Time Value of Money

NOTRE DAME OF
DADIANGAS UNIVERSITY
GRADUATE SCHOOL
Time Value of
Money
EdMAN 205
CELINA N. UGALDE
Reporter
July 13, 2013
What is Time Value?
• We say that money has a time value because that

money can be invested with the expectation of
earning a positive rate of return
• In other words, “a dollar received today is worth more
than a dollar to be received tomorrow”
• That is because today’s dollar can be invested so
that we have more than one dollar tomorrow
Why TIME?
Why is TIME such an important

element in your decision?
TIME allows you the opportunity to

postpone consumption and earn
INTEREST.
The Terminology of Time
Value
• Present Value - An amount of money today, or the
current value of a future cash flow
• Future Value - An amount of money at some future
time period
• Period - A length of time (often a year, but can be a
month, week, day, hour, etc.)
• Interest Rate - The compensation paid to a lender
(or saver) for the use of funds expressed as a
percentage for a period (normally expressed as an
annual rate)
Abbreviations
• PV - Present value
• FV - Future value
• Pmt - Per period payment amount
• N - Either the total number of cash
flows or the number of a
specific period
• i - The interest rate per period
Timelines
A timeline is a graphical device used
to clarify the timing of the cash flows
for an investment
Each tick represents one time period
PV FV
0 1 2 3 4 5
Today
Time lines
0 1 2 3
I%
CF0 CF1 CF2 CF3
• Show the timing of cash flows.

• Tick marks occur at the end of periods, so
Time 0 is today; Time 1 is the end of the
first period (year, month, etc.) or the
beginning of the second period.
Types of TVM
Calculations
• There are many types of TVM
calculations
– Present value of a lump sum
– Future value of a lump sum
– Present and future value of cash flow
streams
– Present and future value of annuities
9
Interest
Compensation or rent paid to the

owner of cash for its use by
others over time
O17.1
Future value
The value in the future of a

payment stream with the effect
of interest included and
expressed as a single value
O17.1
Future value
(FV)
What will this
Computing
dollar be worth future value
one year from
today? assumes some
rate of interest
At 8% per year
Interest
FV = $1 x 1.08
Principal
FV = $1.08
O17.1
Future value
(FV)
Any amount times 1 + interest rate
equals the FV after one time period
EXAMPLES
Interest
$500 x 1.08 = $540

Principal or
$12 x 1.08 = $12.96
or
$15,560 x 1.08 = $16,805
O17.1
Future
PresentVal Interest rate is 8% per year
ue Single
Value
Amount Single
Interest
earned Amount
Principa
l
Year
Year 5
Year 4
Year 3
Year 2
Year 1
0
X 1.08
X 1.08
X 1.08
X 1.08
X 1.08
O17.1
Steps to Solve Time
Value of Money
Problems
1. Read problem thoroughly
2. Create a time line
3. Put cash flows and arrows on time line
4. Determine if it is a PV or FV problem
5. Determine if solution involves a single
CF, annuity stream(s), or mixed flow
6. Solve the problem
7. Check with financial calculator (optional)
Types of Interest
 Simple Interest
Interest paid (earned) on only the original
amount, or principal, borrowed (lent).
• Compound Interest
Interest paid (earned) on any previous
interest earned, as well as on the principal
borrowed (lent).
Simple Interest Formula
Formula SI = P0(i)(n)
SI: Simple Interest
P0: Deposit today (t=0)
i: Interest Rate per Period
n: Number of Time Periods
Simple Interest Example
• Assume that you deposit $1,000 in an

account earning 7% simple interest for 2
years. What is the accumulated interest at
the end of the 2nd year?
• SI = P0(i)(n)
= $1,000(.07)(2)
= $140
Simple Interest (FV)
• What is the Future Value (FV) of the

deposit?
FV = P0 + SI
= $1,000 + $140
= $1,140
• Future Value is the value at some future time
of a present amount of money, or a series of
payments, evaluated at a given interest rate.
Simple Interest (PV)
• What is the Present Value (PV) of the

previous problem?
The Present Value is simply the
$1,000 you originally deposited.
That is the value today!
• Present Value is the current value of a
future amount of money, or a series of
payments, evaluated at a given interest
rate.
Calculating the Future
Value
• Suppose that you have an extra $100 today
that you wish to invest for one year. If you
can earn 10% per year on your investment,
how much will you have in one year?
-100
0 1 2 3 4 5
FV1  1001  010

