Time Value of Money

Time Value of Money

 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
 The time value of money says that a peso received today is worth more than a peso
received tomorrow.
 This is true because a peso received today can be invested to earn interest.
 Time Value of Money
 Simple Interest
 Compound Interest
 Future Value
 Present Value
 Annuities
 Intra year Compounding Interest
 Future Value of Annuities
 Present Value of Annuities
 Perpetuities
 Simple Interest
 Interest – A rental fee to borrow money.
 Simple Interest – Simple Interest is when the interest received or paid is based
solely on the amount of money that was initially invested. Therefore, the interest
earned each period or year will be the same
 Simple Interest
 Simple Interest Formula
 Initial Investment x (1 + (Interest Rate x Number of Periods))

Example:
Initial investment: P1000
Number of periods: 5 years
Interest Rate: 10%
P1000 x (1 + (0.10 x 5)) =P1500
 Compounding Interest
 Compounding Interest is much different than Simple Interest. Compounding
Interest is the kind of interest you would like to receive in an investment but not the
kind of interest you would pay. Because the interest rate is based on the balance of
the investment when it is calculated, not the initial investment. What this means is
that interest is being earned on both the investment, and the interest earned from the
previous periods.
 Compounding Interest

0 1 2 3 4 5 6

10% 10% 10% 10% 10% 10%

P100 P110 P121 P133.1
And will grow exponentially
 Compounding Interest
Formula:
 

FV = Future Value
PV = Present Value
i = Interest paid by the Investment
N = Number of periods the investment will be held
 Compounding Interest
Example:
  

PV = P1000
i = 10%
N = 5 years

FV =
FV = 1000 x 1.61051
FV = P1610.51
 Future Value
 Future Value is what a money today will be worth in the future. This is because of
the interest that money can earn over time, therefore making it more valuable in the
future.

Today Future
P1000 10% P1100
 Future Value
Formula:
 

FV = Future Value
PV = Present Value
i = Interest paid by the Investment
N = Number of periods the investment will be held
 Present Value
 Present Value is the current worth of a future sum of money or stream of cash flows
given a specified rate of return.

Today Future
P1000 10% P1100
interest

Today >
Future
 Present Value
Formula:
 
PV
FV = Future Value
PV = Present Value
i = Interest paid by the Investment
N = Number of periods the investment will be held
 Present Value
 
Example:

FV = P1610.51
i = 10%
N = 5 years
PV
PV
PV
PV = P1000
 Annuity
 An annuity is a series of equal payments that are either paid to you or paid from
you. Annuities can be cash flows paid such as monthly rent payments, car
payments, or they can be money received such as semi-annual coupon payments
from a bond. Just remember, for a series of cash flows to be considered an annuity,
the cash flows need to be equal.
 Annuity
 Annuity Due
 An annuity due is when payment is made at the beginning of the payment period. Rent
for example where you are usually required to pay rent in advance at the first of every
month.
 Ordinary Annuity
 An ordinary Annuity is a payment that is paid or received at the end of the period. An
example of an ordinary annuity would be coupon payments made from bond. Usually,
bond will make semi-annual coupon payments at the end of every 6 month.
 Present Value of a Cash Flow Series
Present
   Value of an Annuity
Pays P1000 at the end of the next 3 years in a fund that pays 10% interest.
Today Year 1 Year 2 Year 3
P1000 P1000 P1000

Year 1: P909.09
Year 2: P826.45
Year 3: P751.31
PV: P2,486.85
This means that if you invested P2486.85 in a fund that earned 10% interest, you would withdraw
P1000 for the next 3 years.
 Intra year Compounding Interest
 Intra year compounding interest is when interest is compounded more frequently
than one time per year. This means that there are multiple compounding periods per
year.
 For example, some interest rates are compounded semi-annually (2 times per year),
monthly (12 times per year), etc.
Year one Year two

% % % % %
 Intra year Compounding Interest
 When interest is compounded semi-annually interest is compounded every 6
months and when interest is compounded monthly it is compounded every month.

