Faculty of Management & Entrepreneurship

TOPIC 4
TIME VALUE of
MONEY

MAC3603: FINANCIAL MANAGEMENT

 CONTENT

4. 1 Overview •
•
Time Lines
Definition

4. 2 Amount Problems •
•
FV Single Amount
PV Single Amount

4. 3 Annuity Problems •
•
FV Annuity
PV Annuity

4. 4 Other Discussion • Perpetuity

• Uneven cash flows stream

• Interest rate & issues of
timeline
An Overview of Time Value of Money
 4.1 Overview

4.1.1 Definition

The idea that money available at the present

time is worth more than the same amount in the
future due to its potential earning capacity
4.1.2 Timelines

0 1 2 3
i%

CF0 CF1 CF2 CF3

Tick marks at ends of periods, so

Time 0 is today;
Time 1 is the end of Period 1; or the beginning of Period 2
.
Example 1:
Time line for a $100 lump sum due at the end
of Year 2

0 1 2 Year
i%

100
 Tutorial
Construct a time lines for below cases:

a) Time line for a $100 lump sum due at the end

of Year 2.
b) Time line for an ordinary annuity (series of
payment) of $100 for 3 years.
c) Time line for uneven CFs: -$50 at t = 0 and
$100, $75, and $50 at the end of Years 1 thr
ough 3.
4.1.3 Timelines for Future Value (FV)

What’s the FV of an initial $100 after 3 years

if i = 10%?

0 1 2 3
10%

100 FV = ?

Finding Future Values (moving to the right on a time

line) is called compounding.
 What’s the FV of an initial $100 after 3 years
if i = 10%?

0 1 2 3
Annually – 1 time
10% Semi-annual – 2 times
Quarterly – 4 times
100 Monthly – 12 times
FV = ?
Daily – 365 times
Continuously –
(FV= 𝐏𝐕 𝐗 𝐞𝒓 𝒙 𝒏 )
Finding Future Values (moving to the right on a time
line) is called compounding. n = no. of years x no of compounding
periods in a year

n=nxm
4.1.4 Timelines for Present Value (PV)

What’s the $100 will be given in 3 years, today?

Assume the i = 10%?

0 1 2 3
10%

PV = ? 100

Finding Present Values is discounting, and it’s the

reverse of compounding
n=nxm
 4.2 Amount Problems

4.2.1 Introduction

Present Value (PV) and Future Value (FV) of

Single amount
(lump-sum)
4.2.2 Future Value (FV) of a Single Amount

Example 2:
Time line for a $100 lump sum at the end of Year 1, 2 and 3

After 1 year: FV1 = PV + INT1 = PV + PV (i)

= PV (1 + i)
= $100 (1.10)
= $110.00
After 2 years: FV2 = PV (1 + i)2
= $100 (1.10)2
= $121.00
After 3 years: FV3 = PV(1 + i)3
= $100(1.10)3
= $133.10

0 1 2 3

10%
100 110
10% 121
10%
FV = 133.10
In general, the formula:

FV = PV (1 + i )nxm
4.2.3 Present Value (PV) of a Single Amount

In general, the formula:

𝐅𝐕 𝟏 𝒏𝒙𝒎
PV = 𝒏𝒙𝒎
or PV = 𝐅𝐕
𝟏+𝒊 𝟏+𝒊
Example 3:
What’s the PV of $100 due in 3 years if i = 10%?

100 100
= =
1+0.10 3 1.331

= RM 75. 13
4.2.4 Finding the Time to Double
Example 4:
What year/s It will take to double up RM1 to RM2 if i = 20%?

0 1 2 ?
i = 20%

PV = - RM 1 FV = RM 2
FV = PV (1 + i)n
$2 = $1 (1 + 0.20)n
(1.2)n = $2 / $1
n Ln (1.2) = Ln (2)
n = Ln (2) / Ln (1.2)
n = 0.693 / 0.182
= 3.8
4.2.5 Five Ways to Find PV & FV

1. Solve the equation with a regular calculator.

2. Use a financial calculator.
3. Use a spreadsheet (e.g.: excel)
4. Mobile Apps - (find financial calculator free)
5. Using Tables (PVIF, FVIF, PVIFA, FVIFA)
 Way 2: Financial Calculator Solution

Here’s the setup to find FV:

INPUTS 3 10 -100 0 133.10

OUTPUT N I/YR PV PMT FV

Clearing automatically sets everything to 0, but for

safety enter PMT = 0.
Set: P/YR = 1, END.

