Chapter

9 The Time Value of Money

McGraw-Hill Ryerson 2003McGraw-Hill Ryerson

2003 McGraw-Hill RyersonLimited
Limited
 PPT 9-2

Chapter 9 - Outline

Time Value of Money

Future Value and Present Value

Annuities

Time-Value-of-Money Formulas

Adjusting for Non-Annual

Compounding
Compound Interest Tables

Summary and Conclusions

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 Time Value of Money

Money Has Time Value

In 1624 Manhattan Island
was sold for $24.
$24 invested at 6% annual
interest rate could be $130
billion in 2009 : Buy New
York City partly
$ 1 received 2009 years ago
invested at 6%
Source: http://en.wikipedia.org/wiki/Manhattan

2003 McGraw-Hill Ryerson Limited

 PPT 9-3

Time Value of Money

The
basic idea behind the concept of time value of
money is:
$1 received today is worth more than $1 in the future
OR
$1 received in the future is worth less than $1 today

Why?
because interest can be earned on the money

Theconnecting piece or link between present

(today) and future is the interest or discount rate
2003 McGraw-Hill Ryerson Limited
 PPT 9-4

Future Value and Present Value

FutureValue (FV) is what money today will be

worth at some point in the future

PresentValue (PV) is what money at some point in

the future is worth today

2003 McGraw-Hill Ryerson Limited

Figure 9-1 PPT 9-5
Relationship of present value and future
value

$
$1,464.10
future
value
$1,000 present
10% interest
value

0 1 2 3 4
Number of periods

2003 McGraw-Hill Ryerson Limited

C. Solving time value of money problems

You can solve time value of money problems

in three different ways:

First, you can use a financial calculator.

Second, you can use the actual formulas

given in Chapter 9.

Third, you can use the interest factor tables

in the back of your textbook.

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1. Future Value of a Lump Sum

A. Future value of a single amount.

First, you must understand that if a single lump sum

of money is deposited in a bank, or other financial
institution, and allowed to grow at a given interest
rate over a period of time, the end result will be its
future value.

B. Future value formula. You can calculate the future

value of a single amount given this formula:
FV = PV X (1 + i)n
Where: FV = Future Value
PV = Present Value
i = interest rate and n = time

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C. Interest Factor Tables

Using the interest factor tables, Appendix A and

the following formula:

FV = PV X FVIF

Where: FV = Future Value

PV - Present Value
IF = factor from interest factor table

Sample Problem: You invest Tk. 1000 for four

years at 10 percent interest. What is the value at
the end of the fourth year?

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2. Present Value of a Lump Sum

A.Present value of a single amount

Present value is the mathematical reciprocal of future

value.

If you expect to receive a sum of money at some future time, what

is the value of that sum of money today?

In other words, what would you pay for the opportunity of

receiving that money today?

A good example is the lottery. If you win the lottery, you may be
given the option of receiving your proceeds over 20 years or as a
lump sum. Money that you receive in the lump sum now is worth
more to you than money you receive over 20 years due to the time
value of money.
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B. Present Value Formula. You can calculate the present value of a
lump sum using this formula:
PV = FV X 1/(1 + i)n
Where: FV = Future Value
PV = Present Value
I = interest rate and n = time

C. Interest Factor Tables. Using interest factor tables, Appendix B,

use the following formula:
PV = FV X PVIF
Where: FV = Future Value
PV = Present Value
IF = factor from interest factor table

Sample problem: You will receive Tk.1,000 after four years at a

discount rate of 10 percent. How much is this worth today?

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3. Future Value of An Annuity

A.Future Value of An Annuity

An annuity is a series of equal, consecutive

payments.

In calculating the future value of an annuity, you

must consider the value of compounding for each
time period in which the annuity is deposited.

The best methods are to use either a financial

calculator or the interest factor tables at the end of
your textbook.

