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9/13/2016

Interest, the time value of money, implicitly derives from an individuals preference for

current consumption over future consumption. People prefer current consumption

because people have present wants and needs and because there is a risk that they might

not be around in the future if they forego consumption today. However, people will

forego consumption today, if they are rewarded for doing so. The reward, which we will

call interest, must reimburse the individual who sacrifices todays consumption for the

uncertainty associated with the deferral of present consumption. The model for evaluating

the present and future values of monetary transactions is built from this basic need for a

reward to sacrifice todays consumption.

In accounting and finance, the time value of money is used to measure and evaluate many

business and economic transactions, including:

accounts and notes payable

long-term capital assets

stocks, bonds and other securities

long-term leases

pensions and retirement plans

investment analysis

depreciation

business combinations

capital budgeting decisions

mergers and acquisitions

comfortable with techniques for evaluating financial transactions using time value of

money techniques.

For an introduction to the basic structure and technique of determining the time value of

money, consider that you have deposited $1,000 in a savings account at the bank today

and that you will leave the money with the bank for one year. You might ask yourself if

you would be willing to leave the money with the bank for the year, then at the end of the

year, withdraw the funds ($1,000), with no additional compensation. If not, why not?

Reflecting on your response may help you to understand the introductory paragraph.

No, you probably expect to receive more than $1,000 from the bank at the end of the year.

There are many ways to view the subtleties of this event. One perspective directs you to

recognize that the bank is borrowing your money for one year - and because they are

using your money, you expect to receive rent for the use of the funds for the year.

Another way of thinking about this transaction is to consider that you are investing your

funds in a relatively low-risk investment (the savings account) and that you expect to

329485633.doc; The Time Value of Money

Accounting 490

9/13/2016

receive a return on your investment. In either case, you expect a reward for placing

your funds at the disposal of the bank, thus the bank pays you a fee, called interest. The

interest fee or rent is usually quoted as a rate or interest rate and refers to the

percentage payment that will be paid on the principal for a period of time. Unless stated

otherwise, the conventional means of quoting interest rates is to state the interest rate for

an annual period or one year. Thus, if our $1,000 deposited at the bank earned interest at

9%, it would be assumed that the bank is paying us $90 for use of the money deposited for

one year.

To place the above scenario into a more structured argument and contemporary syntax, if

we deposit $1,000 today (the present value) which will earn 9% per year (the

compounding rate of interest per period); the funds on deposit in one year (the future

value) total $1,090. This future value is calculated as follows:

Future value (FV) = Present value (PV) + [Present value (PV) * Interest rate ( r )]

or

FV = PV + [PV * r]

or

FV = $1,000 + [$1,000 * .09]

= $1,090

Suppose we decided to leave the funds on deposit for two years instead of one year. This

could be calculated as follows:

FV =

=

=

=

=

$1,000 + [$1,000*.09] + {[$1,000 + ($1,000 * .09)] * .09}

$1,000 + [$90] + [$1,090 * .09]

$1,000 + $90 + $98.10

$1,188.10

If you are comfortable with algebra, you might notice that the right hand side of the

preceding equation can be simplified by factoring.

Begin with:

FV = PV + [PV * r] + {[PV + (PV * r)] * r}

Clear the brackets, which produces:

FV = PV + PVr + PVr + PVr2

Then factor the term PV from the restated equation and collect terms:

FV = PV (1+ r + r + r2)

329485633.doc; The Time Value of Money

Accounting 490

9/13/2016

FV = PV (1+ 2r + r2)

Then reduce the result to its simplest form:

FV = PV (1+ r )2

If we substitute the information from our earlier example for $1,000 earning 9% interest

compounded annually for two periods, we get the result:

FV =

FV =

FV =

FV =

FV =

PV (1+ r )2

$1,000 (1+ .09 )2

$1,000 (1.09 )2

$1,000 (1.1881)

$1,188.81

As you might have suspected, the calculation of the future value of a present amount is a

geometric series and the formula can be generalized as follows:

FV = PV (1 + r)n

where:

FV = Future value of a present amount

PV = Present value of amount

r = Interest rate per period

n = Number of compounding periods

This generalized form serves as the basis of all calculations involving the time value of

money. For instance, suppose that we were interested in determining the present value of

an amount we wanted or expected to receive in the future. By solving the future value

equation for the unknown PV, we can determine the present value.

Consider that you want to buy a car in 4 years and you want to pay cash for the vehicle.

You expect the car to cost $10,000. If you could earn 8% per year on a Certificate of

Deposit at the local bank, how much would you have to deposit today in order to

accumulate the $10,000?

We can solve this problem by manipulating the equation for future value.

We know that:

FV = PV (1 + r)n

$10,000 = PV (1 + .08)4

$10,000 = PV (1.08)4

PV = $10,000/(1.08)4

PV = $10,000/(1.08)4

329485633.doc; The Time Value of Money

Accounting 490

9/13/2016

PV = $10,000/1.3604889

PV = $7,350.30

The result is that if you deposit $7,350.30 today in an interest-bearing investment that

earns 8% annually for four years, you would accumulate $10,000 by the end of four years.

