TIME VALUE OF MONEY

Single Amount
Future Value
1+r n

Formula: FV = PV
Example:

If you deposited 500 today into account that pays 5% interest. How
much do you have in the account in 10 years?
Given: PV= 500 r = 5%

n = 10

Solution:
n

FV = PV

1+r

FV = 500

1+5 10

FV = 814.45

Present Value
n

Formula: PV =

1+r

FV

Example:
Pam Valentin wishes to find the present value of 1,700 that she will
receive in 8yrs from now. Pams opportunity cost is 8%.
Given: FV = 1,700
Solution:

r = 8%

n=8

PV =

1+r

FV

PV =

1+8 8

1,700

PV = 918.46

Annuity
Ordinary Annuity
Future Value
n

Formula: FV = Cf x

1+r

Example:
Fran Abrams wishes to determine how much money she will have at
the end of 5 years if she chooses annuity A, the ordinary annuity. She will
deposit 1,000 annually, at the end of each of the next 5 years,into a savings
account paying 7% annual interest.
Given: CF = 1,000

r = 7%

Solution:

FV = Cf x

1+r

n= 5

FV = 1,000 x

1+7

FV = 5, 750.74
Annuity Due
n

Fomula: FV = Cf x

1+r

} x (1 + r)

Solution:

FV = Cf x

1+r n

} x (1 + r)

FV = 1,000 x

1+7

} x ( 1 + 7%)

FV = 1,000 x 6. 15329
FV = 6,153.29

Present Value
n

Formula: PV =

Example:

Cf
r

1+r

1
1

Braden Company, a small producer of plastic toys, wants to determine

the most itshould pay to purchase a particular ordinary annuity. The annuity
consists of cash flows of 700 at the end of each year for 5 years. The firm
requires theannuity to provide a minimum return of 8%.
Given: Cf = 700

r = 8%

n= 5

Solution:
n

PV =

Cf
r

1+r

1
1

PV =

700
8

1+8

1
1

= 8,750 x 0.3194
PV = 2,794.90

Annuity Due
n

Formula: PV =

Cf
r

1+r

1
1

Solution:

PV =

Cf
r

1+r n

1
1

x (1 + r)

x (1+ r)

PV =

700
8

1+8

1
1

x (1 + 8%)

PV = 8,750 x .344970
PV = 3,018.49

Mixed Stream
Future Value:
Example:
Shrell Industries, a cabinet manufacturer, expects to receive the
following mixedstream of cash flows over the next 5 years from one of its
small customers.
Year
1
2
3
4
5

cashflow
11,500
14,000
12,900
16,000
18,000

If Shrell expects to earn 8% on its investments, how much will it accumulate

bythe end of year 5 if it immediately invests these cash flows when they are
received?
Solution :
Year
1

cashflow
4

11,500 x (1.08

FV
15,645.62

3
14,000 x (1.08

17,635.97

2
12,900 x (1.08

15,046.56

1
16,000 x (1.08

5
Future Value

18,000

17,280
18,000
83,608.15

Present Value
Example:
Frey Company, a shoe manufacturer, has been offered an opportunity
to receive the following mixed stream of cash flows over the next 5 years:
Year
cashflow
1
400
2
800
3
500
4
400
5
300
If the firm must earn at least 9% on its investments, what is the most it
should pay for this opportunity?
Solution:

Year
1
2

cashflow
400/ (1.09)
2
800/ (1.09

PV
366.97
673.34

500 (1.09

386.09

4
400/(1.09

283.37

5
300/(1.09

194.98

Present Value

1,904.75

Nominal and Effective Annual Rate of Interest

Formula: EAR =
Example:

(1+ mr )

Fred
Moreno
wishes
to
find
the
effective
annual
rate
associatedwith an 8% nominal annual rate when interest is compounded
(1) annually ; (2) semi annually ; and (3) quarterly.
Solution:
1. Annually
EAR =

(1+ 81 )

EAR = 8%
2. Semi annually
8
1+ 2
EAR =
2

EAR = 8.16%
3. Quarterly
8
1+
EAR =
4

( )
( )

EAR = 8.24%