LECTURE

NATIONAL COLLEGE OF BUSINESS AND ARTS 04a

NOTE
Cor. Regalado St. Commonwealth Ave., Fairview, Quezon City

Business Administration Department

BASIC FINANCE

TIME VALUE OF MONEY

The concept of time value of money has many applications in Finance and wealth
accumulation. Of course, we did discuss about investment opportunities where we can place our
extra or surplus funds to earn more income or to accumulate wealth. The classic example is the time
deposit in the bank where time is the very important element and of course the interest rate.

Future Value

A peso in hand today is worth more than a peso to be received in the future because, if you
had it now, you could invest it, earn interest, and end up with more than one peso in the future. The
process of going from todays values, or present values (PVs), to future values (FVs) is called
compounding.

To illustrate, suppose you deposit Php100 in a bank that pays 5 percent interest each year.
How much would you have at the end of one year? To begin, we define the following terms:

PV - Present Value, or beginning amount, in your account. Here PV Php100.

i - Interest Rate the bank pays on the account per year. The interest earned is
based on the balance at the beginning of each year, and we assume that it is paid at
the end of the year. Here i = 5%, or, expressed as a decimal, i = 0.05.

IN - dollars of interest you earn during the year = Beginning amount X i. Here
INT= Php100(0.05) = Php5.

FVn - Future Value, or ending amount, of your account at the end of n years.
Whereas PV is the value now, or the present value, FVn is the value n years into the
future, after the interest earned has been added to the account.

n - Number of periods involved in the analysis. Here n = 1.

In our example, n 1, so FVn can be calculated as follows:

FVn = FV1 = PV +INT

= PV + PV(i)
= PV(1 + i)
=100(1 + 0.05) = 100(1.05) = 105.

Prepared by: Rey G. Parcon, MBA

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 LECTURE

NATIONAL COLLEGE OF BUSINESS AND ARTS 04a

NOTE
Cor. Regalado St. Commonwealth Ave., Fairview, Quezon City

Business Administration Department

BASIC FINANCE

Present Value

In general, the present value of a cash flow due in years in the future is the amount which, if
it were on hand today, would grow to equal the future amount. Since 100 would grow to 105 in 1
year at a 5 percent interest rate, 100 is the present value of 105 due in 1 year when the opportunity
cost rate is 5%.

Opportunity cost rate is the rate of return on the best available alternative investment of
equal risk.

Finding present values is called discounting, and it is simply the reverse of compoundingif
you know the PV, you can compound to find the FV, while if you know the FV, you can discount to
find the PV. We can solve for PV using the formula we have earlier with the help of some algebraic
manipulation, thus,

Solving for interest (i) and time (n)

At this point, you should realize that compounding and discounting are related, and that we
have been dealing with one equation that can be solved for either the FV or the PV.

FV Form:

PV Form:

Through algebraic employment, we can solve for (i) this way:

and eventually, we can solve for (n) this way:

Prepared by: Rey G. Parcon, MBA

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 LECTURE

NATIONAL COLLEGE OF BUSINESS AND ARTS 04a

NOTE
Cor. Regalado St. Commonwealth Ave., Fairview, Quezon City

Business Administration Department

BASIC FINANCE

Example 1:

Given:

PV = 10,000
i = 10%
n = 5
FV = ?

Using the formula for FV, we can solve:

Example 2:

Given:
PV = 5,000
i = 6.50%
N = ?
FV = 10,000

Using the formula for (n), we can solve:

( )

( )

Prepared by: Rey G. Parcon, MBA

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 LECTURE

NATIONAL COLLEGE OF BUSINESS AND ARTS 04a

NOTE
Cor. Regalado St. Commonwealth Ave., Fairview, Quezon City

Business Administration Department

BASIC FINANCE

Example 3:

Given:
PV = 250,000
i = ?
N = 18
FV = 1,000,000

Using the formula for (i), we can solve:

References:

Brigham, E and Houston, J. Fundamentals of Financial Management 10E

Medina, G. (2007). Business Finance, Manila City: Rex Book Store

Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott.
Copyright 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company.

Prepared by: Rey G. Parcon, MBA

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