Time Value of Money

MODULE 2
 Time Value of Money

 Money has time value because the purchasing power of money as

well as the earning power of money changes with time.
 It indicates that a sum of money available today is worth more than
the same amount in the future because of its capacity to generate
earnings, whether through interest, investment, or other
opportunities.
 Time Value of Money
 Simple Interest.
 The time value of money is specified in terms of an interest rate, “i”. If an
initial amount of money, “P”, called the present worth or present value
(hence the symbol P), is invested at an interest rate, “i”, for a time period,
“n”, the investment will earn an interest payment at the end of the time
period of “Pin”. We have this equation.

I = Pin
Where:
I = Simple Interest
P = present value of the
money
i = rate of interest
n = interest period
 Example 1: Simple Interest
 What is the interest of PhP 8,600 after 4 years at 12% simple interest rate?
 Solution: I = Pin
where: P = 8,600;
i = 12%
n = 4 years

hence:
I = PhP 8,600(0.12)(4)
= PhP 4,128
 Example 2: Simple Interest
 Find the present worth with a total interest of PhP 5,000 after 2 years at
simple interest rate of 6.25%.
 Solution: I = Pin
 where, I = PhP 5,000
i = 6.25%
n = 2 year

hence; PhP 5000 = P x (0.0625) x (2)

P = PhP 5,000 / (0.0625) x (2)
= PhP 40,000
 Example 3: Simple Interest
 In how many years will the investment doubles its value at 5% simple
interest?
 Solution: F = P (1 + in)
 where, F = 2P; (why?)
i = 5%

hence, 2P = P (1+0.05n)
2P = P + 0.05Pn
n =
2P – P = 0.05Pn
P/0.05P
P n = 0.05Pn
=
 Example 3: Simple Interest
 Future Amount:
 A PhP 5,000 will become how much after one year at simple interest
of 15%?
 Solution: F = P (1+in)
 Where P = 5000
i = 15%
n = 1 year

hence, F = 5000 {1+(0.15)(1)}

= PhP 5,750
 Example 4: Simple Interest
 A price tag of PhP 1,500 is payable in 70 days but if paid in 35 days it will have a 5%
discount. Find the rate of interest.
 Solution: F = P (1+ in)
 where, F = PhP 1,500
P = PhP 1,500 – 0.05(PhP 1,500)
= PhP 1,425
n = 35 days (1-yr/360 days)
= 75
0.0972 year =
138.51(i)
1500 = 1425 {1 + (i)(0.0972)}
i =
1500 = 1425 + (138.51)(i)
75/138.51
1500 – 1425 = 138.51(i) =
0.5415
 Example: Future Worth
 A man deposited PhP 10,000 in a bank at 10% per annum for 3 years, 8 months and 25 days.
Find the ordinary simple interest.
 Solution: I = Pin
 where, P = PhP 10,000
i = 10%
n = 3 years + 8 months and 25 days
= {(8 months) x (1yr / 12 months)} +
{(25 days x (1-yr /360 days)}
= 0.6667 + 0.0694
= 0.735
= 3 + 0.735
= 3.735
hence, I = PhP 10,000 x (0.10) x (3.736)
 Example 7: Nominal Rate
 A bank charges 1.5% per month on a loan. Find the equivalent nominal rate of
interest.
 The equivalent nominal rate of interest is the interest rate stated on an annual basis,
compounded periodically. In this case, the bank charges 1.5% per month.
 Nominal Rate = Monthly Rate x
Number of Compounding Periods in a Year
 In this scenario, the monthly rate is 1.5%, and since there are 12 months in a year, the
number of compounding periods in a year is 12. Thus,
 Nominal Rate = 1.5% x 12
= 18%
 Therefore, the equivalent nominal rate of interest is 18% per annum.
 Practice:
1. A man wishes to accumulate PhP 3,722 after 5 yrs, 8 months and 28 days. How
much should be deposited by the man in a bank if the ordinary simple interest is
15% per annum?
2. A man deposited 2000P in a bank at the rate of 15% per annum from March
21,1996 to October 25,1997. Find the exact simple interest.
3. A bank charges 1.5% per month on a loan. Find the equivalent nominal rate of
interest.