.   110
Calculating the Future
Value (cont.)
• Suppose that at the end of year 1 you decide
to extend the investment for a second year.
How much will you have accumulated at the
end of year 2?
-110 ?
0 1 2 3 4 5
FV2  1001  010

. 1  010
.   121
or
FV2  1001  010
.   121
2
Generalizing the Future
Value
• Recognizing the pattern that is
developing, we can generalize the
future value calculations as follows:
FVN  PV1  i
N
 If you extended the investment for a third

year, you would have:
FV3  1001  010

.   13310
3
.
Compound Interest
• Note from the example that the future value is
increasing at an increasing rate
• In other words, the amount of interest earned
each year is increasing
– Year 1: $10
– Year 2: $11
– Year 3: $12.10
• The reason for the increase is that each year
you are earning interest on the interest that
was earned in previous years in addition to
the interest on the original principle amount
Compound Interest
Graphically
4500
3833.76
4000
5%
3500
10%
3000
15%
Future Value
2500 20%
2000 1636.65
1500
1000
672.75
500 265.33
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years
The Time Value of
Money
Compounding and
Discounting Single
Sums
We know that receiving $1 today is
worth more than $1 in the future.
This is due to opportunity costs.
The opportunity cost of receiving $1
in the future is the interest we could
have earned if we had received the
$1 sooner.
Today Future
If we can measure this
opportunity cost, we can:
• Translate $1 today into its equivalent in the
future (compounding).
Today Future
?
Today Future
?
• Translate $1 in the future into its equivalent
today (discounting).
Today Future
?
• Translate $1 in the future into its equivalent
today (discounting).
Today Future
?
Future Value - single sums
If you deposit $100 in an account earning 6%,
how much would you have in the account
after 1 year?
If you deposit $100 in an account
earning 6%, how much would you have
in the account after 1 year?
PV = FV =
0 1
If you deposit $100 in an account earning 6%,
how much would you have in the account
after 1 year?
PV = -100 FV =
0 1
Calculator Solution:
P/Y = 1 I=6
N=1 PV = -100
FV = $106
in the account after 1 year?
PV = -100 FV = 106
0 1
P/Y = 1 I=6
N=1 PV = -100
FV = $106
If you deposit $100 in an account earning 6%, how

