Lecture 3rd Time Value of Money
Lecture 3rd Time Value of Money
Lecture 3rd Time Value of Money
TVM is dependent not only on the time interval being considered but also the
rate of interest used in calculating current or future values.
Based on this, we can use the time value of money concept to calculate how
much you need to invest or borrow now to meet a certain future goal
Five components: Present value(PV), Future Value(FV), Periodic
Payment (PMT), Compounding, discounting.
6 Why TIME?
Why is TIME such an important element in your
decision?
SI = P0(i)(n)
Number of time period that the
Principal is the amount of money money is borrowed or invested (in
borrowed or invested. years).
Compound Interest:
A p1 r
t
0 1 2 3 4 5
For any simple interest rate, the future value of an account at the end of n periods
is FVn = P0 + SI => P0 + P0(i)(n) P0 = 100, i = 8%, n = 10 =>
SI = P0(i)(n) => SI = 100(0.08)(10) = $80
What is the Future Value (FV) of the deposit according to simple interest?
Formula: FV = P0 + SI FV = P0 + P0(i)(n)
To solve for the F.V at the end of 10 years (FV10), add interest earned on the
principal only to the original amount invested. Now,
FV10 = $100 + [$100(0.08)(10)] = $180
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Q?? PV= 190 i = 14% n = 15 Ans: ??
Present Value
Is the current value of a future amount of money, or a series of
payments, evaluated at a given interest rate.
What is the Present Value (PV) of the previous problem w.r.t simple
interest?
The Present Value is simply the $1,00 you originally deposited. That
is the value today! 03/24/2024
FVn = P0[1 + (i )(n)]
Data: FV = 180 i = 8% n = 10
PV = 180 / [1 + (0.08 )(10)]
PV = 100
QUESTION
FV= 1100 i = 13% n = 15
Ans: ??
14 Annuity
Annuity is a series of payment occurring over a specified
number of periods.
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15 Ordinary Annuity
An ordinary annuity is that in which the payment occur at
the end of the each period over a specific time. Ordinary
annuity payments are made monthly, quarterly, semi-
annually or annually.
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16 Annuity due
An annuity due is that in which the payment occur
at the beginning of the each period over a specific
time.
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Ordinary Annuity Compounding
17 FVA = P(FVIFAi,n)= 1000(FVIFA5%,5)= 5526
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Explanation:
The bank sign an ordinary annuity compounding contract
of 5 year with a person paying him 5% interest on each
installment he made to bank.
He sign a contract today and pay $1000 after first period
(month/year) as ordinary annuity, then second time $1000
till end of the 5th year.
When he deposit last installment then after few days he
receives all his amount with 5% interest on each
installment which is 5526.
19 Future value annuity on compounding
FVA = P (FVIFAi,n)
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Present Value Ordinary Annuity Discounting
20 PVA = (PVIFAi,n) = (PVIFA5%,5) = 4329
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Explanation:
This PVOA calculation tells you that receiving $952.38 today is
equivalent to receiving $1000 at the end of each of the next five years, if
the time value of money is 5% per year. If the 5% rate is a company's
required rate of return, this tells you that the company could pay up to
$178.30 for the two-year annuity.
The $4329.48 is computed by using the PV of five payments. In other
words, receiving $1000 at the end of the first year has a present value of
$952.38 (for n = 1; i = 5%).
Receiving the second $1000 at the end of the second year has a present
value of $907.03 (for n = 2; i = 5%). The total of those five present
values of all periods (A+B+C+D+E) equals $4329.48.
The difference between the $5000 of total future payments and the
present value of $4329.48 is the interest our money earns while we wait
to receive the payments. This $670.52 difference is referred to as
interest, discount, or a company's return on its investment.
22 Present value annuity on Discounting
PVA(present value of an annuity)
PVA = 1000(PVIFA )
8%,3
= 1000(2.577)
PVA = $2577 03/24/2024
Calculate the FV or PV of a series of uneven cash flows (i.e.,
compound or discount the Cash flows)
Calculate the present value of $5000 to be received annually at the end of years 1 and 2, then $6000
annually at the end of year 3 and 4, and then finally $1000 in at the end of year 5. All cash flows will
be discounted at 5%.
$5000 $5000 $6000
$6000 $1000
0 1 2
3 4 5
Formula: PV = FVn /[1 + (i )(n)] or PV = FV(PVIFi,n) => on page 704, Table II
4760 PV = 5000 / [1 + (0.05 )(1)]
4535 PV = 5000 / [1 + (0.05 )(2)]
5184 PV = 6000 / [1 + (0.05 )(3)]
4938 PV = 6000 /
[1 + (0.05 )(4)]
784 PV = 1000 / [1 + (0.05 )(5)]
PV=$20201
24 Hints for Annuity valuation
The future value of an ordinary annuity can be
viewed as occurring at the end of the last cash flow
period, The present value of an ordinary annuity
can be viewed as occurring at the beginning of the
first cash flow period
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Business Joke
A businessman who needed millions of dollars to clinch an
important deal went to church to pray for the money.
By chance he knelt next to a man who was praying for $100
to pay an urgent debt.
The businessman took out his wallet and pressed $100 into
the other man’s hand.
Overjoyed, the man got up and left the church.
The businessman then closed his eyes and prayed, “And
now, Lord, that I have your undivided attention….”
You will never really understand
finance until you understand the
time value of money.
Thank you