12/2/2023
 Practice: No.1
 A man deposited 2000P in a bank at the rate of 15% per annum from March
21,1996 to October 25,1997. Find the exact simple interest.
 Solution: Use Simple Interest (I):
I = Pin
P = PhP 2000
n = March 21, 1996 – October 25, 1997
= 1 year + 7 months and 4 days
= 1 yr. + {(7 months) x (1yr /12 months)} + {(4
days x (1-yr /360 days)}
= 1 yr. + 0.5833 + 0.0111
= 1.5944 years
i = 15%
SI = (PhP 2000)(0.15)(1.5944)}
= PhP 2,000 x 1.86175
 Practice: No.2
 A man wishes to accumulate PhP 3,722 after 5 yrs, 8 months and 28 days. How
much should be deposited by the man in a bank if the ordinary simple interest is
15% per annum?
 Solution
F = P (1+ in)
P = PhP 3,722
n = 5 yrs, 8 months and 28 days
= 5 yrs + {(8 months) x (1yr /12 months)} + {(28
days x (1-yr /360 days)}
= 5 yrs + 0.667 + 0.0778
= 5.745 years
i = 15%

F = PhP 3722 / (1+ {(0.15)(5.745)}

= PhP 3,722 / 1.86175
 Compound Interest
 Compound Interest - is the interest on top of interest

1. Nominal Rate of Interest (j) = the rate of interest that specifies the
number of interest periods in one year.
 Formula:
j
i =
n

Where: n = no. of interest periods in one year.

 Ex: j = 12% compounded quarterly (n = 4);
then i = 3% per quarter
 Compound Interest
 Common Methods of Compounding:
Common Methods of Compounding
Values of n

annually
1
semi-annually every 6 months
2
Quarterly every 3
months 4
bi-monthly every 2 months
6
monthly
 Compound Interest
 Effective Rate of Interest ( ie) = the actual rate of interest in one year.
 The general formula is:

1. ie (1 + i)n - 1

= j n
2. ie ( 1 + n ) -1
=
 Sample Problem: Effective Rate

 Let's say you borrow $1,000 at a nominal interest rate of 5%, compounded
annually. What is the effective rate?
 Effective Interest Rate:
n
ie (1 + j/n) -1

= ie = {1 + (0.05/1)}1 −1
= 0.05 or 5%

 In this case, the effective interest rate would be the same as the nominal
interest rate because there is no compounding.
 Sample Problem: Effective Rate
 Suppose you deposit $2,000 in a bank account with an annual nominal interest
rate of 4%, compounded quarterly. What is the effective rate?

Effective Interest Rate:

n
ie (1 + j/n) -1
= {1 + (0.04/4)}4 – 1
=
= (1 + 0.01)4 – 1
= 1.0406 – 1
= 0.0406 = 4.06%
 In this example, the effective interest rate is higher than the nominal rate because
of the quarterly compounding.
 Sample Problem: Effective Rate
 Suppose you take out a loan of $5,000 with an annual nominal interest rate of
8%, and the interest is compounded monthly.

Effective Interest Rate:

n
ie (1 + j/n) ―1
= {1 + (0.08/12)}12 – 1
=
= (1 + 0.0066667)12 – 1
= 1.0832823 – 1
= 0.08328 = 8.33%
 Again because of compounding, the ie is bigger than the nominal rate.
 Summary: Effective Rate
 When the nominal interest rate is stated on a monthly basis and interest is
compounded monthly, the nominal rate and the effective rate will be the same.
 Why? n
ie (1 + j/n) -1

When the nominal rate= (j) is divided by 12 (which is the number of compounding
periods per year for monthly compounding) and then added to 1, the resulting
expression raised to the power of 12 will yield the effective interest rate.
ie (1 + j/12)12 ―1
a.) if j = 5% = {1 + (0.05/12)}12 – 1
=
= ( 1.004167)12 – 1
= 1.051166 – 1
 Summary: Effective Rate

b.) if j = 3% = {1 + (0.03/12)}12 – 1
= (1.0025)12 – 1
= 1.03416 – 1
= 0.03416

c.) if j = 8% = {1 + (0.08/12)}12 – 1
= ( 1. 1.00667)12 – 1
= 1.083 – 1
= 0.083
 Summary: Effective Rate
 If j is stated on a monthly basis, and there is monthly compounding, then j and
ie will be equal. However, if the nominal rate (j) is stated on an annual basis and
then divided by 12 for monthly compounding, j and ie will generally differ, with ie
being higher due to the effect of compounding.