If you wish to evaluate this, you might consider reviewing the table that reflects the

extended form of calculation.

Date

1/1/Year1 Deposit

12/31/Year1

12/31/Year2

12/31/Year3

12/31/Year4

Interest Rate

8%

8%

8%

8%

Interest Earned

588.02

635.07

685.87

740.74

Balance

7,350.30

7,938.32

8,573.39

9,259.26

10,000.00

As may be obvious, we could simply restate the future value equation to solve for the

present value, which would produce:

FV = PV (1 + r)n

PV = FV /(1 + r)n

The term, (1 + r)n , is usually referred to as a time value of money factor and is the

variable that relates the future value to the present value. You are probably familiar with

tables of present value factors and future value factors. The equations above reflect the

information contained in the tables; that is, the tables represent the calculation of the

factor for various combinations of interest rates and time periods. Further, our formulas

tell us that the present value factors are directly related to the future value factors. The

relationship is evident - the factor for the future value table, (1 + r)n , is the inverse of the

factor found in present value tables 1/(1 + r)n

To affirm that this is the case, consider the factors used to solve the previous problem. If

we wanted to know the future value of $7,350.30 deposited in an interest bearing

investment, earning 8% per year for four years, we would use the future value equation, as

follows:

FV = PV (1 + r)n

FV = $7,350.30 (1 + .08)4

FV = $7,350.30 (1 + .08)4

FV = $7,350.30 (1.3604889)

FV = $10,000.00

The factor for this future value calculation is (1.3604889). From the present value

calculation, the factor was (1/1.3604889), the inverse of the future value factor. From this

simple example, you could prepare a full set of present and future value tables, for as many

combinations of interest rates and time periods as you would like. Of course, since you

can calculate any factor (with a calculator), the tables may not be a necessity, but a

Accounting 490

9/13/2016

convenience. To permit you to practice with present and future value factors, you should

sit down with a calculator and the attached Tables 1 and 2 and verify the construction of

few numbers on the tables. The tables are included in the appendix.

Generally, there are two concepts of interest: simple interest and compound interest. The

distinction is simple, really. Simple interest refers to situations when interest is earned on a

principal amount only. This usually occurs when the interest is remitted to (or withdrawn

by) the person entitled to receive the interest. Compound interest describes situations

where interest is earned on the original principal amount as well as any interest earned and

accumulated with the original principal. Our example of the $1,000 on deposit for two

years is an example of compound interest. Had the $90 interest earned in the first year

been withdrawn from the bank (and all interest for all subsequent years), then the example

would have converted to a simple interest example. The focus of our study from this point

on will be on compound interest situations - which as you will discover, is the heart of the

time value of money calculation and the key to resolving many complex accounting,

finance and investment problems.

Before we leap into the nuances of present and future value problems, consider the matter

of compounding. Recall that unless stated otherwise, you should assume that interest is

compounded and paid annually. However, most banks and savings and loans company

transactions, mortgage company transactions, corporation bond and other monetary

transactions are based upon compound interest and/or dividends for periods other than

one year (quarterly, monthly, weekly, even daily). When this situation arises, it is easy to

convert an annual interest rate to the appropriate interest rate per compounding period.

When the stated annual interest rate is compounded on any basis other than annually,

simply divide the stated annual interest rate by the number of times the interest is

compounded during the year to determine the interest rate per compounding period. For

example, if the annual interest rate is 12% and the interest is compounded quarterly (every

three months), the compounding rate is 3% or 12%/4.

It may be obvious to you, but when interest is compounded more than once a year, the

actual or effective interest rate will always be greater than the stated annual interest rate

(sometimes called the nominal or face rate). This concept is of some significance to

business people, investors and consumers. For example, suppose a bank offers to lend you

$ 10,000 for one year at an annual rate of 10%. If the interest is compounded annually,

the interest accrued is $1,000. However, if the interest is compounded and paid quarterly

(every three months), the interest amount paid each quarter equals $250, but because of

the fact that the debtor must pay the amounts every three months, rather than at the end of

the year, the cost of the sacrifice (loss of the use of the money) increases the effective cost

of the debt to the borrower. Because the creditor enjoys the use of the money in four

installments during the year, instead of having to wait until the end of the year (and the

funds can be reinvested), the creditor (bank) enjoys a higher rate of return. Note that you

can use your knowledge of future value to determine the difference between the rates of

return for the two options.

