Lesson 3 – Time Value of

Money
 SIMPLE INTEREST
• An interest is said to be simple when the total interest earned or charged
is linearly proportional to the initial amount of the loan.
• This is not used frequently in modern commercial practice.

Where:
I = total interest earned/paid
I = P(n)(i ) P = principal amount
n = number of interest periods
i = interest rate per interest period
 SIMPLE INTEREST
EXACT SIMPLE INTEREST

 n 
I = P (i )
 365 
ORDINARY SIMPLE INTEREST
NOTE: n is given in days
 n 
I = P (i )
 360 
SIMPLE DISCOUNT
I = F (d )(t )
Where:
I = interest earned
F = amount due at the end of time t
d = discount rate
 COMPOUND INTEREST
• An interest is said to be compound when the interest charge for any
interest period is based on the remaining principal amount plus any
accumulated interest charges up to the beginning of the period.

F = P (1 + i ) n
Where:
F = Future amount
P = principal amount
nm
 i  n = number of interest periods
F = P 1 +  m = compounding term
 m i = interest rate per interest period
 COMPOUND INTEREST
COMPOUNDING PERIODS
Annual (m=1)
• there is only 1 interest period in a year
Semi-Annual (m=2)
• there are 2 interest periods in a year
Quarterly (m=4)
• there are 4 interest periods in a year (1 quarter = 3 months)
Monthly (m=12)
• there are 12 interest periods in a year
 Example 3.1
Jenny loaned $2,000 from her friend to add as capital for her business.
They have agreed that Jenny will pay the loan back in 2 years.
(a) How much will Jenny pay at the end of 2 years if her friend allowed
to have a simple interest rate of 3% per year?
(b) How much will Jenny pay at the end of the second year if the loan is
compounded at 3% per year?
 Example 3.2
Mandy invested Php10,000 on a bank offering a
simple interest rate of 12% per year. She plans on
withdrawing this investment after 128 days. How
much is the future value of the lump sum of her
investment?
 Example 3.3
A man promised to pay 36,000 pesos at the end of
90 days. He was offered 10% discount if he pays in
30 days. Find the rate of interest.
 Example 3.4
A price tag of 1,200 pesos is payable in 60 days. A 3%
discount is offered if paid in 40 days. What is the rate
of interest?
 Example 3.5
Steph loaned P15,000 from her friend at a simple
interest of 10%. How much will she pay her friend if
she decides to return the loan after 75 days? Use
exact simple interest rate.
 Effect of different interest periods
Show the effect on the interest rate and the number of
periods for the given conditions below for an investment
worth $100,000.
• 6% compounded semi-annually for 5 years
• 6% compounded quarterly for 5 years
• 6% compounded monthly for 5 years
 Equivalence in compound interest
1. What rate in percent compounded semi-annually is equivalent to 20%
compounded annually?
2. What rate in percent that is compounding monthly is equivalent to
17% compounding quarterly?
3. Compare the future equivalent of Php1,500 using the converted
interest rates.
 Cash Flows
Conventions:
1.The horizontal line is the time scale, with the progression of time moving
from left to right. The period labels can be applied to intervals of time
rather than to points on the time scale.
2.The arrows signify cash flows and are placed at the end of the period. A
downward arrow represents expenses and upward arrows represent
receipts.
3.The cash-flow diagram is dependent on the point of view.
 Single Cash Flows
Example 3.6: An investor has an option to purchase a tract of land that will be
worth $10,000 in six years. If the value of the land increases at 8% each year,
how much should the investor be willing to pay now for the property? Draw
the appropriate cash flow diagram.
Example 3.7: You borrowed $8,000 now, promising to repay the loan principal
plus the accumulated interest in four years at i = 10% per year. Draw the cash
flow diagram. How much will you repay at the end of four years?
 Uniform Series Cash flows
Example 3.8 ABC Corporation had an investment of $10,000 produces an
annual revenue of $5,310 for five years and then have a market value of
$2,000 at the end of year five. Annual expenses will be $3,000 at the end of
each year for operating and maintaining the project. Draw a cash flow
diagram for the five-year life of the project. Use the corporation’s
viewpoint.
 Uniform Series Cash flows
Example 3.9 If a certain machine undergoes a major overhaul now, its
output can be increased by 20%- which translates into additional cash flow
of $20,000 at the end of each year for five years. Draw a cash flow diagram
for the five-year life of the project.
 Uniform Series Cash flows
Example 3.10 You borrowed $15,000 from your credit union to purchase a
used car. The interest rate on your loan is 0.25% per month and you will
make a total of 18 monthly payments. Draw the cash flow diagram.
 Other useful formula
Finding Interest rate given P, F, and N

i = F / P −1
n

Finding N when given P, F, and i

log( F / P)
N=
log(1 + i )
 Seatwork #2
Problem 1: What is the future equivalent of $1,000 invested at 8% simple
interest per year of 2.5 years?

Problem 2: An investment earns 20% compounded semi-annually. After

how many years will it triple?

Problem 3: A man is required to pay P57,500 at the end of 15 days and for
P60,000 at the end of 60 days. Determine the rate of interest.
 Seatwork #2
Problem 4: How much should you deposit in an account 5% interest semi-
annually if you want to have $25,000 after 10 years?

Problem 5: How much should Jane return at the end of 60 days if she
loaned P10,000 from a friend at a simple interest of 10%?