FINANCIAL TECHNIQUES

FOR
PROCUREMENT AND SUPPLY CHAIN MANAGEMENT

BY LUKAS NAKWEENDA
 CHAPTER 2A

TIME VALUE OF MONEY

R = N$

(For more detailed content, please refer to the text book and other sources)!

Source: Correia
 After this chapter, be able to handle the following:
3  Define and calculate an effective rate;

 Distinguish between nominal and real interest rates;

 Apply compounding and discounting to complex cash flow

streams;

 Apply time value of money principles to real world problems

and the valuation of bonds;

 Establish the factors that determine the term structure of

interest rates;

 Apply time value of money principles in retirement planning.

 Overview
4
 Using formulae, tables, financial calculators and
spreadsheets to determine the:
 Future Value of:
a single sum
an annuity
 Present Value of:
a single sum
an annuity
a perpetuity
a growing perpetuity
a cash flow growing at a constant rate
an uneven cash flow stream
 2.1. Future Value
5

 Future value is the value in N$ that an investment or series of

investments will grow over a stated time period at a specified

interest rate.
 FUTURE VALUES
6

FV: The amount of cash which will have accrued by a given

date resulting from earlier lump-sum or periodic
investments.

PV: The value of an investment at the beginning/end of a

period, sometimes referred to as the principal sum.

r: The interest rate, expressed as a decimal fraction.

I: The periodic investments or instalments made

n: The number of periods for which the investment is to

receive interest.
 Example 1: Future Value based on a Single Sum
7
PV = 100 FV = ?

0 1
 Suppose Logistics and Procurement Solutions (Pty) Ltd “LPS Pty
Ltd”) invested an amount of N$100 for a one year at a rate of
12% p.a. Determine the future value of the investment?
FV = PV (1 + r)^n
= R100 (1.12)
= R112
Remark: The investment has yielded N$12 in interest over 1 year.
 EXAMPLE 2: FUTURE VALUE BASED ON MULTIPLE PERIODS
Lump Sum:
8
Multiple periods – Annual Interest Compounded
Objective: Calculating the future value: more than one year
Suppose the same amount of R100 is invested for 10 years at a rate of
12% p.a. compound interest. What is the future value of this investment
at the end of 10 years?
For year one, FV = R100 (1.12) = R112
For year two, FV = R112 (1.12) = R125.44
For year three, FV = R125.44 (1.12)= R140.50 etc
This can be generalized to:
FV = PV (1 + r)n (Formula 2.1)
FV = R100 (1.12)10
= R100 × 3.1058
= R310.58 Financial Calculator 10BII+
N I/YR PV PMT FV
10 12 -100 0 310.58
 FUTURE VALUES

Lump Sum:
9
Multiple periods – Annual Interest Compounded
Example 2.1: Calculating the principal
Inversely, suppose LPS Pty Ltd wishes to invest a sum of money which
will accumulate to R310.58 in 10 years time. How much must be
invested today, if a rate of 12% p.a. is applicable?
Changing the subject of Formula 2.1, it can be stated as:

PV = FV / (1+r)n (Formula 2.2)

= 310.58 / (1.12)10
= 310.58 / 3.1058 Financial Calculator 10BII+
N I/YR PV PMT FV
= R100 10 12 -100 0 310.6

As expected from the results of Example 2.1, the required investment is

R100. Equally, the PVIF table above may clearly be used to determine
the calculation of (1.12)10 .
 FUTURE VALUES
Lump Sum:
10
Multiple periods – Annual Interest Compounded
2.2. Calculating the number of periods
Suppose LPS Pty Ltd is informed that an investment of R100 today will grow to
R310.58. If it is known that the applicable rate is 12%, after how long can the
R310.58 be collected? The use of logarithms (or PVIF Table) is required:
(1+r)n = FV / PV (Formula 2.2)

= 310.58 / 100
= 3.1058
The number 3.1058 is the factor defined in the PVIF table. Because it is known that the
interest rate is 12%, it is possible to move down the 12% column until the number nearest
to 3.1058 is found. In this example, it is found in the 10-period row.
Also: Ln3.1058/Ln1.12 = 10 years
Financial Calculator 10BII+
N I/YR PV PMT FV
10 12 -100 0 310.6
 FUTURE VALUES
Lump Sum:
11
Multiple periods – Annual Interest Compounded
Example 2.3: Calculating the interest rate
LPS Pty Ltd is given the opportunity of investing R100 today with a
promised future value of R310.58 in 10 years’ time.
At what rate is the investment accruing interest?
Developing from equation 2.2, it is possible to make r the subject of
the formula as follows:
(1+r)n = FV / PV (Formula 2.3)
r = (FV/PV)(1/n) - 1
= (310.58/100)(1/10) – 1 Financial Calculator 10BII+
N I/YR PV PMT FV
= 0.12 OR 12% 10 12 -100 0 310.6

The PVIF can again be used. This time one would search for a number close to 3.106 by
looking along the 10 period row. Once the closest number to 3.106 is located, the column in
which it is situated is the required interest rate.
 Practical scenario: Investing with Warren Buffett
12
 Warren Buffett earned 20.9% per year from 1965 to 2017 (53 yrs).

If LPS Pty Ltd had invested R1000 then, how much would it have at

the end of 2017?

 FV = 1000 (1+0.209)53 = R23 366 515

 Conversely, how much would LPS Pty Ltd have accumulated if it had

rather invested in the general share market (S&P500)?

 What did you notice from this scenario?