Put in RM100 today, take out RM133.10 after 3 years.

 Here’s the setup to find PV:

INPUTS 3 10 -75.13 0 100

OUTPUT N I/YR PV PMT FV

Either PV or FV must be negative.

Here PV = -75.13. Put in $75.13 today, take out

$100 after 3 years.
 Here’s the setup to find N (no. of years)

INPUTS 3.8 10 -1 0 2

OUTPUT N I/YR PV PMT FV

RM1 today will double up to RM 2 after 3.8 years.

 TUTORIAL 4.2
Calculate below case:

a) If you deposit RM10 000 in a bank account that pays

10% interest annually, how much will be in your
account after 5 years?

b) What is the PV of a security that will pay RM5 000 in

20 years if securities of equal risk pay 7% annually?

c) If you deposit money today in an account that pays

6.5% annual interest, how long it will take to double
your money?
d) Mary wishes to have RM 10 000 in her bank account
in three years’ time. She can invest her money in a
3-year deposit account which pays an annual
compounded rate of 6%. How much she must put into
the account which now to achieve her goal?

e) You have deposited RM 1 000 today and the bank

offers 8% interest compounded semi-annual. If you
plan to save your money for 3 years, determine your
FV of money at the end of 3 years.
 4.3 Annuity Problems

4.3.1 Introduction
– What is Annuity
– Difference off Ordinary Annuity & Annuity Due
– Annuities:
– Ordinary Annuity (PVA, FVA)
– Annuity Due (PVA, FVA)
– Perpetuity
4.3.2 What is Annuity?

Series of equal payments – made at fixed intervals

– specified no. of period.

0 1 2 3
i%

PMT PMT PMT

What’s the difference between an ordinary annuity and
an annuity due?

Ordinary Annuity
0 1 2 3
i%

PMT PMT PMT

PV FV

0 1 2 3
i%

PMT PMT PMT

Annuity Due
4.3.3 Future Value (FV) of an Ordinary Annuity

Example 5:
What’s the FV of a 3-year ordinary annuity of $100 at
10%?
0 1 2 3
10%

100 100 100

110
121
FV = 331
 In general, the formula:

(𝟏+𝒊)𝒏𝒙𝒎 − 𝟏
FVA Ordinary= 𝐏𝐌𝐓
𝒊
 Financial Calculator Solution

INPUTS 3 10 0 -100 331.00

OUTPUT N I/YR PV PMT FV

Have payments but no lump sum PV,

so enter 0 for Present Value.
4.3.4 Present Value (PV) of an Ordinary Annuity

Example 6:
What’s the value of a 3-year ordinary annuity of $100
today, discounted at 10%?
0 1 2 3
10%
100 100 100
90.91
82.64
75.13
248.68 = PV
 In general, the formula:
𝟏
𝟏−
(𝟏+𝒊)𝒏𝒙𝒎
PVA Ordinary = 𝐏𝐌𝐓
𝒊
 Financial Calculator Solution

INPUTS 3 10 -248.69 100 0

OUTPUT N I/YR PV PMT FV

Have payments but no lump sum FV, so enter

0 for future value.
 Spreadsheet Solution

A B C D
1 0 1 2 3
2 100 100 100
3 248.69

Excel Formula in cell A3: = NPV(10%,B2:D2)

 Special Function for Annuities (EXCEL)

For Present Value ordinary annuities, this formula i

n cell A3 gives 248.96:

= PV(10%,3,-100)

A similar function gives the Future Value of 331.00:

= FV(10%,3,-100)
4.3.5 Future Value (FV) of an Annuity Due

Example 7:
Find the FV of a 3-year annuity due of $100 at 10%?

0 1 2 3
10%
100 100 100
110.00
121.00
133.10
FV = 364.10
 In general, the formula:
(𝟏+𝒊)𝒏 − 𝟏
FVA = 𝐏𝐌𝐓 𝐱 𝟏+𝒊
𝒊
4.3.6 Present Value (FV) of an Annuity Due

Example 7:
Find the PV of a 3-year annuity due of $100 at 10%?