much would you have in the account after 1 year?
PV = -100 FV = 106
0 1
Mathematical Solution:
FV = PV (FVIF i, n )
FV = 100 (FVIF .06, 1 ) (use FVIF table, or)
FV = PV (1 + i)n
FV = 100 (1.06)1 = $106
in the account after 5 years?
much would you have in the account after 5
years?
PV = FV =
0 5
much would you have in the account after 5 years?
PV = -100 FV =
0 5
P/Y = 1 I=6
N=5 PV = -100
FV = $133.82
PV = -100 FV =
133.82
0 5
P/Y = 1 I=6
N=5 PV = -100
FV = $133.82
PV = -100 FV =
133.82
0 5
FV = 100 (FVIF .06, 5 ) (use FVIF table,
or)
FV = PV (1 + i)n
FV = 100 (1.06)5 = $133.82
earning 6% with quarterly
compounding, how much would you
have in the account after 5 years?
PV = FV =
0 ?
PV = -100 FV =
0 20
P/Y = 4 I=6
N = 20 PV = -100
FV = $134.68
If you deposit $100 in an account earning 6% with
quarterly compounding, how much would you have in the
account after 5 years?
PV = -100 FV =
134.68
0 20
P/Y = 4 I=6
N = 20 PV = -100
FV = $134.68
If you deposit $100 in an account earning 6%
with quarterly compounding, how much
would you have in the account after 5 years?
PV = -100 FV =
134.68
0 20
FV = 100 (FVIF .015, 20 ) (can’t use FVIF
table)
FV = PV (1 + i/m) m x n
FV = 100 (1.015)20 = $134.68
monthly compounding, how much would you have
If you deposit $100 in an account earning 6%
with monthly compounding, how much would
you have in the account after 5 years?
PV = FV =
0 ?
earning 6% with monthly compounding,
how much would you have in the
PV = -100 FV =
0 60
P/Y = 12 I=6
N = 60 PV = -100
FV = $134.89
earning 6% with monthly compounding,
how much would you have in the
PV = -100 FV =
134.89
0 60
P/Y = 12 I=6
N = 60 PV = -100
FV = $134.89
monthly compounding, how much would you have
PV = -100 FV =
134.89
0 60
FV = 100 (FVIF .005, 60 ) (can’t use FVIF
table)
FV = PV (1 + i/m) m x n
FV = 100 (1.005)60 = $134.89
Future Value - continuous compounding
What is the FV of $1,000 earning 8% with
continuous compounding, after 100 years?
Future Value - continuous
compounding
What is the FV of $1,000 earning 8%
with continuous compounding, after
100 years?
PV = FV =
0 ?
PV = -1000 FV =
0
100
FV = PV (e in)
FV = 1000 (e .08x100) = 1000 (e 8)
FV = $2,980,957.99
PV = -1000 FV =
$2.98m
0
100
FV = PV (e in)
FV = 1000 (e .08x100) = 1000 (e 8)
FV = $2,980,957.99
PV = -1000 FV = $2.98m
$2.98m
0
100
FV = PV (e in)
FV = 1000 (e .08x100) = 1000 (e 8)
FV = $2,980,957.99
Present Value
Rule #1
A dollar received today is always

more valuable than a dollar
received in the future and A
dollar received in the future is
always less valuable than a
dollar received today
O17.1
Present value
The value today of a payment

stream with the effect of interest
removed and expressed as a
single value
O17.1
Present value (PV)
If this dollar is To compute PV
received in one
year, what is it
DIVIDE by 1+
worth today? the interest
rate
At 8% per year
PV = $1 / 1.08
PV = $.93
O17.1
Present value
(PV)
Any amount DIVIDED by 1 + interest
rate equals the PV for one time period
EXAMPLES
$500 / 1.08 = $463

or
$12 / 1.08 = $11
or
$15,560/ 1.08 = $14,407
O17.1
Present
Present value
FutureVa
Value lue
0 1 2 3 4
$
SINGLE AMOUNT
Reducing payment streams to their

present value is called discounting
O17.1
Rule #2
The more time periods, the

higher the future value and the
more time periods, the lower the
present value
EXAMPLE –Future Value
Value after 1 year = $50 x 1.08 = $54

Value after 2 years = $50 x 1.08 x 1.08 = $58
O17.1
Rule #2
The more time periods, the

higher the future value and the
more time periods, the lower the
present value
EXAMPLE –Present value
Value today if received in 1 year = $50 / 1.08

= $46
Value today if received in 2 years = $50 / 1.08 /1.08 = $43
O17.1
Rule #3
The value in the future is always

higher if the interest rate is
higher and the value today is
always lower if the interest rate
is higher
EXAMPLE –Present value
O17.1
Present Interest rate is 8% per year
Future
Value Fifth Year Principal Value
Discounted
Principal
Year
Year 5
Year 4
Year 3
Year 2
Year 1
0
÷ 1.08
÷ 1.08
÷ 1.08
÷ 1.08
÷ 1.08
Present Interest rate is 25% per year
Future
Value Fifth Year Principal Value
Discounted
Principal
Year
Year 5
Year 4
Year 3
Year 2
Year 1
0
Much ÷ 1.25
smaller
than at
÷ 1.25
8% ÷ 1.25
÷ 1.25
÷ 1.25
Compounding
During a time period (year), the
computation of interest and the
addition to or subtraction from
principle.
O17.1
Rule #4
The more compounding periods

the higher the future value and
The more compounding periods
the lower the present value.
O17.1
Compounding
EXAMPLE –Future value
A $5,000 savings deposit pays 4% per year compounded

