Time Value of Money

Time value of money refers to the fact that a peso in hand today is worth more than a peso promised
at some time in the future.

The three basic patterns of cash flows include:

 A single amount: A lump sum amount either held currently or expected at some future date.
 An annuity: A level periodic stream of cash flow.
 A mixed stream: A stream of unequal periodic cash flows.

FUTURE VALUE OF CASH FLOWS

Future value (FV) refers to the amount of money an investment will grow to over some period
of time at some given interest rate.

The Process of Compounding

Compounding refers to the process of accumulating interest on an investment over time to

earn more interest.

Interest on Interest is the interest earned on the reinvestment of previous interest

payments.

Compound Interest is the interest earned on both the initial principal and the interest
reinvested from prior periods.

Future Value of a Single Amount

To compute for the future value of single amount:

First, compute for the Future Value Factor
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 = (1 + 𝑖)𝑛
Where:
i = interest
n = number of period
Finally, compute for the Future Value
Future Value = Principal x FV Factor

Example:
On January 1, year 1, You are to invest 10,000 to a debt investment that pays 10% per year.
What is the value of the investment at the end of 3 years?

𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 = (1 + 10%)3

𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 = 1.331

Future Value = Principal x FV Factor

Future Value = 10,000 x 1.331
Future Value = 13,310

Let us examine at how we calculated 13,310

Year Principal(A) Interest on Interest on Compound Total Total Value
Principal Interest Interest Interest of Inv.
(B) Earned
E = D Previous
C = ( E previous year Year + D Current F = F previous
A B = (A*i) * i) D= B + C Year year + D

1/1/Y1 10,000 0 10,000

12/31/Y1 10,000 1,000 0 1,000 1,000 11,000
12/31/Y2 10,000 1,000 100 1,100 2,100 12,100
12/31/Y3 10,000 1,000 210 1,210 3,310 13,310
Future Value of an Ordinary Annuity

To compute for the future value of an ordinary annuity:

First, compute for the Future Value Factor
[(1 + 𝑖)𝑛 − 1]
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 =
𝑖
Where:
i = interest
n = number of period
Finally, compute for the Future Value
Future Value = Principal x FV Factor

Example:

You are to invest 10,000 every year end to a debt investment that pays 10% per year. What
is the value of the investment at the end of year 3?

(1 + 10%)3 − 1
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 =
10%
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 = 3.31

Future Value = Principal x FV Factor

Future Value = 10,000 x 3.31
Future Value = 33,100

Let us examine at how we calculated 33,100

Year Principal(A) Interest on Interest on Compound Total Total Inv.
Principal Interest Interest Interest
(B) Earned
F= A+E
E = D Previous
B = (A previous C = ( E previous year Year + D Current
A year*i) * i) D= B + C Year

12/31/Y1 10,000 0 0 10,000

12/31/Y2 20,000 1,000 0 1,000 1,000 21,000
12/31/Y3 30,000 2,000 100 2,100 3,100 33,100

Notice that on year 1, no interest is earned because it is the first installment of the investment.
Notice also that the interest on principal is based on the previous year principal because only the
previous year investment had a lapse of time sufficient to earn interest. The additional investment in
year 2 of 10,000 made at year end of year 2 will not earn interest on year 2 because basically the year
2 additional 10,000 investment had no lapse of time. TAKE NOTE: Interest is earned because of lapse
of time, and the rates are normally expressed annually. Thus, interest is normally paid at year-end.

Future Value of an Annuity Due

To compute for the future value of an ordinary annuity:

First, compute for the Future Value Factor
[(1 + 𝑖)𝑛+1 − 1]
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 = −1
𝑖
Where:
i = interest
n = number of period
Finally, compute for the Future Value
Future Value = Principal x FV Factor

Example:

You are to invest 10,000 every beginning of the year to a debt investment that pays 10% per
year. What is the value of the investment at the end of year 3?
 (1 + 10%)3+1 − 1
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 = −1
10%
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)𝑓𝑎𝑐𝑡𝑜𝑟 = 3.31

Future Value = Principal x FV Factor

Future Value = 10,000 x 3.641
Future Value = 36,410

Let us examine at how we calculated 33,100

Year Principal(A) Interest on Interest on Compound Total Total Inv.
Principal Interest Interest Interest
(B) Earned
F= A+E
E = D Previous
B = (A *i) C = ( E previous year Year + D Current
A * i) D= B + C Year

12/31/Y1 10,000 1,000 0 1,000 1,000 11,000

12/31/Y2 20,000 2,000 100 2,100 3,100 23,100
12/31/Y3 30,000 3,000 310 3,310 6,410 36,410

Notice that there is an interest in the principal in 12/31/y1 because the initial principal was invested
1/1/y1 thus there was a lapse of time.

