Time Value of Money - refers to the

observation that it is better to receive

money sooner than later.

Money that you have in hand today
can be invested to earn a positive rate
of return, producing more money
tomorrow.

Suppose a firm has an opportunity to spend
$15,000 today on some investment that will
produce $17,000 spread out over the next
five years as follows:
Year 1 $3,000
Year 2 $5,000
Year 3 $4,000
Year 4 $3,000
Year 5 $2,000


$-15000 $3,000 $5000 $4,000 $3,000 $2,000


0 1 2 3 4 5

End of Year
Future Value techniques typically measure cash flows at the
end of a projects life.
Present Value techniques measure cash flows at the start of
a projects life (time zero).
Compounding and Discounting time
line showing compounding to find future
value and discounting to find present
value.

Computational Tools
Financial Calculators include numerous
programmed financial routines.
Electronic Spreadsheet have built-in
routines that simplify time value
calculations.

Single Amount a lump sum amount
either currently held at some future
date.

Annuity a level periodic stream of
cash flow.

Mixed Stream - a stream of cash flow
that is not an annuity.

The Concept of Future Value
future value - the value at a given future
date of an amount placed on deposit today
and earning interest at a specified rate.
compound interest - Interest that is earned
on a given deposit and has become part of
the principal at the end of a specified
period.
Principal - the amount of money on which
interest is paid.

Equation for present value
PV =FVn/(1 + r)n

Equation for the future value
FVn = PV * (1 + r)n

If Fred Moreno places $100 in a savings account paying 8%
interest compounded annually, at the end of 1 year he will
have $108 in the accountthe initial principal of $100 plus
8% ($8) in interest.

Future value at end of year 1 = $100 * (1 + 0.08) = $108
Future value at end of year 2 = $100 * (1 + 0.08) * (1 + 0.08)
= $100 * (1 + 0.08)2
= $116.64


- A series of payments of an equal
amount at fixed intervals for a specified
number of periods.

An ordinary or deferred
annuity consists of a series
equal payment made at the
end of each period









Where:

FV = Future Value of Ordinary Annuity
CF = Periodic cash flow/payment
r = Interest
n = Number of periods

Fran Abrams will deposit $1,000
annually, at the end of each year
for the next 5 years, into a savings
account paying 7% annual interest.
How much money he will have 5
years from now?
CF = $1000
r = 7%
n = 5
FV = ?








Where:

PV = Present Value of an Ordinary Annuity
CF = Periodic cash flow/payment
r = Interest
n = Number of periods
Braden Company, a small producer of
plastic toys, wants to determine the most
it should pay to purchase a particular
annuity due. The annuity consists of cash
flows of $700 at the end of each year for 5
years. The firm requires the annuity to
provide a minimum return of 8%. How
much is the present value of the said
annuity due?





= $700 x (3.9927)
= 2794.89
An annuity due has cash flows that
occur at the beginning of each period.


An annuity due will always be greater
than an otherwise equivalent ordinary
annuity because interest will
compound for an additional period.




Where:

FV = Future Value of Annuity Due
CF = Periodic cash flow/payment
r = Interest
n = Number of periods
Fran Abrams will deposit $1,000
annually, at the beginning of each
year for the next 5 years, into a
savings account paying 7% annual
interest.
How much money he will have 5
years from now?
CF = $1000
r = 7%
n = 5
FV = ?

= 1000
(1+.07)
5
1
.07
x (1+ .07)
= 1000 x 5.75073901 x 1.07
= $6153.29
Where:

PV = Present Value of Annuity Due
CF = Periodic cash flow/payment
r = Interest
n = Number of periods

Braden Company, a small producer of
plastic toys, wants to determine the most it
should pay to purchase a particular annuity
due. The annuity consists of
cash flows of $700 at the beginning of each
year for 5 years. The firm requires the
annuity to provide a minimum return of 8%.
How much is the present value of the said
annuity due?
CF = $700
r = 8%
n = 5
PV = ?

=
700
.08
x [ 1
1
(1+.08)
5
] (1 + .08)
= 8750 1 .680583197 1.08
= 8750 .319416803 1.08
= $3018.49



A stream of unequal periodic cash flows that
reflect no particular pattern.