Accounting 490

9/13/2016

For the annual payment, the effective interest rate is the same as the annual or stated

rate, i.e., 10%. But, for the quarterly compounding of interest, the effective interest rate

or yield is 10.38%, calculated by determining the future value at the end of the year of

four quarterly payments of $250 and comparing that to the amount of the loan. The

calculations are presented in the schedule below:

Totals

Interest Paid

10%/4 = 2.5%

$ 250

$ 250

$ 250

$ 250

$ 1,000

Compounding

Periods

3

2

1

0

Factor at 2.5%

1.07689

1.05063

1.02500

1.00000

Future Value

269.22

262.66

256.25

250.00

1,038.13

Dividing the Yield calculation ($1,038.13) by the loan principal ($10,000) produces an

effective interest rate of 10.38%.

Coincidentally, the formula for calculating the effective rate when interest is calculated

more frequently than annually is:

Yield or Effective Rate = (1 + r ) n -1

where:

r = compounding rate per period

n = number of compounding periods for the year

Accounting 490

9/13/2016

Annuities

Often, business transactions involve equal periodic payments; e.g., mortgages, bonds,

consumer loans, life insurance contracts, leases, the Christmas savings club. For example,

suppose that you are interested in purchasing a new stereo for your apartment. You want

to be able to pay cash and you are willing to save $50 per month for one year to save for

the stereo. If you put your money in a savings account earning 6% per year, compounded

monthly, how much would you be able to spend for the stereo at the end of the year?

Future Value of an Annuity

One way we could solve this problem would be to think of the savings amounts of $50 per

month as twelve (12) future value problems. It would take a few minutes, but this

technique would certainly provide an answer. Lets assume that we started saving at the

end of January and we plan to purchase the new stereo during the after Christmas and

inventory clearance sales that occur right after the first of the year. The calculations are

presented in the schedule below:

Date of

Deposit

Deposit or

Present Value

Interest Rate

6% Per Year

Interest Factor

(1+r)n

1/31/XX

2/28/XX

3/31/XX

4/30/XX

5/31/XX

6/30/XX

7/31/XX

8/31/XX

9/30/XX

10/31/XX

11/30/XX

12/31/XX

$50.00

$50.00

$50.00

$50.00

$50.00

$50.00

$50.00

$50.00

$50.00

$50.00

$50.00

$50.00

.5% per month

.5% per month

.5% per month

.5% per month

.5% per month

.5% per month

.5% per month

.5% per month

.5% per month

.5% per month

.5% per month

1.0563958

1.0511401

1.0459106

1.0407070

1.0355294

1.0303775

1.0252513

1.0201505

1.0150751

1.0100250

1.0050000

1.0000000

$ 52.81

52.56

52.30

52.04

51.78

51.52

51.26

51.01

50.75

50.50

50.25

50.00

12.3355623

$616.78

Future Value

There are a couple of points to note: first, by saving $50 per month, you will accumulate

$616.78 in twelve months; second, by examining the table carefully, we could take

advantage of a shortcut. If we factored the $50.00 monthly saving from the calculations

(it is the same amount each month, we could simply add up the interest factors for each

month and multiply that total by the uniform savings amount (an annuity) to find the total

amount saved; e.g., $50.00 * 12.3355623 = $616.78. Further, by constructing a table for

several combinations of interest rates and compounding periods, we could reduce the

calculations for the future value of an annuity to a formula approach. From out example

above, we can state that:

Accounting 490

9/13/2016

Future value of ordinary annuity (FVoa) = Annuity amount (A) * Factor (F)

or

FVoa = A * Fr,n

where:

A

Fr,n

is the compounded interest factor for the interest rate per period [r] and

number of time periods [n]

FVoa = A * Fr,n

FVoa = $50 * F .05, 12

FVoa = $50 * 12.3355623

FVoa = $616.78

And, in fact, that is precisely what a future value of an annuity table provides - an array of

various combinations of compounding periods and interest rates. It would be useful to

examine Table 3 in the appendix and use the table to solve the following problem:

In order to accumulate funds for the construction of a new building, a company

invests $50,000 a year for 5 years. The funds will earn 9% annually. How much

money will the company have at the end of the five years?

Using the factors from Table 3, the solution is straightforward. We know the

annuity amount, A, is $50,000. And we know the annual interest rate is 9% and

that there are five (5) compounding periods. Using the Future Value of an

Annuity Table, we determine that the interest compounding factor is 5.98471. If

we substitute these items into our formula for the future value of an annuity, we

obtain the result that the company will have $299,235.50 at the end of the fifth

year, as follows:

FVoa = A * Fr,n

FVoa = $50,000 * 5.98471

FVoa = $299,235.50

You might want to affirm the calculation and your understanding of the

relationships between the future value of a principal amount and the future value of

an annuity by turning to Table 1 and summing the factors under the 9% interest

column for 5 periods (this is looking at the problem as five individual future value

problems, rather than an annuity!) Be careful now - we have assumed that the first

payment is being deposited by the company at the end of the first year, thus, when

we obtain the data from Table 1, we must be sure to recognize that the last deposit

is made at the end of the five year period and earns no interest. This particular

transaction is usually not reflected in a future value of a principal amount table.

