Time Value of

Money
INTEREST
 term used in business
 cost of using money over time
 interest expense = borrower / debtor
 interest income = lender / creditor

Time Value of Money – term used by economist

3 Factors: 2 Concepts:

1. Principal a. Future Value

2. Interest Rate b. Present Value
3. Time Period
FUTURE VALUE:

 compounds money forward in time to

determine its worth in the future

Compounding is the process of determining

future value when compound interest is
applied.
Compounding Can Be Computed Using:

A. Simple Interest (interest paid or earned

on the initial principal only)
B. Compound Interest (interest paid on both
the principal and the amount of interest
accumulated in prior periods)
Simple Interest:

A. ABC Corporation deposits P 10,000 in a bank at

10% interest in a year. How much is the future
value of the principal at the end of year 1?

Interest (I) = Principal (P) x Rate (R) x Time (T)

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

Principal = P 10,000
Interest = P 1,000 (10,000 x 10%)
FV = P 11,000
Activity
Simple Interest:

DEF Corporation deposits P 650,000 in a bank

at 10% interest in a year. How much is the
future value of the principal at the end of year
1?

1. Interest (I)
2. Future Value (FV)
Simple Interest:

B. ABC Corporation deposits P 10,000 in a bank at

10% interest in a year. How much is the future
value of the principal after 6 months?

Interest (I) = Principal (P) x Rate (R) x Time (T)

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

Principal = P 10,000
Interest = P 500 (10,000 x 10% x 6/12 )
FV = P 10,500
Activity
Simple Interest:

DEF Corporation deposits P 500,000 in a bank at 8%

interest in a year. How much is the future value of
the principal at year end if it was deposited at
August 31?

3. Interest (I)
4. Future Value (FV)
Simple Interest:

C. ABC Corporation deposits P 10,000 in a bank at

10% interest for 5 years. How much is the future
value of the money after 5 years?

Interest (I) = Principal (P) x Rate (R) x Time (T)

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

Principal = P 10,000
Interest = P 5,000 (10,000 x 10% x 5 )
FV = P 15,000
Activity
Simple Interest:
DEF Corporation deposits P 400,000 in a
bank at 12% interest for 5 years. How much
is the future value of the money after 5
years?

5. Interest (I)
6. Future Value (FV)
Compound Interest:

A. ABC Corporation deposits P 10,000 in a bank

compounded annually at 10% interest. How
much is the future value of the principal at
the end of year 2?
Year Amount Compound Future Value
Interest
1 10,000 1,000 11,000
2 11,000 1,100 12,100
Total interest 2,100
Compound Interest:

DEF Corporation deposits P 200,000 in a

bank compounded annually at 15% interest.
How much is the future value of the principal
at the end of year 3?
Year Amount Compound Future Value
Interest
Compound Interest:

B. ABC Corporation deposits P 10,000 in a bank compounded

annually at 10% interest. How much is the future value of
the principal after 5 years?

Year Amount Compound Interest Future Value

1 10,000 1,000 11,000

2 11,000 1,100 12,100

3 12,100 1,210 13,310

4 13,310 1,331 14,641

5 14,641 1,464.10 16,105.10

6,105.10
Compound Interest:

ABC Corporation deposits P 10,000 in a bank

compounded annually at 10% interest. How much is
the future value of the principal after 5 years?

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)
Recap

– Present Value – value of your money today

– Future Value – value from present value
– Compound Interest
– Simple interest
Time Line

– An important tool used in time value

analysis, it is a graphical
representation used show the timing
of cash flow
Compound Interest:

ABC Corporation deposits P 200,000 in a bank

compounded annually at 12% interest. How much is
the future value of the principal after 3 years?

FV= PV (1 + i )n where: FV = future value

= PV = initial principal
= i = interest rate
= n = period
EXERCISE:
CAE Corporation borrowed P 20,000 in a bank at 12%
interest. Using simple interest method,

1. How much is the interest after 3 years?

2. What is the FV of the principal after 8 years?

CAE Corporation borrowed P 20,000 in a bank

compounded annually at 12% interest. Using
compound interest method,
1. How much is the interest after 3 years?
2. What is the FV of the principal after 6 months?
3. What is the FV of the principal after 10 years if it is
compounded quarterly?
Examples

1. Principal - 45O,OOO
Rate - 13%
Time - 1OO days

2. Principal - 9,OOO
Rate - 1O 1/4%
Time - 6O
Future Value (With Intra-period Compounding)

Intra-period Compounding - compounding that occurs more

than once in a year

Examples: monthly, quarterly, semi-annually

FV = PV (1 + i/m)m*n

Where:
m refers to the number of times interest is
compounded in a year
Example:

A. 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.

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

A. FV = PV (1+ i) 1
= 10,000 ( 1.10)1
= 11,000

B. FV = PV (1+ i/m) nm
= 10,000 ( 1 + (.10/2)2*1
= 10,000 (1 + .05)2
= 10,000 (1.1025)
= 11,025

C. YES BPI = 11,000

BDO = 11,025
25 difference
Nominal Rate:
 is also known as stated rate

Effective Rate:
 is also called - APR (annual 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
Example:

ABC deposits P 10,000 at BDO that pays a 10 percent interest

rate compounded semi-annually

APR = (1 +i/m) m - 1
= (1 + .10/2)2 -1
= (1 + .05)2 -1
= 1.1025 – 1
= .1025 or 10.25%

Checking: Principal = 10,000

Interest = 1,025 (10,000 x .1025)
FV = 11,025
SUMMARY EXERCISES:

1. If you invest P 12,000 today, how much will you have

a. in 6 years at 7 percent (ordinary interest)

b. in 15 years at 12 percent (compounded annually)
c. In 25 years at 10 percent (compounded semi-annually)

2. If a bank pays 12 percent nominal interest rate, what is the

effective interest rate assuming quarterly compounding ?
Future Value of a Stream of Payments

Stream of Payments - compounding of a series or stream of

payments

A. Stream of Unequal Payments

How: Compute the FV of each payment at a specified
future date and then summing all FVs

FV = ϵ PV (1 +i)n - t

where t refers to the no. of periods in which interest

is earned / accrued
Example:

A. A firm plans to deposit P 2,000 today and P 1,500 on the

second year at BPI. The bank pays 10 percent interest
compounded annually. The FV of the account at the end of
four years is?

FV = 2,000 (1+.10)4 + 1,500 (1+.10)3

= 2,000 (1.4641) + 1,500 (1.331)
= 2,928.20 + 1,996.50
= 4,924.70
ACTIVITY:

A. A firm plans to deposit P 40,000

today and P 20, 000 on the second
year at CitiBank. The bank pays 12
percent interest compounded
annually. The FV of the account at the
end of five years is?

1. What is the future value

Example:

B. A firm plans to deposit P 10,000 on the first year,

P 8,000 on the second year and P 5,000 on the third year at
BDO. The bank pays 8 percent interest compounded annually.
No future deposits or withdrawals are made. The FV of the
account at the end of 5 years is?

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

= 10,000 (1.4693) + 8,000 (1.3605) + 5,000 (1.2597)
= 14,693 + 10,884 + 6,298.5
= 31,875.50
ACTIVITY:

B. A firm plans to deposit P 100,000 at the

beginning the first year, P 80,000 at the
beginning of third year and P 50,000 at
the end of fourth year at BPI. The bank
pays 15 percent interest compounded
annually. No future deposits or
withdrawals are made.
1. The FV of the account at the end of 6
years is?
2. What is the interest earned?
Future Value of a Stream of Payments

A. Stream of Equal Payments

Annuity (Fixed Annuity) – a stream of equal payments

made at regular time intervals

2 Types:

1. Ordinary Annuity (Deferred Annuity) – one in

which payments or receipts occur at the END OF
EACH PERIOD

2. Annuity Due – one in which payments or receipts

occur at the BEGINNING OF EACH PERIOD
ACTIVITY:

B. A firm plans to deposit P 100,000

January 1, 2018, P 80,000 on December
31,2018 and P 50,000 January 1, 2020 at
BPI. The bank pays 15 percent interest
compounded annually. No future deposits
or withdrawals are made.
1. The FV of the account at the end of
2021?
2. What is the interest earned?
Future Value of a Stream of Payments

1. Ordinary Annuity (Deferred Annuity)

FVOA = A (FVIFAin)

FVIFAin = (1+i)n -1
i
where FVOA - means future value of ordinary
annuity
A - means the amount of the fixed annuity
payment
FVIFAin - future value interest factor of an
ordinary annuity
Example:

A. ABC Corporation deposits P 10,000 at the end of each year

for the next 3 consecutive years in a bank paying 10 percent
interest compounded annually. No future deposits or
withdrawals are made. The FV of the account at the end of the
3rd year is?

FVOA = A (FVIFAin)
= 10,000 (3.310)
= 33,100
Activity
DEF Corporation deposits P 50,000 at the end
of each year for the next 7 consecutive years in
a bank paying 12 percent interest compounded
annually. No future deposits or withdrawals
are made. The FV of the account at the end of
the 7th year is?

3. What is the Future Value Factor (round of to

4 decimal places)
4. What is the Future Value of ordinary annuity
Future Value of a Stream of Payments

1. Annuity Due

FVAD = A (FVIFADin)

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

i
where FVAD - means future value of annuity due
A - means the amount of the fixed annuity
payment
FVIFADin - future value interest factor of an
annuitydue
Example:

B. ABC Corporation deposits P 10,000 at the beginning of each

year for 3 consecutive years with a bank paying 10 percent
interest compounded annually. No future deposits or
withdrawals are made. The FV of the account at the end of the
3rd year is?

