Financial

Management 2
TIME VALUE OF MONEY

Presented by : Joel A. Chua

 CongratulaEons!!! You have won a cash prize!

You have two payment opEons: A - Receive
$10,000 now OR B - Receive $10,000 in three
years. Which opEon would you choose?

Time Value of Money

is the value of money guring in a given amount of interest earned or
inaEon accrued over a given amount of Eme.
a certain amount of money today has dierent buying power than the
same amount of money in the future.
is based on the concept that a value that you have today is worth more
than the promise or expectaEon that you will receive the value in the
future.
Interest (%) - charge for borrowing money, usually stated as a percentage of
the amount borrowed over a specic period of Eme.
1. Simple interest - is computed only on the original amount borrowed.
It is the return on that principal for one Eme period.
2. Compound Interest - is calculated each period on the original amount
borrowed plus all unpaid interest accumulated to date.

Simple and Compound Interest

Simple Interest ComputaEon :
Year
Year
Year
Year
Year

1:
2:
3:
4:
5:

5%
5%
5%
5%
5%

of
of
of
of
of

$100
$100
$100
$100
$100

=
=
=
=
=

$5
$5
$5
$5
$5

+
+
+
+
+

$100
$105
$110
$115
$120

=
=
=
=
=

$105
$110
$115
$120
$125

Compound Interest ComputaEon :

Year
Year
Year
Year
Year

1:
2:
3:
4:
5:

5%
5%
5%
5%
5%

of
of
of
of
of

$100.00
$105.00
$110.25
$115.76
$121.55

=
=
=
=
=

$5.00
$5.25
$5.51
$5.79
$6.08

+
+
+
+
+

$100.00
$105.00
$110.25
$115.76
$121.55

=
=
=
=
=

$105.00
$110.25
$115.76
$121.55
$127.63

Uses of Time Value of Money (TVM)

Time Value of Money or TVM is a concept that is used in all aspects of nance
including:
1. Bond valuaEon
2. Stock valuaEon
3. Accept/reject decisions for project management
4. Financial analysis of rms
5. And many others. (Lease Payments)

Future Value and Present Value

Present Value is an amount today that is equivalent to a future payment,
or series of payments, that has been discounted by an appropriate
interest rate. The future amount can be a single sum that will be received
at the end of the last period, as a series of equally-spaced payments (an
annuity), or both. Since money has Eme value, the present value of a
promised future amount is worth less the longer you have to wait to
receive it.
1. Single amount
2. Annuity

Future Value is the amount of money that an investment with a xed,
compounded interest rate will grow to by some future date. The
investment can be a single sum deposited at the beginning of the rst
period, a series of equally-spaced payments (an annuity), or both. Since
money has Eme value, we naturally expect the future value to be greater
than the present value. The dierence between the two depends on the
number of compounding periods involved and the going interest rate.
1. Single amount
2. Annuity

Basic Pacerns of Cash Flow

Single Amount

A lump-sum amount either currently held or expected at some future

date.

Annuity

A level periodic stream of cash ow. For our purposes, well work
primarily with annual cash ows.

Mixed Stream

A stream of cash ow that is not an annuity; a stream of unequal periodic
cash ows that reect no parEcular pacern.

I. Single Cash Flow

The concept of Future Value
The future value of a present amount is found by applying compound
interest over a specied period of Eme.
The EquaEon for Future Value :
We use the following notaEon for the various inputs:
FVn = future value at the end of period n
PV = iniEal principal, or present value
r = annual rate of interest paid. (Note: On nancial calculators, I is
typically used to represent this rate.)
n = number of periods (typically years) that the money is lef on deposit.
Hence :



FVn = PV * (1 + r)n

Future Value ComputaEon :

Exercise :
1. You deposited Php2,000 today at 6% interest. How much will you have in
5 years?

The Answer: Php2,000 1.3382 = Php2,676.40

I. Single Cash Flow

The concept of Present Value
Present value is the current dollar value of a future amountthe amount of

money that would have to be invested today at a given interest rate over a
specied period to equal the future amount.

The process of nding present values is ofen referred to as discounJng cash
ows. (discount rate, required return, cost of capital, and opportunity cost)
The EquaEon for Future Value :
We use the following notaEon for the various inputs:

PV = FVn
(1 + r)n

Present Value ComputaEon :

Exercise :
1. How much would you have to deposit now to have $15,000 in 8 years if
interest is 7%?

The Answer: $15,000 .582 = $8,730

II. AnnuiEes

a stream of equal periodic cash ows, over a specied Eme period. These cash
ows are usually annual but can occur at other intervals, such as monthly rent or
car payments.
Deals with : 1. Payment today, on a guaranteed amount in the future.
2. Future amount of a currently placed investment today.

This topic aims to discuss the following :
I. Finding the Future Value of an Ordinary Annuity
II. Finding the Present Value of an Ordinary Annnuity
III. Finding the Future Value of an Annuity Due
IV. Finding the Present Value of an Annuity Due
V. Finding the Present Value of a Perpetuity

III. Mixed Streams of Cash Flow

Mixed Stream is a stream of unequal periodic cash ows that reect no parEcular
pacern.
Future Value of Mixed Streams
We determine the future value of each cash ow at the specied future date and
then add all the individual future values to nd the total future value.
Present Value of Mixed Streams
We determine the present value of each future amount and then add all the
individual present values together to nd the total present value.

Special ApplicaEons of Time Value

1. Determining Deposits Needed to Accumulate
a Future Sum
2. Loan AmorEzaEon
3. Finding interest or Growth Rates
4. Finding an unknown number of periods.