Accounting 490

9/13/2016

It is usually a good idea to draw a picture of the problem before you begin to

consult tables and perform calculations. It doesnt take long and it can provide a

schematic or framework for the problem-solving tasks. One example of such a

schematic is:

Time

$50,000

$50,000

$50,000

$50,000

$50,000

Notice that the number of deposits is five(5), but that the number of compounding

periods is four(4), because the first deposit is made at the end of the first period.

This kind of annuity example is usually referred to as an ordinary annuity or an

annuity in arrears. It is possible to prepare a table for annuity payments which

occur at the beginning of the first period. This type of annuity table is usually

called an annuity in advance or an annuity due. We will return to this issue

shortly.

Back to the problem, your results should be:

Deposit Number

1

2

3

4

5

Total

Compounding Periods

4

3

2

1

0

Interest Factor

1.41158

1.29503

1.18810

1.09000

1.00000

5.98471

If your results were the same as mine, you will note that the factor calculated from

Table 1 is equal to the factor extracted from Table 3. A nice result to know! If you

were hard-pressed, you wouldnt really need a future value of an annuity table, you

could simply extract what you needed from a future value table.

Just to satisfy your curiosity, the future value of an ordinary annuity table factors can be

calculated by formula. The formula is derived from the sum of a uniform set of geometric

series and is stated as follows:

FVoa = [( 1 + r ) n -1] / r

where:

FVoa = Future value of an ordinary annuity

r = interest rate per compounding period

n = number of annuity payments

If you are faced with a future value of an annuity due (annuity in advance); that is, the

terms of the annuity require or provide for a payment at the beginning a period, the

formula for this interest factor is:

Accounting 490

9/13/2016

where:

FVad = Future value of an annuity due

r = interest rate per compounding period

n = number of annuity payments

If you examine this formula carefully, you will notice that the only difference is to add the

term ( 1 + r ) to the calculation. This term adjusts the ordinary annuity formula for the one

additional compounding period that results from moving the annuity payments from the

end of the compounding period to the beginning of the compounding period.

One final point about future value annuities. If you are using a future value of an

ordinary annuity table (annuity in arrears), but you are confronted with a future value

of an annuity due (annuity in advance) problem, you can adjust the factors in the

ordinary annuity table for use in annuity due (in advance) problems. All you must do is

increase the number of compounding periods by one and subtract the number one (1) from

the factor. Think about it - the ordinary annuity table provides an interest factor for the

final compounding period of one (1); there is no interest earned on the final deposit or

payment. If we advance all the payments by one period, we add one compounding period

of earned interest, replacing the period for which no interest was earned.

And, if you have an annuity due table, but are trying to solve an annuity in advance

(ordinary annuity) problem, simply subtract one compounding period and add the integer

1 to the factor that you extract from the table.

Present Value of an Annuity

As you might expect, just as the present value of principal amounts are related to future

value of principal amounts are related and that future value of annuities and future value of

single principal amounts are related, it follows that the present value of an annuity and the

present value of a principal amount are related. The primary formula involving the present

value of an annuity is:

Present value of ordinary annuity (PVoa) = Annuity amount (A) * Factor (F)

or

PVoa = A * Fr,n

where:

A

Fr,n

is the compounded interest factor for the interest rate per period [r] and

number of time periods [n]

Accounting 490

9/13/2016

The interest factor (F) is derived by the formula, which can be computed by calculators

with exponent functions, or found in tables:

PVoa = [ 1 - { 1 / ( 1 + r ) n } ] / r

As an example of solving for the present value of an annuity, suppose you were given the

choice of receiving $8,000 a year for five years or receiving $25,000 today. What would

you do? Well, for the sake of analysis, lets suppose that your time preference rate for

money is 10% (reflecting your feelings about present versus future consumption, risk,

inflation and other uncertainties about the future) and that you can earn this in a money

market fund. What you want to be able to do is to compare the two cash flows to see if

you have a preference for one or the other. If we examine just the total aggregate cash

flows, it is evident that the choice is difficult.

We can take $25,000 today, but if we take the $8,000 per year for five years, we receive a

total of $40,000. The problem is that the two cash flows are not comparable, are they?

The $25,000 is a present value. The five $8,000 payments are an annuity and the

aggregate of $40,000 is not comparable to the $25,000. But, if our concerns about risk

are reflected properly in our time preference rate of 10% and the money market fund that

we could invest in reflects an appropriate return/risk relationship (10%), we could

evaluate the present value of those future cash flows and compare them with the value of

the option of having the $25,000 today. Of course, one way of evaluating the two cash

flows would be to convert the two cash payoffs to future values and compare them (given

the material presented earlier, we already know how to do that). But that would involve

two calculations: first evaluating the future value of the $25,000, then evaluating the

future value of the annuity of five $8,000 payments. As you will see, by simply

determining the present value of annuity, the calculation and analysis can be completed in

one step. Go to Table 4, Present Value of an Ordinary Annuity and extract the interest

factor for an interest rate of 10% over five compounding periods and insert it into the

formula above. Then complete the calculation and compare the result with the $25,000

option. Your calculation should be as follows:

PVoa = A * Fr,n

PVoa = $8,000 * 3.79079

PVoa = $30,326.32

When we compare the present value of the annuity with the present value of the $25,000

cash payment, it should be evident that the annuity is worth more to us. But maybe you

are still somewhat skeptical. We can confirm this finding by restating the problem just a

bit. Suppose that you have just won a lottery and you get your choice of two prize

options - one, you win a $25,000 deposit, which will earn 10% annually. You may not

withdraw any funds from this account for 5 years, at which time the total fund is yours.

