The Time Value of Money

2005, Pearson Prentice Hall

We know that receiving $1 today is worth more than $1 in the future. This is due to opportunity costs.

Today

Future

If we can measure this opportunity cost, we can:

If we can measure this opportunity cost, we can:

Translate $1 today into its equivalent in the future

(compounding).

If we can measure this opportunity cost, we can:

Translate $1 today into its equivalent in the future

(compounding).
Today Future

If we can measure this opportunity cost, we can:

Translate $1 today into its equivalent in the future

(compounding).
Today Future

?
Translate $1 in the future into its equivalent today
(discounting).

If we can measure this opportunity cost, we can:

Translate $1 today into its equivalent in the future

(compounding).
Today Future

?
Translate $1 in the future into its equivalent today
(discounting).
Today Future

Compound Interest

and Future Value

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 1 year?

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 1 year?

PV =
0

FV =
1

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 1 year?

PV = -100
0

FV =
1

Calculator Solution: I=6 N=1 PV = -100 FV = $106

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 1 year?

PV = -100
0

FV = 106
1

Calculator Solution: I=6 N=1 PV = -100 FV = $106

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 1 year?

PV = -100

FV = 106

0 1 Mathematical Solution: FV = PV (FVIF i, n ) FV = 100 (FVIF .06, 1 ) (use FVIF table, or) FV = PV (1 + i)n FV = 100 (1.06)1 = $106

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 5 years?

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 5 years?

PV =
0

FV =
5

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 5 years?

PV = -100
0

FV =
5

Calculator Solution: I=6 N=5 PV = -100 FV = $133.82

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 5 years?

PV = -100
0

FV = 133.82
5

Calculator Solution: I=6 N=5 PV = -100 FV = $133.82

Future Value - single sums

If you deposit $100 in an account earning 6%, how much would you have in the account after 5 years?

PV = -100

FV = 133.82

0 5 Mathematical Solution: FV = PV (FVIF i, n ) FV = 100 (FVIF .06, 5 ) (use FVIF table, or) FV = PV (1 + i)n FV = 100 (1.06)5 = $133.82

Future Value - single sums

If you deposit $100 in an account earning 6% with quarterly compounding, how much would you have in the account after 5 years?

Future Value - single sums

If you deposit $100 in an account earning 6% with quarterly compounding, how much would you have in the account after 5 years?

PV =
0

FV =
?

Future Value - single sums

If you deposit $100 in an account earning 6% with quarterly compounding, how much would you have in the account after 5 years?

PV = -100
0

FV =
20

Calculator Solution: P/Y = 4 I=6 N = 20 PV = -100 FV = $134.68

Future Value - single sums

If you deposit $100 in an account earning 6% with quarterly compounding, how much would you have in the account after 5 years?

PV = -100
0

FV = 134.68
20

Calculator Solution: P/Y = 4 I=6 N = 20 PV = -100 FV = $134.68

Future Value - single sums

If you deposit $100 in an account earning 6% with quarterly compounding, how much would you have in the account after 5 years?

PV = -100

FV = 134.68

0 20 Mathematical Solution: FV = PV (FVIF i, n ) FV = 100 (FVIF .015, 20 ) (cant use FVIF table) FV = PV (1 + i/m) m x n FV = 100 (1.015)20 = $134.68

Future Value - single sums

If you deposit $100 in an account earning 6% with monthly compounding, how much would you have in the account after 5 years?

Future Value - single sums

If you deposit $100 in an account earning 6% with monthly compounding, how much would you have in the account after 5 years?

PV =
0

FV =
?

Future Value - single sums

If you deposit $100 in an account earning 6% with monthly compounding, how much would you have in the account after 5 years?

PV = -100
0

FV =
60

Calculator Solution: P/Y = 12 I=6 N = 60 PV = -100 FV = $134.89

Future Value - single sums

If you deposit $100 in an account earning 6% with monthly compounding, how much would you have in the account after 5 years?

PV = -100
0

FV = 134.89
60

Calculator Solution: P/Y = 12 I=6 N = 60 PV = -100 FV = $134.89

Future Value - single sums

If you deposit $100 in an account earning 6% with monthly compounding, how much would you have in the account after 5 years?

PV = -100
0

FV = 134.89
60

Mathematical Solution: FV = PV (FVIF i, n ) FV = 100 (FVIF .005, 60 ) (cant use FVIF table) FV = PV (1 + i/m) m x n FV = 100 (1.005)60 = $134.89

Future Value - continuous compounding

What is the FV of $1,000 earning 8% with continuous compounding, after 100 years?

