Time Value of Money

Simple Interest:
INTEREST
term used in business ABC Corporation deposits P 10,000
in a bank at 10% interest in a year.
cost of using money over time
How much is the future value of the
interest expense = borrower / principal at the end of year 1?
debtor
interest income = lender / creditor
Interest (I) = Principal (P) x Rate
(R) x Time (T)

Time Value of Money – term used

by economist
Future Value (FV) = Principal (P)
+ Interest (I)

3 Factors:
Principal = P 10,000

Principal Interest =P 1,000

(10,000 x 10%)
Interest Rate
FV = P 11,000
Time Period

2 Concepts:

Simple Interest:
Future Value
B. ABC Corporation deposits P
Present Value 10,000 in a bank at 10% interest in a
year. How much is the future value of
the principal after 6 months?
FUTURE VALUE:

Interest (I) = Principal (P) x Rate

compounds money forward in time to (R) x Time (T)
determine its worth in the future

Future Value (FV) = Principal (P)

Compounding is the process of + Interest (I)
determining future value when
compound interest is applied.
Principal = P 10,000

Can Be Computed Using: Interest =P 500

(10,000 x 10% x 6/12 )
FV = P 10,500
A. Simple Interest (interest paid or
earned on the initial principal Simple Interest:
only)
B. Compound Interest (interest paid C. ABC Corporation deposits P
on both the principal and the 10,000 in a bank at 10% interest for
amount of interest accumulated in 5 years. How much is the future
prior periods) value of the money after 5 years?

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 Interest (I) = Principal (P) x Rate ABC Corporation deposits P 10,000
(R) x Time (T) in a bank compounded annually at
10% interest. How much is the
future value of the principal after 5
Future Value (FV) = Principal (P) years?
+ Interest (I)
YEAR AMOUNT COMPOUND
FUTURE

Principal = P 10,000
Interest =P 5,000 1 10,000 1,000
(10,000 x 10% x 5 ) 11,000

FV = P 15,000 2 11,000 1,100

12,100
3 12,100 1,210
Compound Interest: 13,310
4 13,310 1,331
ABC Corporation deposits P 10,000 14,641
in a bank compounded annually at 5 14,641 1,464.10
10% interest. How much is the 16,105.10
future value of the principal at the
end of year 2? 6,105.10

YEAR AMOUNT COMPOUND Compound Interest:

FUTURE

ABC Corporation deposits P 10,000

1 10,000 1,000 in a bank compounded annually at
11,000 10% interest. How much is the
future value of the principal after 5
2 11,000 1,100 years?
12,100
Total time inetrest 2100
Alternative Solution:

FV= PV (1 + i )n where: FV
= future value
= 10,000 (1 + .10)5 PV
= initial principal
= 10,000 (1.61051*) i
= interest rate
= 16,105.10 n =
period

* 1.61051 is referred to as FVIF

(future value interest
factor)

Compound Interest:

2
Future Value (With Intra-period B. FV = PV (1+ i/m) nm
Compounding)
= 10,000 ( 1 + (.10/2)2*1
= 10,000 (1 + .05)2
Intra-period Compounding -
= 10,000 (1.1025)
compounding that occurs more
than once in a year = 11,025

Examples: monthly, quarterly, C. YES BPI = 11,000

semi-annually
BDO = 11,025
25 difference
FV = PV (1 + i/m)m*n

Nominal Rate:
Where:
is also known as stated rate
m refers to the number of times
interest is compounded in a year
Effective Rate:

Example: is also called - APR (annual

ABC Corporation is contemplating to
deposit P 10,000 to BPI that pays 10
percent interest compounded
annually. However, the financial
manager of ABC Corporation
decided to deposit the money at
BDO that pays 10 percent interest
compounded semi-annually.
percentage rate)
is the true interest rate
arises because of the frequency
of compounding in a year
Nominal Rate = Effective Rate if
compounding of interest happens
once in a year

Questions:
What is the FV of P 10,000 should
ABC Corporation opted to deposit it
at BPI after 1 year?
What is the FV of P 10,000 at BDO
after 1 year ?
Was the decision of ABC
Corporation to deposit the money at
BDO right? By how much was the
difference in future values?

Solution:
Example:

FV = PV (1+ i) 1
= 10,000 ( 1.10)1 ABC deposits P 10,000 at BDO
that pays a 10 percent interest rate
= 11,000 compounded semi-annually

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APR = (1 +i/m) m - 1 = 4,924.70
= (1 + .10/2)2 -1
= (1 + .05)2 -1 Example:
= 1.1025 – 1
= .1025 or 10.25% B. A firm plans to deposit P 10,000
on the first year,
P 8,000 on the second year and P
Checking: Principal = 10,000
5,000 on the third year at BDO. The
Interest = 1,025 (10,000 bank pays 8 percent interest
x .1025) compounded annually. No future
deposits or withdrawals are made.
FV = 11,025 The FV of the account at the end of 5
years is?

