Time value of money

Future Value – Single Amount

A generalized formula for Future Value:

= PV (FV)
Where
FV = Future value
PV = Present value
i = r = Interest rate
n = Number of periods;
In the previous case, PV = $1,000, i = 10%, n = 4, hence;

If $10,000 were invested for 10 years at 8%, the future value would be:
 Present Value – Single Amount
A sum payable in the future is worth less today than the stated amount
 Future Value – Annuity (cont’d)
Annuity - A series of consecutive payments or receipts of equal amount
•Future Value of an Annuity:
–Calculated by compounding each individual payment into the future and then adding up all
of these payments
•A generalized formula for Future Value of Annuity:
FVA = A × FVIFA = A X {[(1+r)n – 1] ÷ i}

Where:
FVA = Future value of the Annuity

FVIFA = Annuity Factor = {[(1+r)n – 1] ÷ i}

A = Annuity value
r = Interest rate
n = Number of periods;
•Assuming, A = $1,000, n = 4, and i = 10%
 Present Value – Annuity
•Calculated by discounting each individual payment back to the present and then adding up
all of these payments
•A generalized formula for Present Value of Annuity:
PVA = A × PVIFA = A X 1 – [1 ÷ (1+r)n] ÷ i}
Where:
PVA = Present value of the Annuity
PVIFA = Annuity Factor = {1 – [1 ÷ (1+r)n] ÷ i}
A = Annuity value
i = Interest rate
n = Number of periods
Assuming that A = $1,000, n = 4, i = 10%, we have:
Annuity Discount factor (obtained from cumulating Present Value factor for r% up to n yrs)
Sum of PV of the money paid to someone each year, typically for n periods.
Annuity - money paid to someone each year, typically for n periods
Six Formulas
 Examples of Annuities

• Student Loan Payments

• Car Loan Payments
• Insurance Premiums
• Mortgage Payments
• Retirement Savings
 Parts of an Annuity

(Ordinary Annuity)
End of End of End of
Period 1 Period 2 Period 3

0 1 2 3

$100 $100 $100

Today
Equal Cash Flows
Each 1 Period Apart
 Parts of an Annuity

(Annuity Due)
Beginning of Beginning of Beginning of
Period 1 Period 2 Period 3

0 1 2 3

$100 $100 $100

Today Equal Cash Flows
Each 1 Period Apart