Future Value - continuous compounding

What is the FV of $1,000 earning 8% with continuous compounding, after 100 years?

PV =
0

FV =
?

Future Value - continuous compounding

What is the FV of $1,000 earning 8% with continuous compounding, after 100 years?

PV = -1000
0

FV =
100

Mathematical Solution: FV = PV (e in) FV = 1000 (e .08x100) = 1000 (e 8) FV = $2,980,957.99

Future Value - continuous compounding

What is the FV of $1,000 earning 8% with continuous compounding, after 100 years?

PV = -1000
0

FV = $2.98m
100

Mathematical Solution: FV = PV (e in) FV = 1000 (e .08x100) = 1000 (e 8) FV = $2,980,957.99

Present Value

Present Value - single sums

If you receive $100 one year from now, what is the PV of that $100 if your opportunity cost is 6%?

Present Value - single sums

If you receive $100 one year from now, what is the PV of that $100 if your opportunity cost is 6%?

PV =
0

FV =
?

Present Value - single sums

If you receive $100 one year from now, what is the PV of that $100 if your opportunity cost is 6%?

PV =
0

FV = 100
1

Calculator Solution: P/Y = 1 I=6 N=1 FV = 100 PV = -94.34

Present Value - single sums

If you receive $100 one year from now, what is the PV of that $100 if your opportunity cost is 6%?

PV = -94.34
0

FV = 100
1

Calculator Solution: P/Y = 1 I=6 N=1 FV = 100 PV = -94.34

Present Value - single sums

If you receive $100 one year from now, what is the PV of that $100 if your opportunity cost is 6%?

PV = -94.34

FV = 100

0 1 Mathematical Solution: PV = FV (PVIF i, n ) PV = 100 (PVIF .06, 1 ) (use PVIF table, or) PV = FV / (1 + i)n PV = 100 / (1.06)1 = $94.34

Present Value - single sums

If you receive $100 five years from now, what is the PV of that $100 if your opportunity cost is 6%?

Present Value - single sums

If you receive $100 five years from now, what is the PV of that $100 if your opportunity cost is 6%?

PV =
0

FV =
?

Present Value - single sums

If you receive $100 five years from now, what is the PV of that $100 if your opportunity cost is 6%?

PV =
0

FV = 100
5

Calculator Solution: P/Y = 1 I=6 N=5 FV = 100 PV = -74.73

Present Value - single sums

If you receive $100 five years from now, what is the PV of that $100 if your opportunity cost is 6%?

PV = -74.73
0

FV = 100
5

Calculator Solution: P/Y = 1 I=6 N=5 FV = 100 PV = -74.73

Present Value - single sums

If you receive $100 five years from now, what is the PV of that $100 if your opportunity cost is 6%?

PV = -74.73
0

FV = 100
5

Mathematical Solution: PV = FV (PVIF i, n ) PV = 100 (PVIF .06, 5 ) (use PVIF table, or) PV = FV / (1 + i)n PV = 100 / (1.06)5 = $74.73

Present Value - single sums

What is the PV of $1,000 to be received 15 years from now if your opportunity cost is 7%?

Present Value - single sums

What is the PV of $1,000 to be received 15 years from now if your opportunity cost is 7%?

PV =
0

FV =
15

Present Value - single sums

What is the PV of $1,000 to be received 15 years from now if your opportunity cost is 7%?

PV =
0

FV = 1000
15

Calculator Solution: P/Y = 1 I=7 N = 15 FV = 1,000 PV = -362.45

Present Value - single sums

What is the PV of $1,000 to be received 15 years from now if your opportunity cost is 7%?

PV = -362.45
0

FV = 1000
15

Calculator Solution: P/Y = 1 I=7 N = 15 FV = 1,000 PV = -362.45

Present Value - single sums

What is the PV of $1,000 to be received 15 years from now if your opportunity cost is 7%?

PV = -362.45

FV = 1000

0 15 Mathematical Solution: PV = FV (PVIF i, n ) PV = 100 (PVIF .07, 15 ) (use PVIF table, or) PV = FV / (1 + i)n PV = 100 / (1.07)15 = $362.45

Present Value - single sums

If you sold land for $11,933 that you bought 5 years ago for $5,000, what is your annual rate of return?

Present Value - single sums

If you sold land for $11,933 that you bought 5 years ago for $5,000, what is your annual rate of return?

PV =
0

FV =
5

Present Value - single sums

If you sold land for $11,933 that you bought 5 years ago for $5,000, what is your annual rate of return?

PV = -5000
0

FV = 11,933
5

Calculator Solution: P/Y = 1 N=5 PV = -5,000 FV = 11,933 I = 19%