Time Value of Money

Time Value of Money
Refers to the expected increase in its

peso value considering the prevailing
interest rates, passage of time, opportunity
cost of capital and similar factors.
Interest defined as the cost of using

money over time.
The cost of the excess resources to the
borrower for the use of the money is called
interest expense.
The benefit of the excess resources to the
lender of the money is called interest
revenue.
Time value of money involves two major

concepts:
1.Principal
2. Interest Rate
3. Time Period
Is the product of the

principal amount
multiplied by the
periods interest
rate.
Example.
ABC Corporation
deposits P10,000 in
a bank at 10%
interest in a year.
Principal
Interest
Future Value
10,000
1,000
11,000
Is the interest paid on both the principal and

the amount of interest accumulated in prior
periods.
The process of determining future value
when compound interest is applied is called
compounding.
Example
Now suppose ABC
Corporation leaves
its P10,000 on
deposit for two
years in a bank
paying 10% annual
interest. At the end
of the first year,
the initial deposit
becomes P11,000.
Bal. at the
beginning of
year 2
Interest for year
2 at 10%
Future Value at
the end of year
2
P11,000
1,100
P12,100
Simple Interest is the interest paid or

earned on the initial principal only.
Compound interest is the interest paid on
both the principal and the amount of
interest accumulated in prior periods.
Using compound interest usually results in a
greater future value than using simple
interest.
Example:
The financial manager ha sthe choice of
leaving P1,000 with a bank paying 10%
simple interest or 10% compound interest
for five years.
Beginnin
g Amount
Simple
Interes
t
[.10x(1
)]
Ending
Amoun
t
Beginning
Amount
Compound
Interest
[(.10)x(4)]
Ending
Amount
[(4)+(5)]
Year
(1)
(2)
(3)
(4)
(5)
(6)
P1,000
P100
P1,10
0
P1,000
P100
P1,100
P1,000
P100
P1,20
0
P1,100
P110
P1,210
P1,000
P100
P1,30
0
P1,210
P121
P1,331
P1,000
P100
P1,40
0
P1,331
P133.10
P1,464.10
P1,000
P100
P1,50
0
P1,464.10 P146.41
P1,610.51
Total
interest
P500
P610.51
FVn=PV(1+i)n
Future Value (FVn) is equal to the initial
principal amount (PV), compounded at the
interest rate (i) for period (n).
Example: The future values of P1,000
compounded at a 10% annual interest rate
at the end of one year, two years, and five
years are computed as follows:
Year1 FV1=(P1,000)(1+.10)1=P1,100.00
Year2 FV2=(P1,000)(1+.10)2=P1,210.00
(P1,000)(1.21)
Year5 FV5=(P1,000)(1+.10)5=P1,610.51
(P1,000)(1.61051)
Instead of computing the value of the term

(1+i)n, you can use a table to find this
value. The value is called the future value
interest factor or FVIFi,n
And may be viewed as the result of
investing or lending P1 at interest rate (i)
for (n) periods.
Compounding that occurs more than once a

year is called intraperiod compounding.
The calendar period over which
compounding occurs is called the
compounding period.
For example, compounding may occur

annually, semiannually, quarterly, or
monthly.
When using intraperiod compounding the
future value formula must be modified to
reflect the number of times per year
compounding occurs, denoted by m.
FVn=PV{1+i/m}mn
Example:
Instead of placing P1,000 in Atlanta Bank
that pays 10% interest annually, the
financial manager decides to put the
money in National bank that pays 10%
interest compounded
semi-annually. Between the two banks,
there would be a difference in the future
value of your investment in one year.
Atlanta Bank
Annual Compounding
FV=(P1,000)(1+.10)1
=(P1,000)(1.10)
=P1,100.00
National Bank
Semiannual
Compounding
FV=(P1,000)(1+0.10/2)
(2)(1)
=(P1,000)(1.1025)
=P1,102.50
Nominal interest rate is simply the stated rate

such as 10%. The effective interest rate also
called the annual percentage rate or APR, is the
true interest rate and may differ from the nominal
rate
depending
on
the
frequency
on
compounding.
APR={1+i/m}m-1
The equation above is used to find the effective
interest rate. In this equation, i is the nominal rate
and m is the number of compounding periods per
year.
Example:
Disney Incorporated deposits money in a
bank that pays a 10% nominal interest
rate and compounds interest semiannually.
Substituting i=0.10 and m= will result to:

APR={1+0.10/2}2-1
=(1.05)2-1
=1.1025-1
=0.1025 or 10.25%
A stream of equal payments made at

regular time intervals is an annuity,
sometimes called a fixed annuity.
There are two types

1. Ordinary Annuity
2. Annuity Due
Ordinary Annuity
-Is one which the payments or receipts occurs at
the end of each period. This type of annuity is
also called a regular or deferred annuity.
FVOAn=A (FVIFAi,n)
FVOAn = future value of an ordinary annuity
A = the amount of the fixed annuity
payment
(FVIFAi,n) = future value interest factor of an annuity
for interest rate (i), and time period of
(n)
1.
Example:
Crystal Corporation deposits P1,000 at the
end of each three consecutive years in a bank
account paying 10% interest compounded
annually. The value of the account at the end
of the third year is computed by, substituting
A=P1,000, i=1.10 and n=3.
FVOA3=(P1,000)(FVIFA0.10,3)
=(P1,000)(3.310)
=P3,310
Assuming that you are receiving Php1,000 every year

for the next five years, and you invested each payment
at 5%.
2. Annuity Due
-Is one which payments or receipts occur
at the beginning of each period.
FVADn =A(FVIFAi,n)(1+i)
FVADn =Future Value of Annuity Due
Example.
Instead of depositing P1,000 at the end of
each year for three consecutive years, the
firm makes deposits at the beginning of
each year. Interest is compounded annually
at 10%. How much will the firm have in
account after three years?
FVAD3=(P1,000)(3.310)(1.10)
=(P1,000)(3.641)
=P3,641
The future value for annuity due (P3,641) is
greater than that for ordinary annuity
(P3,310) because each deposit is made one
year earlier and consequently earns interest
one year longer.
Each payment is made at the beginning of the period rather than at the end.
Present Value
-Is the current value of a future amount of
money, or series of payments, evaluated at
an appropriate discount rate.
Discount rate -sometimes called the
required rate of return, is the rate of
interest that is used to find present values.
The process of determining the present value
of a future amount is called discounting.
Future value determination compounds

money forward in time to determine its
worth in the future. Present value
determination discounts money that will be
received in the future back in time to see
what it is worth in the present.
PV= FVn/(1+i)n or FVn(1/1+i)n
Blueberry Company expects to receive P1,100 one year

from now. What is the present value of this amount if
the discount rate is 10%?
PV= 1,100/(1.10)1
= 1,000
Or
PV=(1,000)[(1/(1.10) 1
=(1,000)(0.9091)
=1,000.01
Present Value of Ordinary Annuity

The current value of a set of cash flows in
the future given a specified rate of return or
discount.
Present Value of Annuity Due

Referred to as an immediate annuity, is
used to calculate a series of periodic
payment
or
cash
flows
that
start
immediately.

Time Value of Money

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Time Value of Money

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Time Value of Money

Refers to the expected increase in its

Interest defined as the cost of using

Time value of money involves two major

Is the product of the

Is the interest paid on both the principal and

Simple Interest is the interest paid or

Instead of computing the value of the term

Compounding that occurs more than once a

For example, compounding may occur

Nominal interest rate is simply the stated rate

Substituting i=0.10 and m= will result to:

A stream of equal payments made at

There are two types

Assuming that you are receiving Php1,000 every year

Future value determination compounds

Blueberry Company expects to receive P1,100 one year

Present Value of Ordinary Annuity

Present Value of Annuity Due

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