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Module 5 Basic Time Value of Money

The document discusses the time value of money concept. It suggests that money received today is worth more than the same amount received in the future due to interest earnings. It provides formulas to calculate future value and present value of lump sums and annuities. Understanding time value of money is important for personal and business financial decision making.

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lord kwantonium
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90 views33 pages

Module 5 Basic Time Value of Money

The document discusses the time value of money concept. It suggests that money received today is worth more than the same amount received in the future due to interest earnings. It provides formulas to calculate future value and present value of lump sums and annuities. Understanding time value of money is important for personal and business financial decision making.

Uploaded by

lord kwantonium
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Time Value of Money

-simply suggests that money


in your hand today is worth
more when you will receive it
at a later
Question: date.

-Let’s assume that someone is


offering you P1,000,000 today or
P1,000,000 after 2 years, what will
you choose?
-If you have to receive P1,000,000
today and deposited the money in
an interest bearing account at 5%
for next 2 years, you will have
P1,102,500
Solution:
P1,000,000*1.05*1.05
=P1,102,500
How Money
Grows

P70,400
Simple Interest
vs
Compound Interest

P30,000
5 10 15 20 25 30 35 40
YEARS
Why STUDY Time Value of Money?
-if you ignore the time value of money
concepts, you will not be able to make
personal or business decisions.
Example:
-You invest P1 Million in an investment
account today and the investment is going
to generate P1.2 Million at the end of 2
years. Based on the info, you assume that
the project is going to generate P200,000
in profits. The problem with this
assumption is you have ignored the time
value of money. If the cost of borrowing is
Why STUDY Time Value of Money?

Investment P1,000,000.00
Interest Payment @12% for
2 years P240,000.00
Value of the Investment
after 2 years P1,200,000.00

Profit (Loss) (P40,000.00)


TIME VALUE OF MONEY
CONCEPTS
-Compounding (taking money now
and earning interest on it) and
Discounting (taking money in the
future and calculating today’s value)
are using a set of formulas to find
equivalent values at any two points in
time. This equivalence just means that
a rational person will be indifferent
between receiving P1,000 today and
P1,100 in one year, given a 10%
TERMINOLOGIES:
*Compound Interest is calculated
each period on the principal amount,
and on any interest earned on the
investment up to that point.
*Simple Interest is the method of
calculating interest in which, during
the entire term of the loan, interest is
only computed on the original sum
borrowed.
TERMINOLOGIES:
-Future Value (FV) is the amount an
investment is worth after one or
more periods in the future.
-Present Value (PV) is the amount that
is today’s value of a future sum.
-*if you know you will receive a
certain sum of money in the future,
given the interest rate, what is the
equivalent value today?
TERMINOLOGIES:
*If you know you are going to receive
P2,200 in one year, and you know the
interest rate is10% Per Annum, the
equivalent value of that future
amount today is P2,000.
*Understanding present values is
very useful because we can use it to
decide which investments are best.
TERMINOLOGIES:
*the number of time periods between
the present value and the future value
is represented by “t”

*the rate of interest for discounting


or compounding is called “r”.

*Annuity - is a sum of money payable


yearly or at regular intervals
TERMINOLOGIES:
*An ordinary annuity is a series of
payments having the following three
characteristics:
1. All payments are in the same amount
(such as a series of payments of P1,000).
2. All payments are made at the same
intervals of time (such as once a month or
quarter, over a period of a year).
3. All payments are made at the end of
each period (such as payments being
made only at the last day of the month).
TAKE NOTE:
*All time value questions involve
these four values: FV, PV, r and t.
*Compounding is the process of
accumulating interest in an
investment over time, to earn more
interest

*Discount rate is the interest rate that


derives a present value from a given
future value.
Lump Sum Time Line:
Annuity Time Line:
FUTURE VALUE OR FV:
Illustration:

Let’s assume you have invested


P1,000 in an investment that grants
10 percent interest annually. How
much money will you have in your
investment account after 5 years?
after one year 1,000*(1+0.10) 1,100.00

after two years 1,100*(1+0.10) 1,210.00

after three years 1,210*(1+0.10) 1,331.00

after four years 1,331*(1+0.10) 1,464.10

after five years 1,464.10*(1+0.10) 1,610.51

*The accumulated value of this investment at the end of five


years can be split into two components:
Original Principal = P1,000.00
Interest Earned = P 610.51
Using simple interest, the total interest earned would only have
been P500. The other P110. 51 is from compounding
FUTURE VALUE OF A LUMP
SUM
FUTURE VALUE OF A LUMP
SUM
Example:
What will P1,000 amount to in Five
Years time if interest is Six Percent
per annum compounded annually?
FUTURE VALUE OF A LUMP
SUM
Example:
What will P1,000 amount to in Five
Years time if interest is Six Percent
per annum compounded annually?

Answer: P1,338.22
FUTURE VALUE OF A LUMP
SUM
Example:
What will P1,000 amount to in Five
Years time if interest is Six Percent
per annum compounded monthly?
FUTURE VALUE OF A LUMP
SUM
Example:
What will P1,000 amount to in Five
Years time if interest is Six Percent
per annum compounded monthly?

Answer: P1,348.85
Albert Einstein
“Compound
Interest is the
eighth wonder of
the world.

He who
understands it,
earns it...he who
doesn’t...pays
PRESENT VALUE OF A LUMP
SUM
Formula:
PRESENT VALUE OR PV:
Illustration:

Let’s assume you will receive P5,000


after five years from a trust account.
What is the value of the trust account
today assuming that the annual
interest rate is 10%?
PRESENT VALUE OF A LUMP
SUM

Computation:
PV=5,000*(1+0.10)-5
PV=3,104.61
FUTURE VALUE OF ANNUITY:
Illustration:

Let’s assume that you are depositing


P1,000 every year in an investment
account for the next five years. What
will be the balance of your investment
account after five years assuming
that the interest rate is 10%.
FUTURE VALUE OF
ANNUITY
Formula:
t
FVA = PMT [ (1 + r) - 1
r ]

*where: PMT = Annuity Payment


FUTURE VALUE OF
ANNUITY

Computation:
FVA=1,000* [(1+0.10)5 -1
0.10 ]
FV=1,000*6.1051
FV=6,105.10
PRESENT VALUE OF ANNUITY

Illustration:

Let’s assume you will receive P1,000


every year for the next five years from
a trust account. What is the value of
the five payments that you will
receive in today’s pesos assuming
that the annual interest rate is 10%?
PRESENT VALUE OF ANNUITY

Formula:
PV = PMT [ 1 - (1 + r)-t
r ]

*where: PMT = Annuity Payment


PRESENT VALUE OF ANNUITY

Computation:
PV=1,000*[(1-(1/(1+0.10)5)/0.10
PV=1,000*3.7908
PV=3,790.80

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