3/28/2021

The Time Value of

Money
Julius D. Obnamia, CIE, AAE

Interest: The Cost of Money

 Interest
is defined as the amount of money paid for
the use of borrowed capital for a certain
period of time.

 Capital
refers to wealth in the form of money or
property that can be used to produce more
wealth

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Concept of Interest:
 Lender
= income for derived for letting other use
his capital or resources

 Borrower
= expenses for using someone’s capital or
resources

Elements of Transactions involving

Interest
 Principal (P)
amount of money in transactions involving
debts or investments

 Interest Rate (i)

measure the cost or price of money
expressed as percentage per period of time

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continuation…
 Interest period
specified length of time that marks the
duration of the transactions

 No. of interest period

determines how frequently interest is
calculated

continuation..
 Plan for Receipts/ Disbursements (A)
cash flow pattern over a specified length
of time to pay off debts or investments

 Future Amount of Money (F)

cumulative effect of interest rate over the
number of interest period
equal to the sum of principal and the total
interest earned.

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Simple Interest
 directly
proportional to the length of time
the amount or principal is borrowed
I = total interest earned
by the Principal

I = Pin P = amount of principal

i = interest rate
n = no. of interest
periods

Simple Interest
 The total amount F to be repaid is equal to
the sum of the principal and the total
interest and is given by the formula:
I = total interest earned
F = P+I by the Principal
P = amount of principal
i = interest rate
= P + Pin n = no. of interest
periods
= P(1 + in) F = total amount to be
paid after the interest
period

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Types of Simple Interest

 OrdinarySimple Interest
computed based on one banker’s year (360
days; 12months each consist of 30 days)

 Exact Simple Interest

computed based on the exact numbers of
days in a year (365 days for regular year
and 366 days for leap year)

d
Ordinary simple = Pi
360
d
Exact Simple = Pi (regular year)
365
d
= Pi (leap year)
366

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Sample Problem 3.1

 Determine the ordinary simple interest on Php10,000 for 9
months and 10 days if the rate of interest is 12%.

 Determine the exact simple interest on P5,000 invested

for the period from January 15, 1996 to October 12, 1996,
if the rate of interest is 18%

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Problem Details

P = Php10,000
i = 12% ordinary
simple
n = 9 mos. & 10days

Ans. I = Php933.33

Sample Problem 3.2

 A bank charges 12% simple interest on a
Php300,000 loan. How much will be repaid if the
loan is paid back in one lump-sum amount after
three years?

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Sample Problem 3.3

 If you borrowed money from your friend with
simple interest of 12%, find the present worth of
Php50,000 which is due at the end of 7 months

Sample Problem 3.4

 A man borrows Php10,000 from a loan firm. The rate of
simple interest is 15%, but the interest is to be deducted
from the loan at the time the money is borrowed. At the
end of one year, he has to pay back Php10,000. What is
the actual rate of interest?

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Compound Interest
 the interest earned by the principal is not
paid at the end of each interest period, but
is considered as added to the principal, and
therefore will also earn interest for the
succeeding periods

F  P(1  i)n
where: (1+i)n = Single Payment Compound Amount Factor
(SPCAF)

Sample Problem 3.5

 The amount of Php50,000 was deposited in the bank
earning an interest of 7.5% per annum. Determine the
total amount at the end of 5 years, if the principal and
interest were not withdrawn during the period

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Sample Problem 3.5

 The amount of Php50,000 was deposited in
the bank earning an interest of 7.5% per
annum. Determine the total amount at the
end of 5 years, if the principal and interest
were not withdrawn during the period

Ans. F5 = Php71,781.47

Sample Problem 3.6

 Find the present worth of a payment of Php30,000 to be

made in five years with an interest rate of 8% per annum

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Sample Problem 3.6

 Find the present worth of a payment of

Php30,000 to be made in five years with an
interest rate of 8% per annum

Ans. P0 = Php20,417.495…..

Sample Problem 3.7

 A sum of Php1,000 is invested now and left for eight years,
at which time the principal is withdrawn. The interest
that has accrued is left for another eight years. If the
effective annual interest rate is 5%, what will be the
withdrawal amount at the end of the 16th year?