every six months.
More 4%/2 = 2% per six months
$5,000 x 1.02 x 1.02 = $5,202.00
compounding
periods =
higher future
A $5,000 savings deposit pays 4% per year compounded
value every quarter.
4%/4 = 1% per quarter
$5,000 x 1.01 x 1.01 x 1.01 x 1.01 = $5,203.02
O17.1
Future Value
Single Deposit (Formula)
FV1 = P0 (1+i)1 = $1,000 (1.07)
= $1,070
FV2 = FV1 (1+i)1
= P0 (1+i)(1+i) = $1,000(1.07)(1.07)
= P0 (1+i)2 = $1,000(1.07)2
= $1,144.90
You earned an EXTRA $4.90 in Year 2 with
compound over simple interest.
General Future
Value Formula
FV1 = P0(1+i)1
FV2 = P0(1+i)2
etc.
General Future Value Formula:
FVn = P0 (1+i)n
or FVn = P0 (FVIFi,n) -- See Table I
Present Value - single sums
If you receive $100 one year from now, what is the
PV of that $100 if your opportunity cost is 6%?
General Present
Value Formula
PV0 = FV1 / (1+i)1
PV0 = FV2 / (1+i)2
etc.
General Present Value Formula:
PV0 = FVn / (1+i)n
or PV0 = FVn (PVIFi,n) -- See Table II
If you receive $100 one year from now, what
is the PV of that $100 if your opportunity cost
is 6%?
PV = FV =
0 ?
is 6%?
PV = FV = 100
0 1
P/Y = 1 I=6
N=1 FV = 100
PV = -94.34
is 6%?
PV = -94.34 FV = 100
0 1
P/Y = 1 I=6
N=1 FV = 100
PV = -94.34
If you receive $100 one year from now,
what is the PV of that $100 if your
opportunity cost is 6%?
PV = -94.34 FV = 100
0 1
PV = FV (PVIF i, n )
PV = 100 (PVIF .06, 1 ) (use PVIF table,
or)
PV = FV / (1 + i)n
PV = 100 / (1.06)1 = $94.34
If you receive $100 five years from now,
PV = FV =
0 ?
PV = FV = 100
0 5
P/Y = 1 I=6
N=5 FV = 100
PV = -74.73
PV = -74.73 FV = 100
0 5
P/Y = 1 I=6
N=5 FV = 100
PV = -74.73
PV = -74.73 FV = 100
0 5
or)
PV = FV / (1 + i)n
PV = 100 / (1.06)5 = $74.73
What is the PV of $1,000 to be received
15 years from now if your opportunity
cost is 7%?
cost is 7%?
PV = FV =
0 15
cost is 7%?
PV = FV = 1000
0 15
P/Y = 1 I=7
N = 15 FV = 1,000
PV = -362.45
cost is 7%?
PV = -362.45 FV = 1000
0 15
P/Y = 1 I=7
N = 15 FV = 1,000
PV = -362.45
cost is 7%?
PV = -362.45 FV = 1000
0 15
or)
PV = FV / (1 + i)n
PV = 100 / (1.07)15 = $362.45
Hint for single sum
problems:
• In every single sum present
value and future value problem,
there are four variables:
FV, PV, i and n.
• When doing problems, you will
be given three variables and
you will solve for the fourth
variable.
• Keeping this in mind makes
solving time value problems
much easier!
Annuities
• Annuity: a sequence of
equal cash flows, occurring
at the end of each period.
Annuities
• An annuity is a series of nominally equal
payments equally spaced in time
• Annuities are very common:
– Rent
– Mortgage payments
– Car payment
– Pension income
• The timeline shows an example of a 5-year,
$100 annuity
100 100 100 100 100
0 1 2 3 4 5
Examples of Annuities
• Student Loan Payments

