Course Code:

Course Title: Introduction to Business Finance

Class Day: Tuesday Timing: 12:15pm - 03:15pm

Lecture / Week No. 4 (Time Value of Money)

(17/10/2023)

Instructor Name: Asim Iqbal

Management Sciences Department

PAF KIET, City Campus

1
 Lecture # 4
Time
Time Value
Value of
of
Money
Money

2
 The Time Value of Money

 The Interest Rate

 Simple Interest
 Compound Interest
 Amortizing a Loan

3
 The Interest Rate

Which would you prefer -- $10,000

today or $10,000 in 5 years?

Obviously, $10,000 today.

You already recognize that there is

TIME VALUE TO MONEY!!

4
 Why TIME?

Why is TIME such an important

element in your decision?

TIME allows you the opportunity to

postpone consumption and earn
INTEREST.

5
 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).

6
 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
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 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
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 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.
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 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.
10
 Why Compound Interest?
Future Value of a Single $1,000 Deposit
Future Value (U.S. Dollars)

20000
10% Simple
15000 Interest
10000 7% Compound
Interest
5000 10% Compound
0 Interest
1st 10th 20th 30th
Year Year Year Year

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 Future Value
Single Deposit (Graphic)
Assume that you deposit $1,000 at
a compound interest rate of 7% for
2 years.
0 1 2
7%
$1,000
FV2
12
 Future Value
Single Deposit (Formula)
FV1 = P0 (1+i)1 = $1,000 (1.07)
= $1,070
Compound Interest
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.
13
 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
14 = $1,000(1.07)2
 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
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 Valuation Using Table I
FVIFi,n is found on Table I at the end
of the book or on the card insert.
Period 6% 7% 8%
1 1.060 1.070 1.080
2 1.124 1.145 1.166
3 1.191 1.225 1.260
4 1.262 1.311 1.360
16
5 1.338 1.403 1.469
 Using Future Value Tables
FV2 = $1,000 (FVIF7%,2)
= $1,000 (1.145)
= $1,145 [Due to Rounding]
Period 6% 7% 8%
1 1.060 1.070 1.080
2 1.124 1.145 1.166
3 1.191 1.225 1.260
4 1.262 1.311 1.360
5 1.338 1.403 1.469
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 TVM on the Calculator
 Use the highlighted row
of keys for solving any
of the FV, PV, FVA, PVA,
FVAD, and PVAD
problems
N: Number of periods
I/Y:Interest rate per period
PV: Present value
PMT: Payment per period
FV: Future value
CLR TVM: Clears all of the inputs
into the above TVM keys

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 Using The TI BAII+ Calculator
Inputs
N I/Y PV PMT FV
Compute

Focus on 3rd row of keys (will be

displayed in slides as shown above)
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 Entering the FV Problem
Press:
2nd CLR TVM
2 N
7 I/Y
-1000 PV
0 PMT
CPT FV

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 Solving the FV Problem
Inputs 2 7 -1,000 0
N I/Y PV PMT FV
Compute 1,144.90

N: 2 periods (enter as 2)
I/Y: 7% interest rate per period (enter as 7
NOT .07)
PV: $1,000 (enter as negative as you have “less”)
PMT: Not relevant in this situation (enter as 0)
FV: Compute (Resulting answer is positive)
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 Story Problem Example
Julie Miller wants to know how large her deposit
of $10,000 today will become at a compound
annual interest rate of 10% for 5 years.

0 1 2 3 4 5
10%
$10,000
FV5
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 Story Problem Solution
 Calculation based on general formula:
FVn = P0 (1+i)n
FV5 = $10,000 (1+ 0.10)5
= $16,105.10
 Calculation based on Table I:
FV5 = $10,000 (FVIF10%, 5)
= $10,000 (1.611)
= $16,110 [Due to
Rounding]
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 Entering the FV Problem
Press:
2nd CLR TVM
5 N
10 I/Y
-10000 PV
0 PMT
CPT FV

24
 Solving the FV Problem
Inputs 5 10 -10,000 0
N I/Y PV PMT FV
Compute 16,105.10

The result indicates that a $10,000

investment that earns 10% annually
for 5 years will result in a future value
of $16,105.10.
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 Double Your Money!!!