The alternate prize is a five-year annuity of $8,000. The annuity is also deposited in a fund

which will earn 10% per year. At the end of five years, the total fund is yours to keep.

Which plan would you prefer? Lets compute the future values of both options.

Plan 1

Accounting 490

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FV = PV (1 + r)n

FV = $25,000 (1 + .10)5

FV = $25,000 (1.10)4

FV = $25,000 (1.4641)

FV = $36,602.50

The results report that the future value of $25,000 deposited in an interest-bearing

investment earning 10% per year is $36,602.50.

Plan 2

FVoa = A * [( 1 + r ) n -1] / r

FVoa = $8,000 [(1 + .10)5 - 1] / .10

FVoa = $8,000 [(1.10)5 - 1] / .10

FVoa = $8,000 [1.61051 - 1] / .10

FVoa = $8,000 [.61051] / .10

FVoa = $8,000 * 6.1051

FVoa = $48,840.80

It seems apparent that, when assessed as a future value comparison, the 5-payment annuity

is the preferred plan. First, just to confirm the validity of the future value tables, go to

Table 3 and identify the factor for a 5-period annuity earning 10% per period. The factor

is 6.1051, consistent with the formula based calculation.

Finally to affirm the relationship between present value and future value concepts, consider

the present value of $48,840.80 to be received in five years. Utilizing the present value of

a future amount formula, the present value is:

PV = FV * 1 / (1 + r)n

PV = $48,840.80 * 1 / ( 1 + .10 ) 5

PV = $48,840.80 * 1 / ( 1.61051 )

PV = $48,840.80 * .62092132

PV = $30,326.29

Notice that, except for the effects of rounding, this result is the equivalent of the

calculation used to determine the present value of the 5-period, 10% annuity at the

beginning of this exercise. Please consider the factors that make this the case. In any

event, it is evident that the best option, under the circumstances, would be to select the

five year annuity of $8,000 rather than the $25,000 today.

As you review the above material, please pay attention to the fact that the problems were

solved in a variety of ways - using the basic formulas, using factors from tables, converting

a present value problem to future value, converting an annuity to a principal-type problem.

Quite often, it is the ingenuity of the problem solver that sees the most efficient and

effective way of resolving the choices, comparisons and calculations involving the time

value of money. While learning to use time value of money techniques, it may be prudent

to use the formulas, tables and various approaches to the problem.

Accounting 490

9/13/2016

Following are some examples to review before you launch into the assigned problem set.

Example 1: Financing the purchase of a new car

Suppose that you are interested in purchasing a new car. You and the dealer have agreed

upon a price of $18,000 (four-wheel drive, short-bed, extended cab pickup!). Now all you

need is the money. The dealer suggests that you contact the local bank. The local banker

offers you the following terms:

Down payment

Annual interest rate

Financing period

$3,000

12%

4 years

The terms seemed reasonable to you and you left the bank to try to figure out where to

get the down payment. The banker knew that you were a recent business student and he

assumed that you were familiar with the techniques for calculating loan payments. When

you arrived home, you realized that you didnt know how much the loan payments would

be.

Required:

a. Calculate the monthly payment that would be required to service the loan used to

finance the purchase of the car.

b. Determine the total amount of interest that would be paid on this loan.

c. Determine the effective cost of the loan.

Solution:

a. While we could use tables to assist us with this part of the problem, the table set

included with this material does not include interest factors equivalent to forty-eight

periods and 1% per period. Consequently, the formula approach will be used to deal

with the issues.

The problem is defined as a loan amortization type and is common in consumer

lending, mortgages, bonds and other types of installment debt. The problem of

determining the monthly payment or the annuity payment is easily resolved using

the present value of an ordinary annuity format, as follows:

PVoa = A * Fr,n

First, recognize that the equation can be restated to solve for the annuity payment (A).

A = PVoa / Fr,n

A = $15,000 / Fr,n

The interest factor (F) is derived by the formula for the present value annuity

F=[ 1- { 1 /( 1 +r) n} ] /r

329485633.doc; The Time Value of Money

Accounting 490

9/13/2016

F = [ 1 - { 1 / ( 1 + .01 ) 48 } ] / .01

F = [ 1 - { 1 / ( 1.01 ) 48 } ] / .01

F = [ 1 - { 1 / 1.6122261 } ] / .01

F = [ 1 - { .62026041 } ] / .01

F = [ .37973959 ] / .01

F = 37.973959

By substituting the factor into the primary annuity equation, the loan payment

(annuity) is determined to be $395.01 per month.

