Summer Class

MTM 508: FINANCIAL MANAGEMENT

A.Y 2019 – 2020
FACULTY: ANN CHARYL M. GALLO

Module 3

Chapter 3: Time Value of Money

Module Introduction:

This module introduces time value of money which is crucial to effective

financial management. It discusses how much one is going to invest today if he/she
intends to get much in the future or how much one expects his/her money will be in
the future. This core principle of finance holds that provided money can earn
interest, any amount of money is worth more the sooner it is received.

Module Objectives:

On successful completion of this module, the learners will be able to:

1. Understand time value of money.

2. Solve for future values and present value of money;
3. Determine annuities using future values and present values.

Lecture Notes:

Outline:
a. Time value of money (TVM)
b. Future values (FV)
c. Present values (PV)
d. Annuities

Session 1 : Time Value of Money (TVM)

The time value of money draws from the idea that rational investors prefer to
receive money today rather than the same amount of money in the future because of
money's potential to grow in value over a given period of time. For example, money
deposited into a savings account earns a certain interest rate and is therefore said to
be compounding in value. The time value of money (TVM) is the concept that
money you have now is worth more than the identical sum in the future due to its
potential earning capacity. TVM is also sometimes referred to as present
discounted value.

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Some Comprehension of the TVM:
 A banker who makes loans and other investments.
 A financial officer whose job includes consideration of various alternative
sources of funds in terms of their cost.
 A company manager who must choose among various alternative investment
projects.
 A security analyst who evaluates securities that affirm sells to investors.
 An individual confronted with a host of daily financial problems ranging from
personal credit account management to deciding how finance a new home
purchase.

Session 2 : Future Value of Money (FVM)

Future value (FV) is the value of a current asset at some point in the future
based on an assumed growth rate. Investors are able to reasonably assume an
investment's profit using the future value (FV) calculation. Determining the future
value (FV) of a market investment can be challenging because of the market's
volatility. There are two ways of calculating the future value (FV) of an asset: FV
using simple interest and FV using compound interest

Future Value Using Simple Annual Interest

The Future Value (FV) formula assumes a constant rate of growth and a
single upfront payment left untouched for the duration of the investment. The FV
calculation can be done one of two ways depending on the type of interest being
earned. If an investment earns simple interest, then the Future Value (FV) formula is:

Future Value Using Compounded Annual Interest

With simple interest, it is assumed that the interest rate is earned only on the
initial investment. With compounded interest, the rate is applied to each period's
cumulative account balance. The formula for the Future Value (FV) of an investment
earning compounding interest is:

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Session 3 : Present Value of Money (PVM)

Present value is the concept that states an amount of money today is worth
more than that same amount in the future. In other words, money received in the
future is not worth as much as an equal amount received today. Money not spent
today could be expected to lose value in the future by some implied annual rate,
which could be inflation or the rate of return if the money was invested. Calculating
present value involves making an assumption that a rate of return could be earned
on the funds over the time period. PV formula is:

Sample Problem:
Suppose you are depositing an amount today in an account that earns 5% interest,
compounded annually. If your goal is to have $5,000 in the account at the end of six years,
how much must you deposit in the account today?

Solution:
The following information is given:
 future value = $5,000
 interest rate = 5%
 number of periods = 6
We want to solve for the present value.
present value = future value / (1 + interest rate)number of periods
or, using notation
PV = FV/ (1 + r)t
Inserting the known information,
PV = $5,000 / (1 + 0.05)6
PV = $5,000 / (1.3401)
PV = $3,731

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Session 4 : Annuities

Annuities are equally-spaced cash flows of equal size which can be either
inflows or outflows. An ordinary (deferred) annuity has cash flows that occur at the
end of each period. 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.

Future Value of an Ordinary Annuity - series of payments-future values-payment

at the end of each year.

Sample Problem : Annie wishes to determine how much money she will have at the end of 5
years if he chooses annuity A, the ordinary annuity and it earns 7% annually. Annuity a is
depicted graphically below:

FVA = $1,000 (FVIFA,7%,5)

= $1,000 (5.751)
= $5,751

Future Value of an Annuity Due – payments are made at the beginning of

each period/year.

