Introduction to

Financial Management
TIME VALUE OF MONEY

Lea Villanueva, Ph.D

Course Facilitator
Question

• If I would give you P10Million and I could give to you

NOW or a YEAR AFTER , would you rather have it now
or later?
Time Value of Money
• Dollar amounts from different time periods should never be
compared; rather, amounts should be compared only when they
are stated in dollars at the same point in time.

• Dollars from different time periods have opportunities to earn

different amounts (numbers of periods) of interest (return).

• TVM concepts provide the principles and computations used to

revalue cash payoffs from different time periods so they are stated in
dollars of the same time period.

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• At a 10 percent opportunity cost rate, which is better, receiving $700
today or receiving $935 in three years?
• To answer the question, we must revalue the cash payoffs so they
are stated in dollars at the same time period.

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Cash Flow Timelines

PV = Present Value—the beginning amount that can be invested (current

value of some future amount); PV = $700.

FV = Future Value—the value to which an amount invested today will

grow at the end of n periods at an opportunity cost rate equal to r (r = 10%
in the example).

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Types of Cash Flow Patterns
• Lump Sum Amount—a single payment (received or made) that
occurs either today or at some date in the future.

• Annuity—multiple payments of the same amount over equal time

periods.

• Uneven Cash Flows—multiple payments of different amounts over

some period of time.

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Future Value
Compounding—to compute the future value of an amount we push
forward the current amount by adding interest for each period in which
the money can earn interest in the future.

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Ways to Solve TVM Problems
• Use a cash flow timeline
• Use an equation
• Use a financial calculator
• Use a spreadsheet
• Use interest tables Obsolete

Besley, Brigham, CFIN, Seventh Edition. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
 FVn—Cash Flow Timeline Solution

The cash flow timeline shows it is better to receive $935 in three years
than $700 today, because investing the $700 at 10 percent for three
years will grow it to only $931.70.

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 FVn—Equation Solution
• The cash flow timeline solution can be written in equation form
as:
FV3 $700(1.10)3

• This relationship is generalized as:

$700(1.10)3
$700(1.33100)
=$931.70
Besley, Brigham, CFIN, Seventh Edition. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
FVn—Financial Calculator Solution

• Cash inflows should be entered in the calculator as

positive values, whereas cash outflows should be
entered as negative values.
• Because $700 is invested, which represents a cash
outflow, PV is stated as a negative number

Besley, Brigham, CFIN, Seventh Edition. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
FVn—Spreadsheet Solution Using MS
Excel
• Set up a table that contains the data used to solve the problem.

• Click fx (insert function) and choose the FV function.

• Click the cells containing the appropriate data to enter the data into
the FV function.
• The solution will appear in the cell that contains the FV function.

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accessible website, in whole or in part.
FVn—Spreadsheet Solution Using MS
Excel

Besley, Brigham, CFIN, Seventh Edition. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
Future Value of an Annuity—FVA
• Annuity—a series of equal amounts paid at equal intervals.

• Ordinary (deferred) Annuity—an annuity with payments that occur at the end
of each period.

• Annuity Due—an annuity with payments that occur at the beginning of each
period.

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 What’s the Future Value of a Three-Year Ordinary
Annuity of $400 at 5%?

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in whole or in part.
FVAn—Equation Solution

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FV of an Annuity Due—FVA(DUE)n
• Payments are made at the beginning of the year, which means
each payment earns one additional year’s worth of 5 percent
interest.

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FVA(DUE)n—Equation Solution (1 of
2)
• Include one additional year’s worth of interest in the
computation.

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publicly accessible website, in whole or in part.
FVA(DUE)n—Equation Solution (2 of
2)

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Cash Flow Streams
• Payment = PMT = constant cash flows—that is, an annuity stream.

• Cash flow = CF = cash flows in general; used to represent both

constant cash flows (i.e., annuities) and uneven cash flows.

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Find the FV of an Uneven Cash Flow Stream—FVCFn

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FVCFn—Equation Solution

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 Present Value, PV
• Present value is the value today (current value) of a future cash flow
or series of cash flows.

• Discounting is the process of finding the present value of a future

cash flow or series of future cash flows

• Finding the present value (discounting) is the reverse of finding the

future value (compounding); i.e., interest is taken out of a future
amount to determine its value today.

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PV of a Lump-Sum Amount—PV
• Discounting—to compute the present value of an amount we bring
back to the present a future amount by taking out interest for each
period in which the money can earn interest in the future.

The cash flow timeline shows it is better to receive a payment

of $935 in three years than to receive a payment of $700 today;
the present value of the $935 payment is $702.48, which is
greater than $700.
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 PV of a Lump-Sum Amount—
Equation Solution (1 of 2)

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What is the PV of $935 due in three (3) years if r = 10%?

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 Present Value of an Annuity
(Ordinary)—PVAn
• PVAn = the present value of an annuity with n payments, each made
at the end of the period.
• Each payment is discounted, and the sum of the discounted
payments is the present value of the annuity.

Besley, Brigham, CFIN, Seventh Edition. © 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part.
PVAn—Cash Flow Timeline Solution
• What is the PV of a three-year $400 ordinary annuity if r = 5%?

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website, in whole or in part.
PVAn—Equation Solution

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Present Value of an Annuity Due—
PVA(DUE)n
• Payments are made at the beginning of the year, which means
one less year of 5 percent interest is taken out of each
payment.

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PVA(DUE)n—Equation Solution
• Because one less year of interest is taken out of each payment,
add back the year that is taken out.

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Perpetuities—PVP (1 of 2)
• Streams of equal payments that are expected to go on forever;
perpetual annuities

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Perpetuities—PVP (2 of 2)
• What is the PV of a perpetuity that pays $100 per year if r =
5%? What is the PV if r = 10%?
This example illustrates a fundamental
principle in finance: Everything else equal,
the higher the rate of return, the lower the
value of an investment.

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PV of an Uneven Cash Flow Stream
—PVCFn

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PVCFn—Equation Solution (1 of 2)

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PVCFn—Equation Solution (2 of 2)

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Comparison of FV with PV
• FV contains interest, whereas PV does not.
• At an opportunity cost rate of 10 percent:
• A lump-sum payment of $700 today is the same as a lump-sum
payment of $931.70 in three years.
• The PV of $700 has no interest; the FV of $931.70 contains three years
of interest, which equals $231.70.

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Amortized Loans
• Amortized Loan—a loan that is repaid in equal payments over its life.

• A portion of the payment represents interest owed on the outstanding

balance.

• The remainder of the payment represents partial repayment of the amount

borrowed (i.e., principal).

• An amortization schedule shows how much of each payment represents

principal repayment and how much represents payment of interest.

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Amortization Schedule (1 of 2)
• An amortization schedule for a $33,000, 6.5 percent loan that
requires three equal annual payments.

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 Year Beginning Balance Total Payment Interest Paid Principal Paid Ending Balance

1 33,000 12460 2145.00 10315.00 22685.00

2 22685 12460 1474.53 10985.48 11699.53

3 11699.53 12460 760.47 11699.53 0.00

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