A = $15,000 / 37.973959

A = $395.01

b. This four year (48 month loan) will incur a total interest expense of $3,960.48 ,

determined as follows:

Total cash payments (395.01 * 48)

Less: Total amount financed

Total interest expense

$18,960.48

15,000.00

$3,960.48

Yield or Effective Rate = (1 + r ) n -1

Yield or Effective Rate = (1 + .01 ) 12 -1

Yield or Effective Rate = (1.01 ) 12 -1

Yield or Effective Rate = (1.126825) -1

Yield or Effective Rate = .126825

Yield or Effective Rate = 12.6825 %

Example 2: Accumulating a Retirement Fund

Jason, age 20, wants to retire at age 45. He wants to accumulate a retirement fund of

$600,000. If he plans to deposit equal monthly amounts, starting one month from

today, in an Individual Retirement Account (IRA) which will earn 6% per year, how

much should he plan to deposit each month? How much will Jason have earned on his

savings?

Solution:

This is an adaptation of the future value of an ordinary annuity and the solution

requires a calculator, unless you have an extensive table set.

FVoa = A * [( 1 + r ) n -1] / r

A = FVoa / [( 1 + r ) n -1] / r

A = $600,000 / [( 1 + .005 ) 300 -1] / .005

A = $600,000 / [( 1.005 ) 300 -1] / .005

Accounting 490

9/13/2016

A = $600,000 / [3.4649695] / .005

A = $600,000 / 692.99

A = $865.81

If Jason saves $865.81 a month for 25 years (300 months) and the funds earn 6%per

year (.5% per month), Jason will have a fund of $600,000.

Total fund accumulation

Total deposits ($865.81 * 300)

Total interest

$600,000

$259,743

$340,743

Jason will earn $340,743 over the 25 year period, if the fund earns interest at 6% per

year.

Accounting 490

9/13/2016

Time Value Concept

Symbol

General Formula

Simple Interest

SI

PV * r* n

n/a

Effective Interest

EI

(1 + r ) n -1

n/a

PV

FV * F

1 / [(1 + r ) n ]

FV

PV * F

(1 + r ) n

PVoa

A * F r,n

[1-{1/(1+r)n}]/r

PVad

A * F r,n

[[ 1 - { 1 / ( 1 + r ) n } ] / r ] * (1 +

r)

FVoa

A * F r,n

[( 1 + r ) n -1] / r

FVad

A * F r,n

{[( 1 + r ) n -1] / r} * (1 + r)

Accounting 490

9/13/2016

[FV = PV (1+r) n]

(n)