Sample Problem : Annie now wishes to calculate the future value of an annuity due for a 5-
period annuity with the first annuity immediately paid in the beginning period.

FVA = $1,000(FVIFA,7%,5)(1+.07)
= $1,000 (5.751) (1.07)
= $6,154

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Present Value of an Ordinary Annuity – series of payment – present values –
payment at the end of each year.

Sample Problem : Braden Company, a small producer of plastic toys, wants to determine
the most it should pay to purchase a particular annuity. The annuity consists of cash flows
of $700 at the end of each year for 5 years. The required return is 8%.

PVA = $700 (PVIFA,8%,5)

= $700 (3.993)
= $2,795.10

Present Value of an Annuity Due – payments are made at the beginning of

each period/year.

Sample Problem : In the earlier example, we found that the value of Braden Company’s
$700, 5 year ordinary annuity discounted at 8% to be about $2,795. If we now assume that
the cash flows occur at the beginning of the year, we can find the PV of the annuity due.

PVA = $700 (PVIFA,8%,5) (1.08)

= $700 (3.993) (1.08)
= $3,018.40

- - End of Lecture Notes - -

Learning Output (Problem-Solving):

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 Submit on or before: August 1, 2020 to Google Classroom

1. A friend of yours requested if you can invest in her business today to receive
P1,000,000 after 10 years with interest of 5%

2. What will be the value of a P500,0000 investment after 15 years that is

compounded annually at 7%?

3. Maddie is pre-empting to invest P 30,000 at the end of the year for the next 20
years at an interest of 5% for her retirement. Help her to know how much would be
the total amount of her investment after 20 years.

4. If you invested today P15,000 and every beginning of the year thereafter for 10 years with
interest rate of 12%, what would be the present value of the investment?

Case Study / Problem-Solving Rubric:

Unacceptable Less Acceptable Acceptable Exemplary Score

I. 0-2 I. 3-4 I. 5-6 I. 7-8
II. 0-4 II. 5-8 II. 9-12 II. 13-16
III. 0-6 III. 7-12 III. 13-18 III. 19-24
IV. 0-3 IV. 4-6 IV. 7-9 IV. 10-12
I. Problem Does not clearly identify Identifies main problem Clearly identifies main Clearly identifies the
Identification the problem; identifies but does not omit relevant problem and includes main problem and
( 8 points ) an inappropriate issues; does not identify some of the subsidiary subsidiary, embedded
problem or represents the relationship between issues or implicit aspects of
the issue inaccurately different aspects or issues the problem
within the problem
II. Interpretation Fails to question data; Identifies some questions; Asks insightful questions; Analyzes insightful
( 16 points ) misses major content recognizes basic content; categorizes content; questions; critics
areas; does not detect states some identifies inconsistencies; content; examines
inconsistencies inconsistencies recognizes context inconsistencies; values
information
III. Analysis & Fails to draw Identifies some Formulates conclusions; Examines conclusions;
Evaluation conclusions; sees no conclusions; sees some recognizes arguments; uses reasonable
( 24 points ) arguments; overlook arguments; identifies notices differences; judgment; discriminates
differences; repeats differences; paraphrase evaluates data and rationally; synthesizes
data and omits data and assumes seeks out information data and vies
research information valid information critically
IV. Presentation Omits argument; Misconstructs arguments; Argues clearly; identifies Argues succinctly;
( 12 points ) misrepresents issues; generalizes issues; issues; attribute sources; discusses issues
excludes data; draws presents few options; suggest solution and thoroughly; shows
faulty conclusions overlooks some incorporate information intellectual honestly;
information justifies decisions and
assimilates information
Total 60/60

References:

Precila R. Bautista, PhD (2018). Simplified Approach to Financial Management (Theories and
Practices). Unlimited Books Library Services & Publishing Inc., Intramuros, Manila. ISBN: 978-
621-417-012-5. Copyright 2018

https://www.investopedia.com/terms/f/futurevalue.asp

https://www.investopedia.com/terms/p/presentvalue.asp

Prepared by:
ANN CHARYL M. GALLO, PhD

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