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Sample Problem 3.7

A sum of Php1,000 is invested now and left
for eight years, at which time the principal
is withdrawn. The interest that has
accrued is left for another eight years. If
the effective annual interest rate is 5%,
what will be the withdrawal amount at the
end of the 16th year?

Ans. F16 = Php705.42

Sample Problem 3.8

 A student plan to deposit Php1,500 in the bank now and
another Php3,000 for the next two years. If he plans to
withdraw Php5,000 three years after his last deposit for
the purpose of buying shoes, what will be the amount of
money left in the bank after one year of his withdrawal?
Effective annual interest rate is 10%.

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Sample Problem 3.8

 A student plan to deposit Php1,500 in the bank now and
another Php3,000 for the next two years. If he plans to
withdraw Php5,000 three years after his last deposit for
the purpose of buying shoes, what will be the amount of
money left in the bank after one year of his withdrawal?
Effective annual interest rate is 10%.

Ans. F6 = Php1,549.6415…

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Sample Problem 3.9

 How long will it take money to triple itself

if invested at 8% compounded annually?

Sample Problem 3.9

 How long will it take money to triple itself

if invested at 8% compounded annually?

Ans. n = 14.27 years

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Nominal Rate of Interest vs. Effective Rate

of Interest

 nominal rate of interest

statement of rate of interest and the number
of interest periods per year.

 effective rate of interest

actual rate of interest on the principal for one
year

Relationship between Nominal & Effective

Rate of Interest

M
 r 
i  1    1
 M

where: M = is the number of compounding periods per

year

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Sample Problem 3.10

 Calculatethe effective rate corresponding

to each of the following rates:
a. 10% compounded semi-annually
b. 10% compounded quarterly
c. 10% compounded bi-monthly
d. 10% compounded monthly

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Sample Problem 3.10

 Calculatethe effective rate corresponding

to each of the following rates:
a. 10% compounded semi-annually
b. 10% compounded quarterly
c. 10% compounded bi-monthly
d. 10% compounded monthly
Ans. a.) i = 10.25%
b) i = 10.38%
c.) i = 10.43%
d.) i = 10.47%

Sample Problem 3.11

 Findthe future worth of an investment

worth Php30,500 after 10 years with an
interest rate of 12% compounded quarterly

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Sample Problem 3.11

 Findthe future worth of an investment

worth Php30,500 after 10 years with an
interest rate of 12% compounded quarterly

Ans. F10 = Php99,492.15266

Sample Problem 3.12

 How many years is required for Php2,000 to

increase by Php3,000 if the interest rate is
12% compounded semi-annually?

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Sample Problem 3.12

 How many years is required for Php2,000 to

increase by Php3,000 if the interest rate is
12% compounded semi-annually?

Ans. n = 7.862…..years

Exercises
 1. What lump-sum amount of interest will be repaid on a
Php10,000 loan that was made on August 1, 2008 and repaid on
November 1, 2012, with ordinary simple interest at 10% per
year?
 2. Kathy buys a television set from a merchant who asks
Php12,500 at the end of 60 days (cash in 60 days). Kathy
wishes to pay immediately and the merchant offers to compute
the cash price on the assumption that money is worth 8% simple
interest. What is the cash price today?
 3. A person has made an arrangement to borrow Php10,000
now and another Php10,000 two years hence. The entire
obligation is to be repaid at the end of four years. If the
projected interest rates in years one, two, three, and four are
10%, 12%, 12%, and 14%, respectively, how much will be repaid
as a lump-sum amount at the end of four years?

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 4. Mr. W borrowed Php200,000 from Mr. Y on June 1, 2004 and

Php50,000 on June 1, 2006. Mr. W paid Php50,000 on June 1,
2007 and Php40,000 on June 1, 2008, and Php70,000 on June 1,
2009. If money is worth 5% compounded annually, what
additional payment should Mr. W pay on June 1, 2012 to
discharge all remaining liability?
 5. Php500,000 was deposited at an interest rate of 6%
compounded quarterly. Compute the compound interest after 4
years and 9 months.
 6. A businessman invested Php10,000 and after 4 years, it
becomes Php16,084.40 when he invested at a certain rate of
interest compounded bi-monthly. Determine the nominal rate
and the corresponding effective rate.

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