ie (1 + j/n)n -1

=
 Sample Problem: Effective Rate

 A bank charges 1.5% per month on credit card. Find (a) the nominal rate of
interest compounded monthly (b) the effective rate of interest (c) the equivalent
nominal rate of interest which is compounded quarterly.
 Solution:
a.) Nominal Rate: i = j/n
i
= 1.5% per month
n
= 12
hence, 1.5 = j/12
Sample Problem: Effective Rate

b.) Effective Rate (ie)

ie = ( 1 + i )n – 1
hence; ie = ( 1 + 0.015)12 – 1
= 0.1956
= 19.56% “per year”
 Sample Problem: Effective Rate
c) Equivalent nominal rate of interest which is compounded quarterly.
1.5% per month to ___% compounded quarterly
ie (quarterly) = ie (monthly)
n =4 n
= 12
j =? i
= 0.015
( 1 + j/4 )4 – 1 = ( 1 + 0.015)12 – 1
solve for j,
j = 0.1827
 Sample Problem: Effective Rate
 Step 1: Simplify
(1+
j/4 )4 – 1 = ( 1 + 0.015)12 – 1
(1+
j/4 )4 = ( 1 + 0.015)12
 Step 2: Raise Both Sides by (1/4):
{( 1 + j/4
)4}1/4 = {( 1.015)12)1/4

1 + j/4 = ( 1.015)3

1 + j/4 = 1.045678
 Step 3: Subtract both sides by 1:
 Sample Problem: Effective Rate
 Find the nominal rate, which is converted quarterly could be used instead of
12% compounded semi-annually.
Solution:
12% compounded semi-annually to __% compounded quarterly
ie (quarterly) = ie (semi-annually)
n=4 n = 2
j=? i = 12%
( 1 + j/4 )4 – 1 = {1 + (0.12/2)}2 – 1
( 1 + j/4 )4 – 1 = (1.06)2 – 1
( 1 + j/4 )4 = (1.1236)2
( 1 + j/4 )4 = (1.262477)
{( 1 + j/4 )4}1/4 = (1. 26247)1/4
1 + j/4 = (1.1262477)1/4
 Sample Problem: Effective Rate
1 + j/4 =
(1.1262477)1/4

1 + j/4 - 1 = (1.1262477)1/4
-1

j/4 =
(1.1262477)1/4 – 1
(j/4)(4) =
{(1.1262477)1/4 – 1}(4)
j =
{(1.1262477)1/4 – 1}(4)
 Practice Problem:

 A bank charges 3% bi-monthly on a highly profitable investment. Find (a) the

nominal rate of interest compounded monthly (b) the effective rate of interest
(c) the equivalent nominal rate of interest which is compounded quarterly.
 Solution:
 Practice Problem:

 A bank charges 3% bi-monthly on a highly profitable investment. Find (a) the

nominal rate of interest compounded monthly (b) the effective rate of interest
(c) the equivalent nominal rate of interest which is compounded quarterly.
 Solution:
a.) Nominal Rate: i = j/n
i
= 3% per month
n
= 6
hence, 3.0 = j/6
Practice Problem: Effective Rate

b.) Effective Rate (ie)

ie = ( 1 + i )n – 1
hence; ie = ( 1 + 0.03)6 – 1
= 1.1940 - 1
= 19.40% “per year”
 Practice Problem:
c) Equivalent nominal rate of interest which is compounded quarterly.
3% per month to ___% compounded quarterly
ie (quarterly) = ie (monthly)
n =4 n
= 12
j =? i
= 0.03
( 1 + j/4 )4 – 1= ( 1 + 0.03)12 – 1 (adding
1 both sides)
( 1 + j/4 )4 = (1 + 0.03)12
{( 1 + j/4 )4}1/4 = (1 +0.03)12}1/4
 Practice Problem:
 Step 1: Simplify

(1 + j/4) = (1 +0.03)3

 Step 3: Subtract both sides by 1:

1 + j/4 -1 = ( 1.03)3 - 1

j/4 = ( 1.03)3 -1
 Step 4: Multiply both sides by 4
(
j/4) x 4 = 4x ( 1.03)3 -1)