End of year Cash flow
1 $11,500
2 14,000
3 12,900
4 16,000
5 18,000


End of year Cash flow
1 $400
2 800
3 500
4 400
5 300

End of Year

0 1 2 3 4 5



366.97 400 800 500 400 300
673.34
386.09
283.37
194.98
$1,904.75
Interest is often compounded
more frequently than annually.
Financial institutions such as
banks compound interest
semi-annually, quarterly,
monthly etc.


S=P(1+j/m)^m*t
S= value after t periods
P= principal amount ( investment )
j= annual nominal interest rate
m= the no. of times the interest is
compounded per year
t= number of years

Involves two compounding periods in a year


Future Value from investing 100 at 8% Interest Compounded
Semi-annually for 24 months (2years)
Period (t) Principal (P) Future Value Calculation Future Value (S)
6 Months 100 100*(1+0.04) 104
12 Months 104 104*(1+0.04) 108.16
18 Months 108.16 108.16*(1+0.04) 112.49
24 Months 112.49 112.49*(1+0.04) 116.99
Involves four compounding periods in a year


Future Value from investing 100 at 8% Interest Compounded
Quarterly for 24 months (2years)
Period (t) Principal (P) Future Value Calculation Future Value (S)
3 Months 100 100*(1+0.02) 102
6 Months 102 102*(1+0.02) 104.04
9 Months 104.04 104.04*(1+0.02) 106.12
12 Months 106.12 106.12*(1+0.02) 108.24


Future Value from investing 100 at 8% Interest Compounded
Quarterly for 24 months (2years)
Period (t) Principal (P) Future Value Calculation Future Value (S)
15 Months 108.24 108.24*(1+0.02) 110.41
18 Months 110.41 110.41*(1+0.02) 112.62
21 Months 112.62 112.62*(1+0.02) 114.87
24 Months 114.87 114.87*(1+0.02) 117.17


Future Value from investing 100 at 8% Interest Rate for
different compounding periods
End of Year Annual Semi-Annual Quarterly
1 108 108.16 108.24
2 116.64 116.99 117.17
A invest 100 at 8% interest compounded
semi-annually and quarterly
*semi-annual
S=P(1+j/m)^m*t S=100(1+0.08/2)^2*2
=116.99
*quarterly
S=100(1+0.08/4)^4*2
=117.17
The nominal, or stated, annual rate is the
contractual annual rate of interest charged by
a lender or promised by a borrower.
The effective, or true, annual rate (EAR) is the
annual rate of interest actually paid or
earned.
Fred Moreno wishes to find the effective annual
rate associated with an 8% nominal annual rate
when interest is compounded (1) annually ; (2)
semiannually ; and (3) quarterly
1. Annual Compounding
=((1+.08/1)^1) -1 =0.08 or 8%
2. Semi Annual Compounding
=((1+.08/2)^2) -1 =0.0816 or 8.16%
3. Quarterly
=((1+.08/4)^4) -1 =0.0824 or 8.24%
Future value and present value techniques
have a number of important applications
in finance. Well study four of them in this
section:
1. Determining deposits needed to
accumulate a future sum.
2. Loan amortization
3. Finding interest or growth rates, and
4. Finding an unknown number of periods







Suppose you want to buy a house 5 years from now and
you estimate that the down payment needed will be
$30,000. How much would you need to deposit at the
end of each year for the next 5 years to accumulate
$30,000 if you can earn 6% on your deposits?
The term loan amortization refers to the
determination of equal periodic loan payments
necessary to provide a lender with a specified
interest return and to repay the loan principal
over a specified period.

A loan amortization schedule is a schedule of
equal payments to repay a loan. It shows the
allocation of each loan payment to interest and
principal.

You borrow $6,000 at 10% and agree to
make equal annual end-of-year payments
over 4 years.

Loan Amortization Schedule ($6,000
Principal, 10% Interest, 4-Year Repayment
Period)


Ray Noble purchased an investment four years
ago for $1,250. Now it is worth $1,520. What
compound annual rate of return has Ray earned
on this investment?



Ann Bates wishes to determine the number of years it will
take for her initial $1,000 deposit, earning 8% annual
interest, to grow to equal $2,500. Simply stated, at an 8%
annual rate of interest, how many years, n, will it take for
Anns $1,000 (PV
n
) to grow to $2,500 (FV
n
)?