 FUTURE VALUES
Lump Sum:
13
Multiple periods – Annual Interest Compounded
Future value, interest compounded monthly
Suppose LPS Pty Ltd deposits R100 into an account which offers 12%
p.a. interest compounded monthly. Find the value of the investment at
the end of one year.
Look: 12% over 12 months = 1% interest added every month.
Thus, at the end of the twelfth month it would be:
FV = R100 (1.01)12
= R100 × 1.1268
= R112.68
The effective rate in this example is 12.68%. The formula required to
generalize this calculation is as follows:
FV = PV (1+ r/m)mn , being the EFF formula (Formula 2.3)
 Self-assessment scenarios
14

Suppose LPS (Pty) Ltd deposits R100 into an account which

offers 12% p.a. interest compounded monthly. (a) What is

the value of the investment at the end of 10 years? (b)

Suppose the account decides to offer 12% p.a. interest

compounded quarterly – How would this affect your answer

initially obtained in (a) ?

15 Future Value Calculation
FV = PV (1 + r/m)mn

= R100 (1 + 0.12/12)12x10

= R100 x 3.300

= R 330
16 Annual Effective Rate

m
 Rn 
Effective Rate = 1 +  - 1
 m 
 Annual Effective Rate
LPS Pty Ltd is contemplating to expand its
17

operations. They approached one of their financial

advisor who presented to them the following
interest rates quoted by three local commercial
banks:
FNB: 15%, compounded daily;
Bank Whk.: 15.5%, compounded quarterly;
Std. Bank: 16%, compounded annually;
(Assume 365 days calendar year).
Take home: Which bank would you recommend
for LPS Pty Ltd to borrow from? Why and How?
 Annual Effective Rate
18

365
 0.15 
Effective Rate FNB = 1 +  - 1 = 16.18%
 365 
4
 0.155 
Effective Rate B- Whk = 1 +  - 1 = 16.42%
 4 
1
 0.16 
Effective RateStd. Bank = 1 +  - 1 = 16%
 1 

Remark: It would be favourable to borrow from Std. Bank @ 16%,

which quoted the ‘highest interest rate’, followed by FNB (16.18%),
then Bank Whk (16.42%). Again, what did you notice from this
scenario?
 What is an Annuity - Ordinary Annuity vs. Annuity Due?

19 Suppose LPS Pty Ltd decides to invest a R100 @ 12% p.a.

@ the end of each year over three years. Determine the
future value of this investment at the end of three years.

0 1 2 3

100 100 100.00

1
(1.12) 112.00

(1.12)2 125.44

337.44
20 Future Value using Tables & Formula

 Formula

 100 x 3.3744 = 337.44

 Go to PVIFA table - select factor of for 3 years and 12%

Financial Calculator 10BII+
N I/YR PV PMT FV
3 12 -100 0 337.44
 Ordinary Annuity or Annuity Due?
21

Annuity Due Key word: Beginning of the period

0 1 2 3
▪ Ordinary Annuity Key word: End of the period

0 1 2 3
 Future Value of an Annuity Due
22

0 1 2 3

100.00 100 100

(1.12)1 112.00

2
(1.12) 125.44

3
(1.12) 140.49

377.93
What is the Future Value if the annuity is payable in advance?
23

 Using the Formula

n+1
FVAdue = I x (1 + r) -1 -1 (Formula 2.9)
r

4
(1 + 0.12) - 1
= R100 x -1
0.12

= R377.93

 FVIFA Table - select 4 periods (3+1) and 12% = 4.7793 and then minus 1 = 3.7793
Financial Calculator 10BII+ Must display BEGIN
N I/YR PV PMT FV
3 12 -100 0 377.93
 Decision making:

The Present Value of a future amount due one year from today
24

LPS Pty Ltd has been granted an investment which offers the
opportunity to receive R100 one year from now if R90 is paid
immediately. Should LPS Pty Ltd who applies a 12% discount rate
take up this investment opportunity?

PV = FV / (1+r)n
= 100 / (1.12)1
= R89.29
Since the R89.29 < R90, LPS Pty Ltd should reject the investment opportunity.
 Present Value of an Annuity – using the Formula & PVIFA Table
25

The formula is – not a mandatory approach though!

R100 x PMT =R100 x 2.4018 = R240.18

Also, use PVIFA Table – 3 periods, 12% = 2.4018

Financial Calculator 10BII+

N I/YR PV PMT FV
3 12 240.18 -100 0
26 Present Value of an Annuity Due
27
PV of an Annuity Due – using a Formula

1
1-
PVAdue = I x (1 + r)n-1 + 1
r
1
1- 2
= R100 x (1.12) + 1
0.12
= R100 x 2.69005
= R269.00
 Deferred Annuity a.k.a. Annuity Due
28
A deferred annuity commences a number of
years in the future. An important example is a
Pension.
 Present Value of a Perpetuity
29
In your own words, what is a Perpetuity?
Suppose LPS (Pty) Ltd wants to buy 1000 non-redeemable 9% preference
shares of R1 each. If the interest rate which he applies is 12%, what is the
present value of the investment?
The investor is buying a future cash flow in perpetuity amounting to 9% of R1000, that is R90.
Because a 12% return on the investment is expected, this problem requires the principal sum to be
determined.

PV = CF / r
= 90 / 0.12
= R750
 The role of Interest Rates
30

Definition: Interest is a payment for the use of other parties’ money.

o The supply and demand for money (loans) is determined by 3 main

factors:

❖ The time value of money (preferring it now rather than later).

❖ The risk of capital repayment – implications?

❖ Expected inflation – implications?

THANK YOU!