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Time Value of Money

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13 views12 pages

Time Value of Money

Uploaded by

Laiba Zia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Time value of money

Affaf Asghar Butt


The Core Question of
Finance
 Congratulations!!! You have won a cash prize!

 There are two optional payment schedules:


 A - receive $100,000 now
 B - receive $100,000 in five years.
 Which option would you choose
Time Value of Money
Concept

 In simple terms the concept implies that money today is always better than
money tomorrow.
Why Time Value of Money
Exists?
 Risk and Uncertainty-future always involves some risk, especially in
respect to cash inflows of company as they are highly uncontrollable;

 Inflation-in an inflationary economy a dollar today has always more


purchasing power in compared to a dollar some point in future;

 Consumption Preference- individuals generally prefer current consumption to


a future one;

 Investment Opportunities-an investor can profitably use money received


today by investing it immediately;
Simple Interest and Compound Interest

 Interest paid (earned) on only the original amount, or principal, borrowed


(lent).

 Interest paid (earned) on any previous interest earned, as well as on the


principal borrowed (lent)
Simple Interest

Formula for
SI = P0(i)(n) =1000*10%
=100*5 =500
F.V=P+1 =1500
 SI: Simple Interest
 P0: Deposit today (t=0)
 i: Interest Rate per Period
 n: Number of Time Periods
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?
Calculate Future Value (total Amount Received
in Future )

 Principle + Interest

 F.V = P0+ P0(i)(n)


 F.V=P0(1+(i)(n))

 Assume that you deposit $1,000 in an account earning 7% simple interest for 2 years. What is the future
value at the end of the 2nd year?

 F.V= 1000(1+(.07)(2))
=1140
Present Value

 P.V=F.V/ (1+(i)(n))
 Assume that you are going to receive 1140 at the end of 2
year earning 7% simple interest. What is the amount you
need to invest today to have such amount at the end of the
2nd year?


Compound Interest
 Assume that you deposit $1,000 at a compound interest rate of 7% for 2
years.

 Compound Interest Example

 At the end of first year


P0 (1+i) = $1,000x (1.07)
= $1,070
 You earned $70 interest on your $1,000 deposit over the first year.
 This is the same amount of interest you would earn under simple interest.
Compound Interest
 At the end of first year = $1,000 (1.07)
= $1,070

 At the end of second year = 1070 (1+i)


=1070x(1.07)
=$1,144.90

 You earned an EXTRA $4.90 in Year 2 with compound over simple


interest.

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