Future Value of a Stream of

Payments FV = 10,000 (1+.08)5 + 8,000
(1+.08)4 + 5,000 (1+.08)3

Stream of Payments - = 10,000 (1.4693) + 8,000

compounding of a series or stream of
payments
Stream of Unequal Payments
How: Compute the FV of each
payment at a specified future date
and then summing all FVs
(1.3605) + 5,000 (1.2597)
= 14,693 + 10,884 + 6,298.5
= 31,875.50
Future Value of a Stream of
Payments

Stream of Equal Payments

FV = ϵ PV (1 +i) n-t

Annuity (Fixed Annuity) – a stream of

where t refers to the no. of equal payments made at regular time
periods in which interest is earned / intervals
accrued

2 Types:
Example:

Ordinary Annuity (Deferred Annuity)

A. A firm plans to deposit P 2,000 – one in which payments or receipts
today and P 1,500 on the second occur at the END OF EACH PERIOD
year at BPI. The bank pays 10
percent interest compounded
annually. The FV of the account at
2. Annuity Due – one in which
the end of four years is?
payments or receipts occur at the
BEGINNING OF EACH PERIOD

FV = 2,000 (1+.10)4 + 1,500

(1+.10)3
= 2,000 (1.4641) + 1,500 (1.331)
Future Value of a Stream of
= 2,928.20 + 1,996.50 Payments

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Ordinary Annuity (Deferred Annuity) where FVAD - means future
value of annuity due
A - means the amount of the
FVOA = A (FVIFAin)
fixed annuity payment
FVIFADin - future value
FVIFAin = (1+i)n -1 interest factor of an
annuitydue
i
where FVOA - means future
value of ordinary annuity Example:

A - means the amount of the

fixed annuity payment
B. ABC Corporation deposits P
FVIFAin - future value 10,000 at the beginning of each year
interest factor of an for 3 consecutive years with a bank
ordinary annuity paying 10 percent interest
compounded annually. No future
deposits or withdrawals are made.
Example: The FV of the account at the end of
the 3rd year is?

A. ABC Corporation deposits P

10,000 at the end of each year for FVAD = A (FVIFADin)
the next 3 consecutive years in a = 10,000 (3.641)
bank paying 10 percent interest
compounded annually. No future = 36,410
deposits or withdrawals are made.
The FV of the account at the end of
the 3rd year is? Comparing FV of ordinary annuity
and annuity due:

FVOA = A (FVIFAin)
= 10,000 (3.310)
33100 36410
= 33,100
Ordinary annuity Annuity Due

Analysis:
The future value for the annuity due
is greater than the ordinary annuity
Future Value of a Stream of because each deposit made one
Payments year earlier earns interest one year
longer

Annuity Due

FVAD = A (FVIFADin)
Present Value:

FVIFADin = (1+i)n -1 x (1 +i)

discounts money that will be
i received in the future back in time to
see what it is worth in the present

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 the current value of a future amount * PVIF
of money or series of payments,
Present Value of Stream of
evaluated at an appropriate discount
Payments:
rate

Stream of Unequal Payments

How: Compute the PV of an
unequal or mixed, stream of
payments separately and then add
altogether

Discount Rate:
PV = ϵ FV (PVIFin)

sometimes called the required rate of

return PVIFin = 1
the rate of interest that is used to find (1+i)n
present values

Example:
Discounting:

XYZ expects to receive payments of

the process of determining the
present value of a future amount
Present Value:
P 10,000, 11,500 and P 20,000 at
the end of one, two and three years
respectively. The present value of
this stream of payments discounted
at 10 percent

PV = FV or PV = FV (1+i) -n PV = ϵ FV (PVIFin)

(1 + i) n = 10,000 (.909) + 11,500

(.826) + 20,000 (.751)
= 9,090 + 9,499 + 15,020
Example:
= 33,609

XYZ expects to receive P 10,000 one

year from now. What is the present
value of this amount if the discount
Present Value of Stream of
rate is 10 percent?
Payments:

PV = FV or PV = FV (1+i) -n
Stream of Equal Payments
(1 + i) n
= 10,000 =
A. Ordinary Annuity
10,000 (1+.10)-1
(1+.10)1
= 10,000 (.9091**) PVOA = A (PVIFAin)
= 9,090.91 =
9,090.91
PVIFAin = 1 – _1_

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 __(1+i)n PV of perpetuity = A nnuity
i Discount rate

Example: XYZ Corporation expects

Example:
to receive P 10,000 at year-end for
the next 3 years. The PV of this JBT Corporation wants to
annuity discounted at 10 percent is? deposit an amount of money that will
The PVIFAin is 2.487. allow it to withdraw P 1,500
indefinitely at the end of each year
without reducing the amount of the
PVOA = 10,000 (2.487) initial deposit. If the bank guarantees
to pay the firm by 10 percent interest
= 24,870
on its deposits , the amount to be
Present Value of Stream of deposited NOW is?
Payments:

PV of perpetuity = 1,500
Stream of Equal Payments
.10
\ =
B. Annuity Due 15,000

PVAD = A (PVIFADin)

PVIFADin = 1 – _1_ (1+i)

__(1+i)n
i
Example:
XYZ Corporation expects to
receive P 10,000 at the beginning
of the year for the next 3 years .
The PV of this annuity discounted at
10 percent is? The PVIFADin is
2.7355

PVAD = 10,000 (2.7355)

= 27,355

Present Value of a Perpetuity:

Perpetuity

* is an annuity with an infinite life,

that is the payments continue
indefinitely