= 4 x (1.092727 – 1)
 Compound Interest
1. For Single Amount:
Let P = original amount of the principal
i = interest rate per period
n = number of interest period
F = Amount of principal at the end of the nth period
including interest
1st Period:
Amount of the beginning = P
Interest earned = Pi
Amount at end P1 = P (Pi)
= P
Compound Interest
2nd Period:
Amount of the beginning = P (1+i)
Interest earned = P (1+i)(i) = Pi (1+i)
= Pi + Pi2 = P(1+i)2
Amount at end; P2 = P (1+i)2

3rd Period:
Amount of the beginning = P (1+i)2
Interest earned = P (1+i)2 i
Amount at end; P3 = P(1+i)3

F =P
(1+i)n
 Compound Interest: P and F Relations
 P AND F Relation with Compounded Interest
 Formulas:
1. F = P (1+i)n
2. P = F (1+i)-n

Fn = P(1 + i)n

F = P{(1 +(i/2)}2nCompounded semi annual

F = P{(1 +(i/4)}4nCompounded quarterly

 Sample Problem 1: Compound Interest

 Suppose you invest $1,000 at an annual interest rate of 5%, compounded

annually, and you want to calculate the value of the investment after 3 years.
 The compound interest formula is:
F = P(1+i)n
= USD 1,000 (1+0.05)3
= USD 1,157.63
 Sample Problem 2: Compound Interest
 1. In 1906, an original painting of Picasso has a market price of 600P and in
1995 its price has increased to 29,000,000P. What is the rate of interest of the
painting?
Solution: F = P(1 + i)n
where: F = 29,000,000
P = 600P
n = 1995 – 1906 = 89 years
hence,
29,000,000 = 600(1 + i )89
 Sample Problem 2: Compound Interest
Re-arrange: hence,
29,000,000 = 600(1 + i )89
(1+i)89 89
= 29,000,000
600
(1+i) = (48,333)89
(1+i) -1 = (48,333)89 -1
i = 1.128839 – 1
= 0.1288
= 12.88%
 Sample Problem 3: Compound Interest
 If PhP100,000 is invested at 12% interest compounded monthly, find the 1st
year interest.
Solution:
j = 12% compounded
F monthly
= P(1+i)n
n = 12 P = 100,000
i = j/n = 12/12 or 0.12/12
i = 1%
F = P (1 + i)n n = 1 yr. 12
I = F-P months
hence,
F = 100,000(1 + 0.01)12
= PhP 112682.5 subst. values to “I”
I = PhP 112,682.5
= PhP 112,682.50 – 100,000 =
 Sample Problem 4: Compound Interest
 After how many years will an investment triple if invested at 10% per annum,
net of deduction, compounded quarterly?
 Solution:
F = P(1 + i )n
where,
F = 3P
j = 10% compounded quarterly
n = 4
i = 10/4 = 2.5% per quarter
hence, 3P = P(1 + 0.025)n
n = 44.5 quarters = 44.5
quarters ( 1𝑦𝑟/4 𝑞𝑢𝑎𝑟𝑡𝑒𝑟𝑠)
 Practice Problems: Answer
1. A man wishes to accumulate USD 3722 after 5 years, 8 months and 28 days.
How much should be deposited by the man in a bank if the ordinary simple
interest is 15% per annum?
2. Find the amount of the following payments at the end of 5th year, USD 3000 at
the end of 1st year, USD 4500 at the end of 2nd year and USD 6000 at the
end of 4th year if money worth 12% per annum.
 Practice Problems: Answer
1. A man wishes to accumulate USD 3,722 after 5 years, 8 months and 28 days.
How much should be deposited by the man in a bank if the ordinary simple
interest is 15% per annum?
Solution:
F = P(1 + in )
where,
F = USD 3,722
i = 15%
n = 5 years + (8 /12 months) + (28/365
days)
= 5 + 0.6667 + 0.0767
= 5.7434
Practice Problems: Answer

F = P(1 + in)

USD 3,722 = P {(1 + (0.15 x 5.7434)

P = USD 3,722 / (1+0.86151)

= USD 3,722 / (1.86151}
= USD 1,999
 Practice Problems: Answer
2. Find the amount of the following payments at the end of 5th year, USD 3,000
at the end of 1st year, USD 4,500 at the end of 2nd year and USD 6000 at the
end of 4th year if money worth 12% per annum.

F = P×(1+i/100​)t
Where:
F = is the future value or amount after interest.
P = is the principal amount (the initial payment).
i = is the annual interest rate.
n = is the time in years.