0 1 2 3
10%
100.00 100 100
90.91
82.64
PV = 273.55
 In general, the formula:
𝟏 𝟏
PVA = 𝐏𝐌𝐓 𝐱 𝐱 𝟏 − (1 + i)
𝒊 (𝟏+𝒊)𝒏
4.3.7 Comparison

Ordinary Annuity Annuity Due

FV
FV = RM 331. 00 FV
FV = RM 364. 10
PV
PV = RM 248. 69 PV
PV = RM 273. 55
4.3.8 Perpetuity

Receipts / Payments to be made until infinity or

forever.

𝑷𝑴𝑻
PV = 𝒊
Example 9:
Find the PV of a perpetuity of $100 at 8%?

0 1 2
8% …..
100 100 100.00

1,250 = PV
 TUTORIAL 4.3
Calculate below case:

a) Roslan has invested a special government bond that

provides income on investment of RM100 per annum
in perpetuity. Determine the present value of this per
petual annuity if you are told that the interest is 85%.

a) Bakri plans to put aside RM 5 000 per year so that

he can make a nice down payment on a BMW car in
6 years time. If he makes the payments at the end of
each year and earns 8% on his deposit, how much
will he have accumulated at the end of 6 years?
c) By referring to (b), assume that we are told that Bakri plans
to put aside RM 5 000 per year starting now and still earns
8% on his deposits, how much will he have accumulated at
the end of 6 years?

d) Dion has won a jackpot which pays her RM 5 000 per year
for 3 years, beginning one year from today. Dion wants to k
now the present value of the jackpot using a discount rate
of 7%.

e) Sally has won a jackpot RM1 million and will get paid in 5
annual payments immediately, over a period of five years.
If Sally opportunity cost of funds is 8%, what is the present
value of her jackpot?
 Financial Calculator Solution

INPUTS 3 10 0 100 364.10

OUTPUT N I/YR PV PMT FV

Switch from “End” to “Begin”.

Then enter variables to find FVA3
FV to find FVA = $364.10
 Financial Calculator Solution

INPUTS 3 10 273.55 100 0

OUTPUT N I/YR PV PMT FV

Switch from “End” to “Begin”.

Then enter variables to find PVA3
Then enter FV = 0 and press
FV to find PVA = $273.55
 Excel Function for Annuities Due

Change the formula to:

= PV (10%, 3 , -100 , 0,1)

The fourth term, 0, tells the function there are no ot

her cash flows. The fifth term tells the function that
it is an annuity due. A similar function gives the fut
ure value of an annuity due:

= FV (10% , 3 , -100 , 0,1)

4.4 Other Discussion

• Uneven Cash Flows Stream?

• Interest rate and The issue of
Timeline?
• Calculating Payment?
4.4.1 Uneven Cash Flow Stream
Example 9:
Find is the PV of below uneven cash flow stream?

0 1 2 3 4
10%
CF1= 100 CF2 = 300 CF3=300 CF4=-50
90.91
247.93
225.39
- 34.15
530.08 = NPV
 Financial Calculator Solution

Input in “CFLO” register:

CF0 = 0
CF1 = 100
CF2 = 300
CF3 = 300
CF4 = -50

Enter I = 10%, then press NPV button to get NPV = 530.09.

(Here NPV = PV.)
 Spreadsheet Solution

A B C D E
1 0 1 2 3 4
2 100 300 300 -50
3 530.09

Excel Formula in cell A3: =NPV(10%,B2:E2)

4.4.2 The Interest Rate
Example 10:
What interest rate would cause RM100 to grow to
RM125.97 in 3 years?
$100 ( 1 + i )3 = $125.97.
( 1 + i )3 = $125.97/$100 = 1.2597
1+i = (1.2597)1/3 = 1.08
i = 8%.

INPUTS 3 8% -100 0 125.97

OUTPUT N I/YR PV PMT FV

We will deal with 3 different rates:

i nom = nominal (or stated in contract)

or quoted, rate per year.

i Per = periodic rate.