Periods

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

8%

1.08000

1.16640

1.25971

1.36049

1.46933

1.58687

1.71382

1.85093

1.99900

2.15892

2.33164

2.51817

2.71962

2.93719

3.17217

3.42594

3.70002

3.99602

4.31570

4.66096

5.03383

5.43654

5.87146

6.34118

6.84848

7.39635

7.98806

8.62711

9.31727

10.06266

10.86767

11.73708

12.67605

13.69013

14.78534

15.96817

17.24563

18.62528

20.11530

21.72452

9%

1.09000

1.18810

1.29503

1.41158

1.53862

1.67710

1.82804

1.99256

2.17189

2.36736

2.58043

2.81267

3.06581

3.34173

3.64248

3.97031

4.32763

4.71712

5.14166

5.60441

6.10881

6.65860

7.25787

7.91108

8.62308

9.39916

10.24508

11.16714

12.17218

13.26768

14.46177

15.76333

17.18203

18.72841

20.41397

22.25123

24.25384

26.43668

28.81598

31.40942

Interest Rates

10%

11%

1.10000

1.11000

1.21000

1.23210

1.33100

1.36763

1.46410

1.51807

1.61051

1.68506

1.77156

1.87041

1.94872

2.07616

2.14359

2.30454

2.35795

2.55803

2.59374

2.83942

2.85312

3.15176

3.13843

3.49845

3.45227

3.88328

3.79750

4.31044

4.17725

4.78459

4.59497

5.31089

5.05447

5.89509

5.55992

6.54355

6.11591

7.26334

6.72750

8.06231

7.40025

8.94917

8.14028

9.93357

8.95430

11.02627

9.84973

12.23916

10.83471

13.58546

11.91818

15.07986

13.10999

16.73865

14.42099

18.57990

15.86309

20.62369

17.44940

22.89230

19.19434

25.41045

21.11378

28.20560

23.22515

31.30821

25.54767

34.75212

28.10244

38.57485

30.91268

42.81808

34.00395

47.52807

37.40434

52.75616

41.14479

58.55934

45.25926

65.00087

12%

1.12000

1.25440

1.40493

1.57352

1.76234

1.97382

2.21068

2.47596

2.77308

3.10585

3.47855

3.89598

4.36349

4.88711

5.47357

6.13039

6.86604

7.68997

8.61276

9.64629

10.80385

12.10031

13.55235

15.17863

17.00000

19.04007

21.32488

23.88387

26.74993

29.95992

33.55511

37.58173

42.09153

47.14252

52.79962

59.13557

66.23184

74.17966

83.08122

93.05097

15%

1.15000

1.32250

1.52088

1.74901

2.01136

2.31306

2.66002

3.05902

3.51788

4.04556

4.65239

5.35025

6.15279

7.07571

8.13706

9.35762

10.76126

12.37545

14.23177

16.36654

18.82152

21.64475

24.89146

28.62518

32.91895

37.85680

43.53532

50.06561

57.57545

66.21177

76.14354

87.56507

100.69983

115.80480

133.17552

153.15185

176.12463

202.54332

232.92482

267.86355

Accounting 490

9/13/2016

[PV = FV / (1 + r )n ]

(n)

Period

s

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

8%

.92593

.85734

.79383

.73503

.68058

.63017

.58349

.54027

.50025

.46319

.42888

.39711

.36770

.34046

.31524

.29189

.27027

.25025

.23171

.21455

.19866

.18394

.17032

.15770

.14602

.13520

.12519

.11591

.10733

.09938

.09202

.08520

.07889

.07305

.06763

.06262

.05799

.05369

.04971

.04603

9%

.91743

.84168

.77218

.70843

.64993

.59627

.54703

.50187

.46043

.42241

.38753

.35554

.32618

.29925

.27454

.25187

.23107

.21199

.19449

.17843

.16370

.15018

.13778

.12641

.11597

.10639

.09761

.08955

.08216

.07537

.06915

.06344

.05820

.05340

.04899

.04494

.04123

.03783

.03470

.03184

Interest Rates

10%

11%

.90909

.82645

.75132

.68301

.62092

.56447

.51316

.46651

.42410

.38554

.35049

.31863

.28966

.26333

.23939

.21763

.19785

.17986

.16351

.14864

.13513

.12285

.11168

.10153

.09230

.08391

.07628

.06934

.06304

.05731

.05210

.04736

.04306

.03914

.03558

.03235

.02941

.02674

.02430

.02210

.90090

.81162

.73119

.65873

.59345

.53464

.48166

.43393

.39092

.35218

.31728

.28584

.25751

.23199

.20900

.18829

.16963

.15282

.13768

.12403

.11174

.10067

.09069

.08170

.07361

.06631

.05974

.05382

.04849

.04368

.03935

.03545

.03194

.02878

.02592

.02335

.02104

.01896

.01708

.01538

12%

15%

.89286

.79719

.71178

.63552

.56743

.50663

.45235

.40388

.36061

.32197

.28748

.25668

.22917

.20462

.18270

.16312

.14564

.13004

.11611

.10367

.09256

.08264

.07379

.06588

.05882

.05252

.04689

.04187

.03738

.03338

.02980

.02661

.02376

.02121

.01894

.01691

.01510

.01348

.01204

.01075

.86957

.75614

.65752

.57175

.49718

.43233

.37594

.32690

.28426

.24719

.21494

.18691

.16253

.14133

.12289

.10687

.09293

.08081

.07027

.06110

.05313

.04620

.04017

.03493

.03038

.02642

.02297

.01997

.01737

.01510

.01313

.01142

.00993

.00864

.00751

.00653

.00568

.00494

.00429

.00373

Accounting 490

9/13/2016

[FVa = (1 + r )n -1 / r]

(n)