• Car Loan Payments
• Insurance Premiums
• Mortgage Payments
• Retirement Savings
Examples of
Annuities:
• If you buy a bond, you will
receive equal semi-annual
coupon interest payments
over the life of the bond.
• If you borrow money to buy a
house or a car, you will pay a
stream of equal payments.
Examples of
Annuities:
• If you buy a bond, you will
receive equal semi-annual
coupon interest payments
over the life of the bond.
• If you borrow money to buy a
house or a car, you will pay a
stream of equal payments.
Types of Annuities
 AnAnnuity represents a series of equal

payments (or receipts) occurring over a
specified number of equidistant periods.
• Ordinary Annuity: Payments or receipts
occur at the end of each period.
• Annuity Due: Payments or receipts occur at
the beginning of each period.
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
Hint on Annuity
Valuation
The future value of an ordinary
annuity can be viewed as
occurring at the end of the last
cash flow period, whereas the
future value of an annuity due
can be viewed as occurring at
the beginning of the last cash
flow period.
Future Value - annuity
If you invest $1,000 each year at 8%,
how much would you have after 3
years?
years?
0 1 2 3
years?
1000 1000 1000
0 1 2 3
P/Y = 1 I=8 N=3
PMT = -1,000
FV = $3,246.40
years?
1000 1000 1000
0 1 2 3
P/Y = 1 I=8 N=3
PMT = -1,000
FV = $3,246.40
years?
years?
years?
FV = PMT (FVIFA i, n )
years?
FV = 1,000 (FVIFA .08, 3 ) (use FVIFA table,
or)
years?
or)
FV = PMT (1 + i)n - 1
i
years?
or)
FV = PMT (1 + i)n - 1
i
FV = 1,000 (1.08)3 - 1 = $3246.40
.08
Present Value - annuity
What is the PV of $1,000 at the end of
each of the next 3 years, if the
Present Value - annuity due
What is the PV of $1,000 at the
beginning of each of the next 3 years, if
your opportunity cost is 8%?
1000 1000 1000
0 1 2 3
Mode = BEGIN P/Y = 1 I
=8
N=3 PMT = 1,000
Mathematical Solution: Simply compound the FV of
the ordinary annuity one more period:
PV = PMT (PVIFA i, n ) (1 + i)
PV = 1,000 (PVIFA .08, 3 ) (1.08) (use PVIFA table, or)
1
PV = PMT 1- (1 + i)n (1 + i)
i
1
PV = PMT 1- (1 + i)n (1 + i)
i
1
PV = 1000 1- (1.08 )3 (1.08) = $2,783.26
.08
Retirement Example
If you invest $400 at the end of each
month for the next 30 years at 12%,
how much would you have at the end of
year 30?
FV = 400 (FVIFA .01, 360 ) (can’t use FVIFA table)
FV = PMT (1 + i)n - 1
i
FV = 400 (1.01)360 - 1 = $1,397,985.65
.01
House Payment Example
If you borrow $100,000 at 7%
fixed interest for 30 years in
order to buy a house, what will
be your monthly house
payment?
House Payment Example
PV = PMT (PVIFA i, n )
100,000 = PMT (PVIFA .07, 360 ) (can’t use PVIFA
table)
1
PV = PMT 1- (1 + i)n
i
1
100,000 = PMT 1 - (1.005833 )360
PMT=$665.30
THANK YOU !!!

Time Value of Money

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NOTRE DAME OF

• We say that money has a time value because that

Why is TIME such an important

TIME allows you the opportunity to

Each tick represents one time period

CF0 CF1 CF2 CF3

• Show the timing of cash flows.

Compensation or rent paid to the

The value in the future of a

$500 x 1.08 = $540

• Assume that you deposit $1,000 in an

• What is the Future Value (FV) of the

• What is the Present Value (PV) of the

FV1  1001  010

FV2  1001  010

 If you extended the investment for a third

FV3  1001  010

If you deposit $100 in an account earning 6%, how

A dollar received today is always

The value today of a payment

$500 / 1.08 = $463

Reducing payment streams to their

The more time periods, the

Value after 1 year = $50 x 1.08 = $54

The more time periods, the

Value today if received in 1 year = $50 / 1.08

The value in the future is always

The more compounding periods

A $5,000 savings deposit pays 4% per year compounded

100 100 100 100 100

• Student Loan Payments

 AnAnnuity represents a series of equal

$100 $100 $100

$100 $100 $100

1000 1000 1000

1000 1000 1000

1000 1000 1000

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