EAR @ EFF% = Effective Annual Rate

(real value of interest after compounding effect)
 Examples:
We will deal8%;
withQuarterly
3 different rates:
8%, Daily interest (365 days)
i nom = nominal (or stated in contract)
orExamples:
quoted, rate per year.
8% quarterly: iPer = 8%/4 = 2%.
i Per = periodic
8% dailyrate.
(365): iPer = 8%/365 = 0.021918%

Look at Example 11
EAR @ EFF% = Effective Annual Rate
Example 11:
What will be the EAR @ EFF of 10% if it compounded
Annually? Quarterly? Monthly? 360 days?

𝒊𝒏𝒐𝒎 𝒏𝒙𝒎
EAR = 𝟏 + - 1
𝒏𝒙𝒎

EAR Annual = 10%

EAR Q = (1 + 0.10/4)4 – 1 = 10.38%.

EAR M = (1 + 0.10/12)12 – 1 = 10.47%.

EAR D (360) = (1 + 0.10/360)360 – 1 = 10.52%.

Example 11 – (effect of EAR)
What is the FV of RM100 after 3 years under 10%
semi-annual compounding? Quarterly?
mxn
FV = PV i Nom
1+
mxn
2x3
FV 3 1 + 0.10
= 100
2

= $100(1.05)6 = $134.01

FV3Q = $100(1.025)12 = $134.49

Example 12:
What is the value at the end of the Year 3 of the following
CF stream if the quoted interest rate is 10% compounded
semiannually? *(6 m-s. periods)

1st - year 2nd - year 3rd - year

0 1 2 3 4 5 6
5%

100 100 100

• Payments occur annually, but compounding occurs each

6 months.
• So we can’t use normal annuity valuation techniques.
 *(6 ms. periods)

1st - year 2nd - year 3rd - year

0 1 2 3 4 5 6
5%

100 100 100

110.25
121.55
331.80
FVA3 = $100 (1.05)4 + $100 (1.05)2 + $100
= $331.80
4.4.3 Determining Payments (PMT)

Example 11:
Ramu and Madhuu have decided to buy apartment. The
cost of the apartment is RM150 000. They can get a 25-
year mortgage at 8% and plan to make a down payment
of 20% of the selling price. What will be their monthly
mortgage payment?

𝑷𝑿𝒊
PMT = 𝟏
𝟏 − (𝟏+𝒊)𝒏
 P = 150 k – 30 k (down payment)
𝑷𝑿𝒊
PMT = 𝟏
i = 0.08 / 12 = 0.0066667
𝟏−
(𝟏+𝒊)𝒏𝒙𝒎 n = 25 x 12 = 300

120 000 X 0.0066667

=
1
1 −
(1 + 0.0066667)300
= RM 926. 18

• Payments occur annually, but compounding occurs

each 6 months.
• So we can’t use normal annuity valuation techniques.
 TUTORIAL 4.4
Calculate below case:

a) On January 1 you deposit $100 in an account that pays a

nominal interest rate of 11.33463%, with daily compounding
(365 days).How much will you have on October 1? (or after
9 months / 273 days - days given).

b) Now suppose you leave your above (a) money in the bank
for 21 months, which is 1.75 years or 273 + 365 = 638 days.
How much will be in your account at maturity?
(Answer: Override N = 273 with N = 638)
c) The nominal rate offered by two different bank is 8%.
Bank 1 offers a semi-annual compounded rate (m = 2)
and Bank 2 offers a quarterly compounded rate (m=4).
In which bank will you save your money in? Why?

d) Suppose a bank is charging its credit card holders 1.2%

on a monthly basis. What is the Annual Percentage
Rate (APR) of this bank will be?

e) Lets say we receive 1.2% return per month from our

savings account in above (d) Bank. What will the EAR
that we receive?
f) Find the present values of following cash flow stream.
The appropriate interest rate is 8%. (Hint: It is fairly
easy to work this problem dealing with the individual
cash flows).

Year Cash Stream A Cash Stream B

1 RM 100 RM 300
2 400 400
3 400 400
4 400 400
5 300 100

Which cash flow will you choose for your investment?

Why?
 END
OF TOPIC

“Learning is a GIFT.
Even when pain is your teacher.”