REPORT

IN
BUSINESS FINANCE
TIME VALUE OF MONEY AND OPPORTUNITY COST
THE CONCEPT OF TIME VALUE OF MONEY STATES THAT A PESO TODAY, ALL THINGS
BEING EQUAL, HAS GREATER VALUE THAN A PESO IN THE FUTURE BECAUSE OF THE
OPPORTUNITY TO INVEST THAT PESO TODAY AND EARN INTEREST.
FOR EXAMPLE, CHOOSING BETWEEN A EUROPEAN OR AN ASIAN TRIP, YOU MUST
CAREFULLY WEIGH ALL CONSIDERATIONS INCLUDING THE COSTS. CHOOSING ONE
OPTIONS MEANS LETTING GO OF THE OTHER OPTION. SO THE COST OF CHOOSING
EUROPEAN TRIP MEANS LOSING THE OPPORTUNITY TO GO ON AN ASIAN TRIP, OR VICE
VERSA.
OPPORTUNITY COST IS ANYTHING GIVEN UP AFTER CHOOSING AN OPTION. IN FINANCE, IT
IS POSSIBLE INCOME FROM ONE OPTION OR INVESTMENT
 GOOD MONEY MANAGEMENT IS A DECISION TO INVEST EITHER IN MONEY MARKET, FIXED-
INCOME SECURITIES, STOCKS, BONDS, REAL STATE, OR IN SMALL BUSINESS VENTURE. IF
YOU DECIDE TO SPEND THE MONEY INSTEAD OF INVESTING IT, YOU ARE FOREGOING THE
OPPORTUNITY TO EARN INTEREST FROM INVESTING THIS MONEY. IF YOU DECIDE TO
INVEST IN FINANCIAL INSTRUMENT-FIXED-INCOME SECURITIES, BONDS, OR STOCKS-YOU
ARE SAYING NO TO INVESTMENT IN REAL STATE AND START-UP BUSINESS.
 TO ILLUSTRATE:
YOU DEPOSITED 10,000 IN A SAVINGS ACCOUNT.
THE BANK PAYS AN INTEREST OF 3% ANNUALLY.
HOW MUCH INTEREST WILL THIS ACCOUNT EARN IN ONE YEAR?

FORMULA:
PRINCIPAL ANNUAL INTEREST RATE TIME = INTEREST EARNED FOR ONE YEAR

SOLUTION:
10,000 0.03 1 = 300 FOR ONE YEAR

ANSWER:
THE ACCOUNT WILL EARN 300 FOR ONE YEAR
PRESENT VALUE
MONEY NOW IS MORE VALUABLE THAN MONEY LATER ON.
PRESENT VALUE IS DETERMINING TODAYS WORTH OF THIS FUTURE VALUE (INVESTMENT +
EARNED INCOME). IT IS ALSO KNOWN AS DISCOUNTING.

THE FORMULA TO COMPUTE FOR THE PRESENT VALUE OF MONEY IS:

PV = FV N / (1 + I) N
WHERE:
PV = PRESENT VALUE
FN = FUTURE VALUE IN N PERIOD
N = NUMBER OF PERIOD
I = INTEREST RATE
PV = FV N / (1 + I) N

EXAMPLE: WHAT IS $570 IN 3 YEARS TIME WORTH NOW, AT AN INTEREST RATE OF 10% ?
PV = $570 / (1+0.10)3
PV = $570 / 1.331 = $428.25 (TO NEAREST CENT)
EXAMPLE: YOU ARE PROMISED $800 IN 10 YEARS TIME. WHAT IS ITS PRESENT VALUE AT AN
INTEREST RATE OF 6% ?
PV = $800 / (1+0.06)10
PV = $800 / 1.7908... = $446.72 (TO NEAREST CENT)
WHY DO WE NEED TO COMPUTE FOR
PRESENT VALUE?
IF YOU KNOW THE PRESENT VALUE OF AN INVESTMENT AS WELL AS THE PRESENT VALUE
OF THE OTHER INVESTMENTS, YOU CAN COMPARE WITH THEIR RESPECTIVE VALUE
TODAY. PRESENT VALUE WILL TELL YOU THE INITIAL AMOUNT OF MONEY REQUIRED TO
ACHIEVE YOUR TARGET RETURN AT A GIVEN INTEREST RATE AT A CERTAIN NUMBER OF
PERIODS. THEREFORE, YOU CONSIDER THE INVESTMENT WITH A LOWER PRESENT
VALUE BUT WITH A HIGHER POSSIBLE RETURN. BEING ABLE TO COMPUTE FOR THE
VARIOUS INVESTMENT RETURNS BASED ON AN INTEREST RATE AND INITIAL REQUIRED
INVESTMENT WILL HELP AN INVESTOR DECIDE WHICH INVESTMENT TO CHOOSE FROM.
FUTURE VALUE
THE FUTURE VALUE OF MONEY IS THE AMOUNT YOUR ORIGINAL FUNDS WILL BE WORTH IN THE
FUTURE, BASED ON EARNING AN INTEREST RATE OVER A TIME PERIOD
COMPOUNDING MAKES MONEY INCREASE OVER TIME, GIVEN A CERTAIN INTEREST RATE
FV MEANS AN AMOUNT OF MONEY IN THE FUTURE DISCOUNTED BY AN INTEREST RATE TO
EQUATE THE BUYING POWER OF THE FUTURE DOLLAR WITH THE PRESENT DOLLAR.
THE FORMULA TO COMPUTE FOR FUTURE VALUE OF MONEY IS:
FVn = PV( 1 + I )n
WHERE:
FV = FUTURE VALUE IN N PERIOD
PV = PRESENT VALUE OR THE MONEY INVESTED TODAY
I = INTEREST RATE
N = NUMBER OF PERIODS
 FVn = PV( 1 + I )n

EXAMPLE: SUPPOSE YOU ARE DEPOSITING AN $5,000 TODAY IN AN ACCOUNT THAT EARNS 5%
INTEREST , COMPOUNDED ANNUALLY. WHAT WILL BE THE BALANCE IN THE ACCOUNT AT
THE END OF SIX YEARS IF YOU MAKE NO WITHDRAWALS?
FV = $5,000 ( 1 + 0.05 ) 6
= $5000 ( 1.3401 )
= $6,701
Rate 3%
Year Principal Interest
1 10,000.00 300.00 10,000
2 10,300.00 309.00 10,300.00
3 10,609.00 318.27 10,609.00
4 10,927.27 327.82 10,927.27
5 11, 255.09 337.65 11, 592.74
5 YEARS LINE GRAPH
FUTURE VALUE WITHIN 5 YEARS
5

10,000 10,300 10,609.00 10,927.27 11,255.09