Periods

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

8%

1.00000

2.08000

3.24640

4.50611

5.86660

7.33592

8.92280

10.63663

12.48756

14.48656

16.64549

18.97713

21.49530

24.21492

27.15211

30.32428

33.75023

37.45024

41.44626

45.76196

50.42292

55.45676

60.89330

66.76476

73.10594

79.95442

87.35077

95.33883

103.96594

113.28321

123.34587

134.21354

145.95062

158.62667

172.31680

187.10215

203.07032

220.31595

238.94122

259.05652

9%

1.00000

2.09000

3.27810

4.57313

5.98471

7.52334

9.20044

11.02847

13.02104

15.19293

17.56029

20.14072

22.95339

26.01919

29.36092

33.00340

36.97371

41.30134

46.01846

51.16012

56.76453

62.87334

69.53194

76.78981

84.70090

93.32398

102.72314

112.96822

124.13536

136.30754

149.57522

164.03699

179.80032

196.98234

215.71076

236.12472

258.37595

282.62978

309.06646

337.88245

Interest

10%

1.00000

2.10000

3.31000

4.64100

6.10510

7.71561

9.48717

11.43589

13.57948

15.93743

18.53117

21.38428

24.52271

27.97498

31.77248

35.94973

40.54470

45.59917

51.15909

57.27500

64.00250

71.40275

79.54302

88.49733

98.34706

109.18177

121.09994

134.20994

148.63093

164.49402

181.94343

201.13777

222.25154

245.47670

271.02437

299.12681

330.03949

364.04343

401.44778

442.59256

Rates

11%

1.00000

2.11000

3.34210

4.70973

6.22780

7.91286

9.78327

11.85943

14.16397

16.72201

19.56143

22.71319

26.21164

30.09492

34.40536

39.18995

44.50084

50.39593

56.93949

64.20283

72.26514

81.21431

91.14788

102.17415

114.41331

127.99877

143.07864

159.81729

178.39719

199.02088

221.91317

247.32362

275.52922

306.83744

341.58955

380.16441

422.98249

470.51056

523.26673

581.82607

12%

1.00000

2.12000

3.37440

4.77933

6.35285

8.11519

10.08901

12.29969

14.77566

17.54874

20.65458

24.13313

28.02911

32.39260

37.27972

42.75328

48.88367

55.74972

63.43968

72.05244

81.69874

92.50258

104.60289

118.15524

133.33387

150.33393

169.37401

190.69889

214.58275

241.33268

271.29261

304.84772

342.42945

384.52098

431.66350

484.46312

543.59869

609.83053

684.01020

767.09142

15%

1.00000

2.15000

3.47250

4.99338

6.74238

8.75374

11.06680

13.72682

16.78584

20.30372

24.34928

29.00167

34.35192

40.50471

47.58041

55.71747

65.07509

75.83636

88.21181

102.44358

118.81012

137.63164

159.27638

184.16784

212.79302

245.71197

283.56877

327.10408

377.16969

434.74515

500.95692

577.10046

644.66553

765.36535

881.17016

1014.34568

1167.49753

1343.62216

1546.16549

1779.09031

Accounting 490

9/13/2016

PVa = [ 1 - { 1/( 1+ i ) n }/ i ]

(n)

Periods

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

8%

.92593

1.78326

2.57710

3.31213

3.99271

4.62288

5.20637

5.74664

6.24689

6.71008

7.13896

7.53608

7.90378

8.24424

8.55948

8.85137

9.12164

9.37189

9.60360

9.81815

10.01680

10.20074

10.37106

10.52876

10.67478

10.80998

10.93516

11.05108

11.15841

11.25778

11.34980

11.43500

11.51389

11.58693

11.65457

11.71719

11.77518

11.82887

11.87858

11.92461

9%

.91743

1.75911

2.53130

3.23972

3.88965

4.48592

5.03295

5.53482

5.99525

6.41766

6.80519

7.16073

7.48690

7.78615

8.06069

8.31256

8.54363

8.75563

8.95012

9.12855

9.29224

9.44243

9.58021

9.70661

9.82258

9.92897

10.02658

10.11613

10.19828

10.27365

10.34280

10.40624

10.46444

10.51784

10.56682

10.61176

10.65299

10.69082

10.72552

10.75736

Interest Rates

10%

11%

.90909

.90090

1.73554

1.71252

2.48685

2.44371

3.16986

3.10245

3.79079

3.69590

4.35526

4.23054

4.86842

4.71220

5.33493

5.14612

5.75902

5.53705

6.14457

5.88923

6.49506

6.20652

6.81369

6.49236

7.10336

6.74987

7.36669

6.98187

7.60608

7.19087

7.82371

7.37916

8.02155

7.54879

8.20141

7.70162

8.36492

7.83929

8.51356

7.96333

8.64869

8.07507

8.77154

8.17574

8.88322

8.26643

8.98474

8.34814

9.07704

8.42174

9.16095

8.48806

9.23722

8.54780

9.30657

8.60162

9.36961

8.65011

9.42691

8.69379

9.47901

8.73315

9.52638

8.76860

9.56943

8.80054

9.60858

8.82932

9.64416

8.85524

9.67651

8.87859

9.70592

8.89963

9.73265

8.91859

9.75697

8.93567

9.77905

8.95105

12%

.89286

1.69005

2.40183

3.03735

3.60478

4.11141

4.56376

4.96764

5.32825

5.65022

5.93770

6.19437

6.42355

6.62817

6.81086

6.97399

7.11963

7.24967

7.36578

7.46944

7.56200

7.64465

7.71843

7.78432

7.84314

7.89566

7.94255

7.98442

8.02181

8.05518

8.08499

8.11159

8.13535

8.15656

8.17550

8.19241

8.20751

8.22099

8.23303

8.24378

15%

.86957

1.62571

2.28323

2.85498

3.35216

3.78448

4.16042

4.48732

4.77158

5.01877

5.23371

5.42062

5.58315

5.72448

5.84737

5.95424

6.04716

6.12797

6.19823

6.25933

6.31246

6.35866

6.39884

6.43377

6.46415

6.49056

6.51353

6.53351

6.55088

6.56598

6.57911

6.59053

6.60046

6.60910

6.61661

6.62314

6.62882

6.63375

6.63805

6.64178