TIME VALUE OF MONEY

Continuation…
 Using Tables to Solve Future Value Problems
Example: Future Value of 1 Table [calculated by (1+i)n]

What is the future value of P100 in 5 years at 5%

compound interest?

Solution:

Beginning value P100

Multiply by factor x 1.2763

Future value P127.63

Note: There may be slight differences between using the formula and
tables due to rounding off
Using Tables to Solve Future Value of Annuity Problems
Annuity
• is an equal, annual series of cash flows
• may be equal annual deposits, equal annual withdrawals, equal annual payments or equal annual receipts

Ordinary annuity – when cash flows occur at the end of the year
Annuity due – when cash flows occur at the beginning of the year

Future Value of an Ordinary Annuity of 1 Table

Example:
Factor = (1 + r)n – 1 Where:
r = interest rate
You deposit P100 each year for 3 years at 5% interest. How much n = number of periods over which payments are made
r
will you have at the end of that time?
Solution:
Annuity P100
Multiply by factor x 3.1525
Future value of annuity P315.25

Checking:
Year 1: P100 deposited at end of the year = P100
Year 2: P100 x . 05 = P5.00 + P100 + P100 = P205
Year 3: P205 x .05 = P10.25 + P205 + P100 = P315.25
Using Tables to Solve Present Value Problems

Example: Present Value of 1 Table

Where:
Factor = 1 / (1 + r)n
How much would you deposit now to have P15,000 in 8 years if r = interest rate
n = number of periods over which payments are made
interest is 7%?

Solution:

Future value P15,000

Multiply by PV factor x 0.58201

Present value P8,730.15

Checking:

Present value P8,730.15

Multiply by FV factor x 1.7182

Future value P15,000

Using Tables to Solve Present Value of an Annuity Problems
Present Value of Annuity of 1 Table
-n
Example: fact o r = 1 - (1+r)
r
Find the present value of a 4-year, P3,000 per year annuity at 6%.

Solution:

Annuity P3,000

Multiply by factor x 3.46511

Present value P10,395.33

Ch e ckin g :

Ye ar An n u it y PV Fa ct o r PV
1 3,0 0 0 0 .9 434 0 2 ,8 30 .2 0
2 3,0 0 0 0 .8 90 0 0 2 ,6 7 0 .0 0
3 3,0 0 0 0 .8 396 2 2 ,5 18.8 6
4 3,0 0 0 0 .7 92 0 9 2 ,37 6 .2 7
To t a l PV 10 ,39 5.33
Net Present Value Analysis
is a method to evaluate the profitability of a project or investment by comparing the present value of future cash flows and the initial investment

The Discount Rate

Example: In the “10% Discount Factor” column, the factor becomes smaller for
periods further in the future, because the discounted value of cash flows
ABC International is planning to acquire an asset that it expects will are reduced as they progress further from the present day.
yield positive cash flows for the next five years. Its cost of capital is
10%, which it uses as the discount rate to construct the net present value
Fu t u re ca sh flow
of the project. P re se n t va lu e of a
(1+Discou n t ra t e ) sq u a re d b y t h e n u m b e r of p e riod s of
fu t u re ca sh flow
= d iscou n t in g
Ca s h Flo w 10 % Dis c o u n t Pre s e n t Va lu e
Ye a r
(in Ph p ) Fa c t o r (in Ph p )
FV
0 (5 0 0 ,0 0 0 ) 1.0 0 0 0 (5 0 0 ,0 0 0 ) or P re se n t Va lu e (P 0 ) = n
(1 + r )
1 130 ,0 0 0 0 .9 0 9 1 118 ,18 3
2 130 ,0 0 0 0 .8 2 6 5 10 7 ,4 4 5
Example: If we forecast the receipt of P130,000 in the 3 rd year at 10%
3 130 ,0 0 0 0 .7 5 13 9 7 ,6 6 9
discount rate, find its present value.
4 130 ,0 0 0 0 .6 8 30 8 8 ,7 9 0
130 ,0 0 0
5 130 ,0 0 0 0 .6 2 0 9 8 0 ,7 17 P re se n t Va lu e (P 0 ) = 3
Ne t Pre s e n t Va lu e (7 ,19 6 ) (1 + 0 .10 )
130 ,0 0 0
Conclusion: = 3
(1 .10 )

The net present value of the proposed project is negative at the 10% =
130 ,0 0 0
discount rate, so ABC should not invest in the project. 1.331

PV = 97,670 .92
Contents of a Net Present Value Analysis
 Asset purchases. All of the expenditures associated with the purchase, delivery, installation, and testing of the asset being purchased.

 Asset-linked expenses. Any ongoing expenses, such as warranty agreements, property taxes, and maintenance, that are associated with the asset.

 Contribution margin. Any incremental cash flows resulting from sales that can be attributed to the project.

 Depreciation effect. The asset will be depreciated, and this depreciation shelters a portion of any net income from income taxes, so note the income tax reduction caused by
depreciation.

 Expenses reductions. Any incremental expense reductions caused by the project, such as automation that eliminates direct labor hours.

 Tax credits. If an asset purchase triggers a tax credit (such as for a purchase of energy-reduction equipment), then note the credit.

 Taxes. Any income tax payments associated with net income expected to be derived from the asset.

 Working capital changes. Any net changes in inventory, accounts receivable or accounts payable associated with the asset. Also, when the asset is eventually sold off, this
may trigger a reversal of the initial working capital changes.

Cautions when using Net Present Value

Net present value does not consider the presence of a constraint in the system of generating cash flow, which could restrict the total amount of cash actually
generated. The result can be an estimated net present value that cannot be realized.
The Risk Return Trade Off
 Higher risk is associated with greater probability of higher return and lower risk with a greater probability of smaller return. This trade off which an
investor faces between risk and return while considering investment decisions is called the risk return trade off.

 In the investing world, the dictionary definition of risk is the chance that an investment’s actual return will be different than expected. Technically,
this is measured in statistics by standard deviation.

 Low risks are associated with low potential returns. High risks are associated with high potential returns. The risk return trade-off is an effort to
achieve a balance between the desire for the lowest possible risk and the highest possible return.

 A common misconception is that higher risk equals greater return. The risk return trade-off tells us that the higher risk gives us the possibility of
higher returns. There are no guarantees.

 On the lower end of the risk scale is a measure called the risk-free rate of return. It is represented by the return on 10-year Government Securities
because their chance of default (i.e., not being able to repay principal and interest) is next to nothing. This risk free rate is used as a reference for
equity markets whereas the overnight repo rate is used as reference for debt markets.

 Risk tolerance differs from person to person. It depends on goals, income, personal situation, etc. Hence, an individual investor needs to arrive at
his own individual risk return trade-off based on his investment objectives, his life-stage and his risk appetite.
THANK
YOU!