2003 McGraw-Hill Ryerson Limited

B. Future Value of An Annuity Formula

Using Appendix C:

FVA = A X FVIFA
Where FVA = Future Value of An Annuity
A = Annuity Payment
FVIFA = Interest factor given an interest rate and time period

Sample Problem: You will receive Tk. 1,000 at the

end of each period for four periods. What is the
accumulated value (future worth) at the end of
the fourth period if money grows at 10 percent?

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4. Present Value of An Annuity

A. Present Value of An Annuity

The present value of an annuity is the reverse of the future value of
an annuity.
B. Present Value of An Annuity Formula:

Using the Appendix D:

PVA = A X PVIVA

Where PVA = Present Value of An Annuity

A = Annuity Payment
PVIFA = interest factor given an interest rate and time period

Sample Problem: You will receive Tk. 1,000 at the

end of each period for four years. At a discount rate
of 10 percent, what is the cash flow currently worth?
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5. Solving for the value of the Annuity

A. Value of the annuity. So far, in time value of money problems,

we've been solving for future and present values. You can
also solve for the value of an annuity.

B. Annuity equaling a future value. If you want to calculate how

much you should save to have a given sum of money at some
date in the future, use this formula:
A = FVA/FVIFA
Where A = Annuity Value
FVA = Future Value of the Annuity
FVIFA = Interest factor

Sample problem: You need Tk. 1,000 after four periods. With an
interest rate of 10 percent, how much must be set aside at the
end of each period to accumulate this amount

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C. Annuity equaling a present value

If you already know the present value of an amount, this

formula will help you determine how many withdrawals you
can make from that amount over a period of time.

A = PVA/PVIFA

Where A = Annuity Value

PVA = Present Value of the Annuity
PVIFA = interest factor

Sample problem: You deposit Tk. 1,000 today and

wish to withdraw funds equally over four years.
How much can you withdraw at the end of each
year if funds earn 10 percent?

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6. Solving for the yield or interest rate

A. Solving for the yield or return on a lump sum

We can also manipulate the formulas used so far to

determine the yield or interest rate we will earn if
we know the present value and future vale of the
investment:

PVIF = PV/FV

Go to the table, present value of a lump sum, and

find the PVIF. The column under which the PVIF lies
is the approximate interest rate.
Sample problem: You invest Tk. 1,000 now, and the
funds are expected to increase to Tk. 1,360 after
four periods. What is the yield on the investment?
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6. Solving for the yield or interest rate

B. Solving for the yield or return on an

annuity

We can also solve for yield or return if the

cash flows from the investment are
annuity payments.

PVIFA = PVA/A

Go to the table, present value of an annuity, and

find the PVIFA. The column under which the
PVIFA lies is the approximate interest rate.

2003 McGraw-Hill Ryerson Limited

7. Special types of time value of money problems

A.Compounding more often than annually

If interest is compounded, for example, semi-
annually, solve for the future or present value in
the same way. However, when determining the
correct interest factor to use, divide the interest
rate by 2 (the number of times interest is
compounded) and multiply the number of years to
maturity by 2.

Sample problem: You invest Tk. 1,000 compounded

semiannually at 8 percent per annum over four
years. Determine the future value.

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7. Special types of time value of money problems

B. Deferred Annuity
A deferred annuity is an annuity paid sometime in
the future. First, calculate the present value of
the annuity using Appendix D. Then, calculate the
present value using Appendix B.

Sample problem: you will receive Tk. 1000 per

period, starting at the end of the fourth period
and running through the end of the eighth period.
With a discount rate of 8 percent, determine the
present value.

2003 McGraw-Hill Ryerson Limited

 PPT 9-20

Summary and Conclusions

The financial manager uses the
time value of money approach to
value cash flows that occur at
different points in time

A dollar invested today at

compound interest will grow a
larger value in future. That future
value, discounted at compound
interest, is equated to a present
value today

Cashvalues may be single

amounts, or a series of equal
amounts (annuity)
2003 McGraw-Hill Ryerson Limited