PERPETUITIES

An annuity in which the cash flows continue forever.

To compute for the value of the perpetuity

𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 =
𝑖

Example:

An investment offers a perpetual cash flow of 10,000 every year. The return on investment
is 10%. What is the value of the investment?

𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 =
𝑖
10,000
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 =
10%
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 = 100,000

CALCULATION OF TIME VALUES USING BASIC CALCULATOR

Computation of Present Values (PVs) using Basic Calculator

Present Value (PV) of 1:

1+Rate [÷](2 times) [=](period)
Steps:
1. Get the sum of 1 plus the rate
2. Press the divide button twice
3. Press the equal sign which should be pressed the same number times as the period

Example: i=10%, n=3

Place in calculator 1.1, press divide twice, then press equal sign you should be getting .90909 press
equal sign again you should be getting .826446 and press equal sign again you should get .751314
notice that the number of times we pressed equal sign is the number of periods ;)

Present Value of Ordinary Annuity (PVOA) of 1:

1+Rate [÷](2 times) [=](period) -1 ÷Rate
Steps:
 1. Get the sum of 1 plus the rate
2. Press the divide button twice
3. Press the equal sign which should be pressed the same number times as the period
4. From number 3, deduct 1
5. From number 4, divide to the rate

Example: i=10%, n=3

Place in calculator 1.1, press divide twice, then press equal sign you should be getting .90909 press
equal sign again you should be getting .826446 and press equal sign again you should get .751314.
1 - .751314 you should be getting .248685 which you will divide by the rate of 10% will give you
2.486851991 

Present Value of Annuity Due (PVAD):

1+Rate [÷](2 times) [=](period less 1) -1 ÷Rate -1
Steps:
1. Get the sum of 1 plus the rate
2. Press the divide button twice
3. Press the equal sign which should be pressed the same number times as the period less one
4. From number 3, deduct 1
5. From number 4, divide to the rate
6. From number 5, deduct 1

Example: i=10%, n=3

Place in calculator 1.1, press divide twice, then press equal sign you should be getting .90909 press
equal sign again you should be getting .826446. 1 - . 826446 you should be getting .1735537 which
you will divide by the rate of 10% less 1 should give you 2.735537 

Computation of Future Values (fVs) using Basic Calculator

Future Value (FV) of 1:

1+Rate [x](2 times) [=](period less 1)
Steps:
1. Get the sum of 1 plus the rate
2. Press the multiply button twice
3. Press the equal sign which should be pressed the same number times as the period

Example: i=10%, n=3

Place in calculator 1.1, press multiply twice, then press equal sign you should be getting 1.21 press
equal sign again you should get 1.331 

Future Value of Ordinary Annuity (FVOA) of 1:

1+Rate [x](2 times) [=](period less 1) -1 ÷Rate
Steps:
1. Get the sum of 1 plus the rate
2. Press the multiply button twice
3. Press the equal sign which should be pressed the same number times as the period less one
4. From number 3, deduct 1
5. From number 4, divide to the rate

Example: i=10%, n=3

Place in calculator 1.1, press multiply twice, then press equal sign you should be getting 1.21 press
equal sign again you should get 1.331 from 1.331 deduct 1 you should get an answer of .331 which
you will divide by the rate of 10% the FVOA is 3.31 

Future Value of Annuity Due (FVAD):

1+Rate [X](2 times) [=](period) -1 ÷Rate -1
Steps:
1. Get the sum of 1 plus the rate
2. Press the divide button twice
3. Press the equal sign which should be pressed the same number times as the period
4. From number 3, deduct 1
 5. From number 4, divide to the rate
6. From number 5, deduct 1

Example: i=10%, n=3

Place in calculator 1.1, press multiply twice, then press equal sign you should be getting 1.21 press
equal sign again you should get 1.331 plus equal sign again you should get 1.4641 from 1.4641
deduct 1 you should get an answer of .4641 which you will divide by the rate of 10% less 1 the FVAD
3.641 