Quick! How long does it take to

double $5,000 at a compound rate
of 12% per year (approx.)?

We will use the “Rule-of-72”.

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 The “Rule-of-72”

Quick! How long does it take to

double $5,000 at a compound rate
of 12% per year (approx.)?

Approx. Years to Double = 72 / i%

72 / 12% = 6 Years
[Actual Time is 6.12 Years]
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 Solving the Period Problem
Inputs 12 -1,000 0 +2,000
N I/Y PV PMT FV
Compute 6.12 years

The result indicates that a $1,000

investment that earns 12% annually
will double to $2,000 in 6.12 years.
Note: 72/12% = approx. 6 years
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 Present Value
Single Deposit (Graphic)
Assume that you need $1,000 in 2 years.
Let’s examine the process to determine
how much you need to deposit today at a
discount rate of 7% compounded annually.
0 1 2
7%
$1,000
PV0 PV1
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 Present Value
Single Deposit (Formula)

PV0 = FV2 / (1+i)2 = $1,000 / (1.07)2 =

FV2 / (1+i)2 = $873.44

0 1 2
7%
$1,000
PV0
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 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
31
 Valuation Using Table II
PVIFi,n is found on Table II at the end
of the book or on the card insert.
Period 6% 7% 8%
1 .943 .935 .926
2 .890 .873 .857
3 .840 .816 .794
4 .792 .763 .735
5 .747 .713 .681
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 Using Present Value Tables
PV2 = $1,000 (PVIF7%,2)
= $1,000 (.873)
= $873 [Due to Rounding]
Period 6% 7% 8%
1 .943 .935 .926
2 .890 .873 .857
3 .840 .816 .794
4 .792 .763 .735
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5 .747 .713 .681
 Solving the PV Problem
Inputs 2 7 0 +1,000
N I/Y PV PMT FV
Compute -873.44

N: 2 periods (enter as 2)
I/Y: 7% interest rate per period (enter as 7 NOT .07)
PV: Compute (Resulting answer is negative
“deposit”)
PMT: Not relevant in this situation (enter as 0)
FV: $1,000 (enter as positive as you “receive $”)
34
 Story Problem Example
Julie Miller wants to know how large of a
deposit to make so that the money will
grow to $10,000 in 5 years at a discount
rate of 10%.
0 1 2 3 4 5
10%
$10,000
PV0
35
 Story Problem Solution
 Calculation based on general formula:
PV0 = FVn / (1+i)n
PV0 = $10,000 / (1+ 0.10)5
= $6,209.21
 Calculation based on Table I:
PV0 = $10,000 (PVIF10%, 5)
= $10,000 (.621)
= $6,210.00 [Due to Rounding]
36
 Deposit 1000,
5 yrs, Interest Rate 7%
 SIMPLE INTEREST  COMPOUND
INTEREST
1.1000 X 7/ 100 =
1.1000 X 7/ 100 = 70
2.70 (1000+70=1070)
2.1000 X 7/ 100 = 70
3.1070 X 7/ 100 = 74.9 (1070+74.9=1144.9)
3.1000 X 7/ 100 = 70
4.1145 X 7/ 100 = 80.15(1145+80.15=1225.15)
4.1000 X 7/ 100 = 70 5.1225.15 X 7/ 100 = 85.76 (1225.15+85.15=
5.1000 X 7/ 100 = 70 1310.91)
6.1310.91 X 7/ 100 = 91.76 (1310.91+91.76)=
1000 +(70X5) = 1350
1000+ 350 = 1350 1402.57

37
 Solving the PV Problem
Inputs 5 10 0 +10,000
N I/Y PV PMT FV
Compute -6,209.21

The result indicates that a $10,000

future value that will earn 10% annually
for 5 years requires a $6,209.21 deposit
today (present value).
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