Module 2

The Time Value of Money

Slide M2.1
 Module 2 Learning
Objectives
Distinguish between simple and compound
interest.
Compute the future value of a single amount.
Compute the future value of an annuity.
Compute the present value of a single amount.
Compute the present value of an annuity.

Slide M2.2
 Time is money.
Ben Franklin

Time value of money concept: the

economic value of a cash
receipt or payment is a function
of both the amount and timing
of that receipt or payment.
Simple premise: A dollar in your
pocket today is worth more
than a dollar you will receive in
one year.
Why study the time value of
money concept? Because it
influences the accounting
treatment of several financial
statement items.

Slide M2.3
Key Terms

Interest
Simple Interest
Compound Interest
Annuity
Future value
Present value

Slide M2.4
Four Basic Time Value of
Money Scenarios

Computing the future value of

a single amount
Computing the future value of
an annuity
Computing the present value of
a single amount
Computing the present value of
an annuity

Slide M2.5
Each time value of money scenario
can be solved either of two ways:

Directly with the

appropriate
mathematical
equation.
Or, by using a simplified
version of that equation
and the assistance of
“time value” tables.

Slide M2.6
 Each time value of
money factor has two
parameters . . .
. . . an assumed interest (or
discount) rate and a given
number of time periods.

a. Table 1: Future Value Factors (FVFs) for a Single Amount

b. Table 2: Future Value of Annuity Factors (FVAFs)
c. Table 3: Present Value Factors (PVFs) for a Single Amount
d. Table 4: Present Value of Annuity Factors (PVAFs)

Slide M2.7
 Future Value of a Single
Amount

Representative scenario: $50,000

invested for five years in a 5% CD.

Basic structure of this scenario:

Present Future
Value Value
$50,000 ?

5 years @ 5%

Slide M2.8
Solution:

1. FV = PV x FVF
2. Where: FVF = the appropriate
future value factor from Table
1
3. For 5 years and 5%, the appropriate
FVF is 1.27628
4. FV = $50,000 x 1.27628 = $63,814

Slide M2.9
Future Value of an Annuity

Representative scenario: Series of

$50,000 investments at the end of each of
the following five years in a mutual fund
yielding 12%.
Basic structure of this scenario:

$50K $50K $50K $50K $50K

Year 1 Year 2 Year 3 Year 4 Year 5

What is the future value of this

annuity? That is, its value on
December 31, Year 5?

Slide M2.10
Solution:

1. FVA = A x FVAF
2. Where: FVAF = the appropriate
future value of an annuity factor
from Table 2
3. For 5 years and 12%, the appropriate
FVAF is 6.35285
4. FVA = $50,000 x 6.35285 = $317,642

Slide M2.11
 Present Value of a Single
Amount

Representative scenario: $100,000 to be

paid in three years with an appropriate
discount rate of 6%

Basic structure of this scenario:

Present Value Future Value

? $100,000

3 years @ 6%

Slide M2.12
Solution:

1. PV = FV x PVF
2. Where: PVF = the appropriate
present value factor from
Table 3
3. For 3 years and 6%, the appropriate
PVF is .83962
4. PV = $100,000 x .83962 = $83,962

Slide M2.13
Present Value of an Annuity

Representative scenario: Series of

$400,000 receipts, one at the end of each of
the following three years. Appropriate
discount rate is 10%.
Basic structure of this scenario:

$400K $400K $400K

Year 1 Year 2 Year 3

What is the present value of this

annuity on Day One of Year 1?

Slide M2.14
Solution:

1. PVA = A x PVAF
2. Where: PVAF = the appropriate
present value of an annuity factor
from Table 4
3. For 3 years and 10%, the appropriate
PVAF is 2.48685
4. FVA = $400,000 x 2.48685 = $994,740

Slide M2.15