TIME VALUE OF MONEY

•How to determine, today, the value

(monetary) of cash transactions that are
expected in the future?

•To have X amount of money at any

future point of time, what should one
posses now?

•Investing now or holding it for future

investment?

•Where to invest? Bank, Alternative-1 or

Alternative-2 etc.?
TIME VALUE OF
•MONEY
Time value of money refers to the fact that
money in hand today is worth more than
the same amount promised at some time
in the future.

Which would you rather have: $100

today or $100 in 5 years?

• Money received sooner rather than later

allows one to use the funds for investment
or consumption purposes. This concept is
referred to as the “Time Value of Money”

• Time allows one the opportunity to

postpone consumption and earn interest.
SIMPLE VS COMPOUND
INTEREST
 Simple Interest
 Interest earned = 5% of $500 = .05×500 = $25 per year
 Total interest earned = $25×2 = $50
 Balance in your savings account:
= Principal + accumulated interest
= $500 + $50 = $550

 Compound interest (assuming compounding once a year)

 Interest earned in Year 1 = 5% of $500 = $25
 Interest earned in Year 2 = 5% of ($500 + accumulated
interest)
= 5% of ($500 + 25) = .05×525 = $26.25
 Balance in your savings account:
= Principal + interest earned = $500 + $25 + $26.25 = $551.25
CASH FLOW DIAGRAM
A cash flow diagram is a graphically presentation of
the timing of the cash flows as well as their nature as
either inflows or outflows.

All the transactions are depicted at the end of year

(EOY)

Cash Inflow (Arrow Upward)

Cash Outflow (Arrow Downward)
CASH FLOW DIAGRAM
TYPES OF CASH FLOW
SYMBOLS & TERMINOLOGY

 P= value or amount of money at present , Also referred as present

worth (PW), present value (PV), net present value, discounted cash
flow and Capital Cost.

 F=Value or amount of money at future time. Also F is called future

worth (FW) and future value (FV)

 A= Series of consecutives, equal, end of period amounts of money

(Receipts/disbursement)

 N or n= Number of interest period; years, months or days

 i= interest rate per time period; percent per year

 t=time, stated in periods; years, months or days

EQUIVALENCE OF CASH FLOW
Economic equivalence is a combination of
interest rate and time value of money to
determine the different amounts of money
at different points in time that are equal in
economic value.

•Relationship between P and F.

•Relationship between P and A
•Relationship between P and G
•Relationship between A and G
RELATION BETWEEN “P” & “F”

F = P (1 + i)n

• Future value refers to the amount of money an investment

will grow to over some length of time at some given interest
rate

• To determine the future value of a single cash flows, we

need:
 Present value of the cash flow (PV)
 Interest rate (i), and
 Time period (n)
RELATION BETWEEN “P”
& “F”

Future Value Interest Factor at ‘i’ rate of

interest for ‘n’ time periods

The notation in parenthesis can be read as follows:

“To find a future sum F, given a present sum, P, at an
interest rate i per interest period and n interest periods
hence” OR simply Find F, given P, at I, over n
PROBLEM
If you wish to have $ 12000 in a saving
account at the end of 5 years and 5% interest
will be paid annually, how much should you
put into saving account now?

F = P (1 + i)n
RELATION BETWEEN “P” & “A”
 i (1  i ) N 
A  P N 
 (1  i )  1 

 i 
A  F 
 (1  i ) n  1
 SO FAR
F = P (1 + i)n
 i (1  i ) N 
A  P N 
 (1  i )  1

Faisal Hasan
Associate Professor
Mechanical Engineering Department
Z.H. College of Engineering & Technology, AMU, Aligarh
Problem 3.55 (Unsolved, Page 132, DeGarmo)
Find the value of “K” for the cash flows to
be equivalent. Let i=15% per year
Find the value of the unknown quantity “A” in
the cash flow below to establish the
equivalence of cash inflows and outflows. Let
i=12% per year.