friend of the owner wanted to borrow cash from the
Company. The Company received a P200,000 interest bearing note as assurance
from that person. The principal, together with a 2% interest on the outstanding
balance, will be paid by the borrower in 4 equal annual installments at the end of
every year for 4 years. The first payment will be made on 12/31/2010. The
prevailing interest rate for this kind of note is 7%.
Q1: What is the present value of the note? In other words, what is the amount of
cash received by the borrower?
A: The present value of the note is P178,114.55. It is the total of the present value
of four P50,000 payments to be received at the end of each year for 4 years,
starting from December 31, 2010 and the present value of the 2% interest
payments to be made on the outstanding balances.
[50T + (200,000 x 0.02)] x 0.934579 = 50,467.26
[50T + (150,000 x 0.02)] x 0.873438 = 46,292.21
[50T + (100,000 x 0.02)] x 0.816297 = 42,447.44
[50T + ( 50,000 x 0.02)] x 0.762895 = 38,907.65
178,114.55
from the Company. The Company received a P200,000 interest bearing note
as assurance from that person. The principal, together with a 2% interest on
the outstanding balance, will be paid by the borrower in 4 equal annual
installments at the end of every year for 4 years. The first payment will be
made on 12/31/2010. The prevailing interest rate for this kind of note is 7%.
A: The discount on notes receivable is P21,885.45 [200,000 – 178,114.55].
This amount will also be amortized for the 4-year period using the effective
interest method and will serve as an adjustment (it will increase) to the
nominal interest income of the Company.
end every year?
Date Periodic Effective Nominal Discount Carrying Value
Payments Interest Interest Amortization
1/1/10 178,114.55
2010 P 50,000 12,468 4,000 8,468 136,582.56
2011 P 50,000 9,560.77 3,000 6,560.77 93,143.33
2012 P 50,000 6,520.03 2,000 4,520.03 47,663.36
2013 P 50,000 3,336.64 1,000 2,336.64 0
You can get the effective interest rate by multiplying the carrying value
of the note for that period with the prevailing interest rate of 7%. The
nominal interest can be derived by multiplying 2% to the outstanding
balance of the note.
A: The carrying value of the note is the sum of the carrying value at the start
of that year plus the discount amortization for that year less the P50,000
installment payment. The discount amortization is the difference of the
effective interest and the nominal interest.
with Unrealistically High Stated Interest Rate
On January 1, 2010, a family friend of the owner wanted to borrow cash from the
Company. The Company received a P200,000 interest bearing note as assurance
from that person. The principal, together with a 20% interest on the outstanding
balance, will be paid by the borrower in 4 equal annual installments at the end of
every year for 4 years. The first payment will be made on 12/31/2010. The
prevailing interest rate for this kind of note is 7%.
Q1: What is the present value of the note? In other words, what is the amount of
cash received by the borrower?
A: The present value of the note is P256,901.64. It is the total of the present value
of four P50,000 payments to be received at the end of each year for 4 years,
starting from December 31, 2010 and the present value of the 20% interest
payments to be made on the outstanding balances.
[50T + (200,000 x 0.20)] x 0.934579 = 84,112.11
[50T + (150,000 x 0.20)] x 0.873438 = 69,875.04
[50T + (100,000 x 0.20)] x 0.816297 = 57,140.79
[50T + ( 50,000 x 0.20)] x 0.762895 = 45,773.70
256,901.64
as assurance from that person. The principal, together with a 20% interest
on the outstanding balance, will be paid by the borrower in 4 equal annual
Q2: What is the amount of Premium on Notes Receivable?
A: The premium on notes receivable is P56,901.64 [200,000 – 256,901.64].
This amount will also be amortized for the four year period using the
effective interest method and will serve as an adjustment (it will decrease)
to the nominal interest income to be earned by the Company.
as assurance from that person. The principal, together with a 20% interest
on the outstanding balance, will be paid by the borrower in 4 equal annual
end every year?
Date Periodic Effective Nominal Premium Carrying value
payments interest interest amortization
1/1/10 256,901.64
2010 P 50,000 17,983.11 40,000 22,016.88 184,884.75
2011 P 50,000 12,941.93 30,000 17,058.06 117,826.68
2012 P 50,000 8,247.86 20,000 11,752.13 56,074.54
2013 P 50,000 3,925.46 10,000 6,074.54 0
You can get the effective interest rate by multiplying the carrying value
of the note for that period with the prevailing interest rate of 7%. The
nominal interest can be derived by multiplying 20% to the outstanding
balance of the note.
the Company. The Company received a P200,000 interest bearing note as
assurance from that person. The principal, together with a 20% interest on the
outstanding balance, will be paid by the borrower in 4 equal annual
installments at the end of every year for 4 years. The first payment will be made
A: The carrying value of the note is the sum of the carrying value at the start of
that year less the premium amortization for that year less the premium
amortization for that year less the P50,000 installment payment. The premium
amortization is the difference of the effective interest and the nominal interest.

TVM Part 2

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

TVM Part 2

Uploaded by

Copyright:

Available Formats

Time Value of Money

To get the interest income, multiply the prevailing interest rate of 7% to

You might also like