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Time Value of Money Formulas Explained

This document introduces some key time value of money concepts and formulas: - Present value represents money received today, while future value is money received at a later date. Interest rates quantify the exchange rate between present and future money. - The future value formula calculates how much a present amount will be worth in the future given a periodic interest rate and number of periods. - The present value formula calculates how much needs to be invested today to achieve a future amount, and is used to discount future cash flows to their value in the present. - Examples demonstrate using the present value formula to calculate how much needs to be invested today to have $10,000 in one year or to receive $500 annually

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Mehedi Hasan
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52 views10 pages

Time Value of Money Formulas Explained

This document introduces some key time value of money concepts and formulas: - Present value represents money received today, while future value is money received at a later date. Interest rates quantify the exchange rate between present and future money. - The future value formula calculates how much a present amount will be worth in the future given a periodic interest rate and number of periods. - The present value formula calculates how much needs to be invested today to achieve a future amount, and is used to discount future cash flows to their value in the present. - Examples demonstrate using the present value formula to calculate how much needs to be invested today to have $10,000 in one year or to receive $500 annually

Uploaded by

Mehedi Hasan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd

5

Formulas

Introduction to Valuation: The


Time Value of Money

0
Basic Definitions
⮚ Present Value – earlier money on a time line
⮚ Future Value – later money on a time line
⮚ Interest rate – “exchange rate” between earlier
money and later money
● Discount rate
● Cost of capital
● Opportunity cost of capital
● Required return

1
Future Values: General Formula
⮚ FV = PV(1 + r)t
● FV = future value
● PV = present value
● r = period interest rate, expressed as a
decimal
● T = number of periods
⮚ Future value interest factor = (1 + r)t

3
Present Values
⮚ How much do I have to invest today to have some
amount in the future?
● FV = PV(1 + r)t
● Rearrange to solve for PV = FV / (1 + r) t
⮚ When we talk about discounting, we mean finding the
present value of some future amount.
⮚ When we talk about the “value” of something, we are
talking about the present value unless we
specifically indicate that we want the future value.

5
Present Value – One Period
Example
⮚ Suppose you need $10,000 in one year for the down
payment on a new car. If you can earn 7% annually,
how much do you need to invest today?
⮚ PV = 10,000 / (1.07)1 = 9,345.79
⮚ Calculator
● 1N
● 7 I/Y
● 10,000 FV
● CPT PV = -9,345.79

6
Present Value for Annuity Cash
Flows

Suppose we were examining an asset that promised to pay $500 at the


end of each of the next three years. The cash flows from this asset are in
the form of a three-year, $500 annuity. If we wanted to earn 10 percent on
our money, how much would we offer for this annuity?

13
Present Value for Annuity Cash
Flows

14
Future Value for Annuities
⮚ Suppose you plan to contribute $2,000
every year to a retirement account paying
8 percent. If you retire in 30 years, how
much will you have?

15
Future Value for Annuities

16
Annuity Due
⮚ An annuity due is an annuity for which the
cash flows occur at the beginning of
each period.

17

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