One year
% % % % % % % % % % %
Jan Fe Mar Apr Ma Jun Jul Aug Se Oct Nov Dec
b y p
 Intra year Compounding Interest

Annual Interest Rate

Number of Compounding Periods Per
Year
Annual Interest Rate
Semi-Annual Compounding Period Rate =
2

Annual Interest Rate

Monthly Compounding Interest Rate =
12
 Intra year Compounding Interest
Example:
 
Annual Interest Rate = 10%
Compounding periods = 12 months
Monthly Compounding Interest Rate =
Monthly Compounding Interest Rate = 0.0083333
 Future Value of Investment that Earns Intra
year Compounding Interest
 Semi-annually
 
Present Value = P1000
Annual Interest Rate = 10%
Length of Investment = 5 years
Compounding Period Rate = 0.10/2 = 0.05
Number of Periods = 5 years x 2 periods per year = 10 compounding periods
FV
FV
FV = 1000 x 1.6289
FV = P1628.9
 Present Value of Monthly Annuity
Compounding Monthly
FV = P1000  January P991.74
Your future value is P1000 because
you're receiving P1000 payments February P983.57
at the end of the next 6 months
March P975.42
i = 10%/12 = 0.00833
Since you’re receiving your April P967.36
payments monthly, you’ll divide
the annual interest rate by 12 since May P959.37
there are 12 months in a year and
your interest rate is annual. June P951.45
N = There are 6 periods (months)
of payment. January is the first PV of Annuity = P5828.91
payment so N=1, February is the
second payment period so N=2 and
so on.
 Future Value of an Ordinary Annuity
Payments: P1000
Interest Rate: 10%
Number of periods: 5 years End of each period

0 1 2 3 4 5

P1000 P1000 P1000 P1000 P1000

Payment paid or received at end of each

period
 Future Value of an Ordinary Annuity
0 1 2 3 4 5
 

P1000 P1000 P1000 P1000 P1000

1000 x

1000 x

1000 x

1000 x

1000 x

Future Value of an Ordinary Annuity = P6105.10

 Future Value of an Ordinary Annuity

 
Formula:

FVOA

FVOA = Future value of ordinary annuity

Pmt = Annuity payment
i = interest rate per period
n = number of compounding periods
 Future Value of an Ordinary Annuity
 
Example:

Payments: P1000
Interest Rate: 10%
Number of periods: 5 years
FVOA
FVOA
FVOA = 1000 x 6.1051
FVOA = P6105.10
 Future Value of an Annuity Due
Payments: P1000
Interest Rate: 10%
Number of periods: 5 years End of each period

0 1 2 3 4 5

P1000 P1000 P1000 P1000 P1000

Payment paid or received at beginning of each

period
 Future Value of an Annuity Due
0 1 2 3 4 5
  

P1000 P1000 P1000 P1000 P1000

1000 x
1000 x
1000 x
1000 x
1000 x
Future Value of an Annuity Due = P6715.61
 Future Value of an Annuity Due
Formula:
  

FVAD x (1+i)

FVAD = Future value of annuity due

Pmt = Annuity payment
i = interest rate per period
n = number of compounding periods
 Future Value of an Annuity Due
 
Example:

Payments: P1000
Interest Rate: 10%
Number of periods: 5 years
FVAD x (1+i)

FVAD x (1+0.10)
FVAD = 1000 x 6.1051 x 1.10
FVAD = P6715.61
Finding the Size of each Periodic Payment
  Future Value of an Ordinary Annuity Formula
Pmt
 Future Value of an Annuity Due Formula
Pmt
Present Value of an Ordinary Annuity
0 1 2 3 4 5
  

P1000 P1000 P1000 P1000 P1000

P 909.09
P8
P7
P6
P6
Present Value of an Ordinary Annuity = P3790.78
 Present Value of an Ordinary Annuity
Formula:
 
PVOA )
PVOA = Present Value of Ordinary Annuity
Pmt = Annuity Payment
i = Interest Rate per period
n = Number of compounding periods
 Present Value of an Ordinary Annuity
Example:
  

Payments: P1000
Interest Rate: 10%
Number of periods: 5 years
PVOA )
PVOA )
PVOA = )
PVOA =1000 x 3.791
PVOA = P3791
 Present Value of an Annuity Due
0 1 2 3 4 5

P1000 P1000 P1000 P1000 P1000

 
P1

P 909.09

P8

P7

P6

Present Value of an Annuity Due = P4169.86

 Present Value of an Annuity Due
Formula:
 
PVAD +1)
PVAD = Present Value of an Annuity Due
Pmt = Annuity payment
i = Interest Rate per period
n = number of compounding periods
 Present Value of an Annuity Due
 
Example:

Payments: P1000
Interest Rate: 10%
Number of periods: 5 years
PVAD +1)
PVAD +1)
PVAD = +1)
PVAD = 3.17+1)
PVAD = P4170
Finding the Size of each Periodic Payment
  Present Value of an Ordinary Annuity Formula

 Present Value of an Annuity Due Formula

 Perpetuity
  A perpetuity is a fixed cash flow received over an indefinite number of periods. For
example, if someone were to received P1000 per month until they died, that would
be a perpetuity.
 Present Value of Perpetuity
PV
 Present Value of a Perpetuity
  P1000 per year forever with an available interest rate of 5%
P20000
 P1000 per month forever with an available interest rate of 5%
P238,095.24