FVAD = A (FVIFADin)
= 10,000 (3.641)
= 36,410
Comparing FV of ordinary annuity and annuity due:

33,100 36,410

Ordinary Annuity
Annuity Due

Analysis:
The future value for the annuity due is greater
than the ordinary annuity because each
deposit made one year earlier earns interest
one year longer
Activity
DEF Corporation deposits P 200,000 at the beginning of each
year for 5 consecutive years with a bank paying 15 percent
interest compounded annually. No future deposits or
withdrawals are made.

5. The FV of the account at the end of the 5th year is?

6. What is the Future Value Factor?
Activity
1-2. DEF Corporation deposits P 200,000 at the beginning of
2019, for 5 consecutive years with a bank paying 15 percent
interest compounded annually. No future deposits or
withdrawals are made.
* The FV of the account on December 31, 2023 is?
* What is the Future Value factor?

3-4. DEF Corporation deposits P 100,000 at the end of 2019,

for 5 consecutive years with a bank paying 15 percent interest
compounded annually. No future deposits or withdrawals are
made.
* The FV of the account on December 31, 2024 is?
* What is the Future Value factor?
Present Value:
 discounts money that will be received in the future back
in time to see what it is worth in the present
 the current value of a future amount of money or series of
payments, evaluated at an appropriate discount rate

Discount Rate:
 sometimes called the required rate of return
 the rate of interest that is used to find present values

Discounting:
 the process of determining the present value of a future
amount
Present Value:

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

Example:

XYZ expects to receive P 10,000 one year from now. What is

the present value of this amount if the discount rate is 10
percent?

PV = FV or PV = FV (1+i) -n
(1 + i) n
= 10,000 = 10,000 (1+.10)-1
(1+.10)1 = 10,000 (.9091**)
= 9,090.91 = 9,090.91
* PVIF
 Activity

–What is the present value factor of 1 if

–The interest is 12, period is 4
–The interest is 12, period is 4,
compounded semi annually
– The interest is 12, period is 4,
compounded quarterly
Present Value:

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

Activity
XYZ expects to receive P 20,000 one year from now.
What is the present value of this amount if the
discount rate is 12 percent?
Present Value:

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

Example:

XYZ expects to receive P 10,000 three years from now. What is

the present value of this amount if the discount rate is 10
percent?

PV = FV or PV = FV (1+i) -n
(1 + i) n
Present Value:

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

Activity
XYZ expects to receive P 20,000 four years from now. What
is the present value of this amount if the discount rate is 12
percent?
Present Value of Stream of Payments:

Stream of Unequal Payments

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

PV = ϵ FV (PVIFin)

PVIFin = 1 .
(1+i)n
Example:

XYZ expects to receive payments of 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 = ϵ FV (PVIFin)
= 10,000 (.909) + 11,500 (.826) + 20,000 (.751)
= 9,090 + 9,499 + 15,020
= 33,609
Activity
XYZ expects to receive payments of P 100,000,
200,500 and P 150,000 at the end of one, three
and four years respectively. The present value
of this stream of payments discounted at 10
percent

PV = ϵ FV (PVIFin)
Present Value of Stream of Payments:

Stream of Equal Payments

A. Ordinary Annuity
PVOA = A (PVIFAin)
PVIFAin = _1- (1+i)-n
i
.

Example: XYZ Corporation expects to receive P 10,000 at year-

end for the next 3 years. The PV of this annuity discounted
at 10 percent is? The PVIFAin is 2.487.

PVOA = 10,000 (2.487)

= 24,870
Activity

XYZ Corporation expects to receive P 120,000

at year-end for the next 4 years. The PV of
this annuity discounted at 10 percent is?
Present Value of Stream of Payments:
Stream of Equal Payments
B. Annuity Due

PVAD = A (PVIFADin)

PVIFADin = _1- (1+i)-n x (1+ i)

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
Activity

XYZ Corporation expects to receive P 250,000 at

the beginning of the year for the next 5 years .
The PV of this annuity discounted at 10 percent is?
Present Value of a Perpetuity:

Perpetuity
* is an annuity with an infinite life, that is the payments
continue indefinitely
PV of perpetuity = A nnuity
Discount rate
Example:
JBT Corporation wants to deposit an amount of money that will allow it
to withdraw P 1,500 indefinitely at the end of each year without
reducing the amount of the initial deposit. If the bank guarantees to pay
the firm by 10 percent interest on its deposits , the amount to be
deposited NOW is?

PV of perpetuity = 1,500
.10
\ = 15,000
EXERCISE;
The Billy Playhouse wants P 10,000 at the end of
each year for the next 6 years. How much must be
deposited today at 10% to yield this annuity? PVOA

What amount must be deposited now in order to

withdraw P 2,000 at the beginning of each year for
5 years if the interest rate is 12% compounded
annually? PVAD

ABC Company wants to deposit an amount of

money that will allow it to withdraw P 2,000
indefinitely at the end of each year without
decreasing the amount of the original deposit. If
the bank guarantees to pay the firm 5 percent
interest , the amount to be deposited NOW is?
Thank you!