Time Value of Money: ABM Department

ABM Department
Accountancy, Business and Management Department
MODULE 4
TIME VALUE OF MONEY
CONCEPTS AND APPLICATION
•1. You want to have P20,000 after 7 years.
What is the amount of money that you need to
invest if you want to have such amount of
money given a 5% annual interest?
•2. What is the amount of money that you will
be having after 10 years if you want to invest
your P25,000 with an 8% interest?
•3. Differentiate Future Value from Present
Value.
Ateneo de Zamboanga University | ABM Department 2
• The time value of money refers
to the observation that it is
better to receive money sooner
than later.
• Money that you have in hand
today can be invested to earn
a positive rate of return,
producing more money
tomorrow.
• For that reason, a peso today
is worth more than a peso in
the future.

FUTURE VALUE VS PRESENT VALUE
• Future value (FV) is the value at a given future date of an amount placed on
deposit today and earning interest at a specified rate. This found by applying
compound interest over a specified period of time.
• Present value (PV), represents the peso value today of a future amount, or
the amount you would invest today at a given interest rate for a specified time
period to equal the future amount. Financial managers prefer present value to
future value because they typically make decisions at time zero, before the
start of a project.

FUTURE VALUE OF A SINGLE AMOUNT
(FV OF 1)
The general equation for the future value at the end of
period n is:
𝑛
𝐹𝑉1 = 𝑃𝑉 × (1 + 𝑟)
• Notations:
FV = the future value of the investment at the end of n years
PV = the present value of the future sum of money
n = the number of years until payment will be received or during which
compounding occurs
r = the annual interest or discount rate
THE CONCEPT OF FUTURE VALUE
• We speak of compound interest to indicate that the amount of interest earned
on a given deposit has become part of the principal at the end of a specified
period.
• The term principal refers to the amount of money on which the interest is
paid. Annual compounding is the most common type.
• The future value of a present amount is found by applying compound interest
over a specified period of time.
• Savings institutions advertise compound interest returns at a rate of x
percent, or x percent interest, compounded annually, semiannually, quarterly,
monthly, weekly, daily, or even continuously.

EXAMPLE
Mang Juan places P800 in a savings account paying 6% interest
compounded annually. He wants to know how much money will be in the
account at the end of 5 years. Substituting PV = P800, r = 0.06% and n = 5
into the equation gives the amount at the end of year 5:
•𝐹𝑉5 = 𝑃500 × (1 + 0.06)5 = 𝑃500 × 1.33823 =

𝐏𝟏, 𝟎𝟕𝟎. 𝟓𝟖

P1,070.58
Compounding
Time line showing
compounding to find future value based on Scenario 3
PV = 800
0 1 2 3 4 5
A decrease in the interest rate lowers the future amount of a deposit for a
given holding period, since the deposit earns less at the lower rate. An
increase in the holding period for a given interest rate would increase the
future value. The increased holding period increases the future value since the
deposit earns interest over a longer period of time.

PRESENT VALUE OF A SINGLE AMOUNT
(PV OF 1)
The general equation for the present value at the end of
period n is:
𝐹𝑉1 −𝑛
𝑃𝑉 = 𝑛
𝒐𝒓 𝑃𝑉 = 𝐹𝑉1 × (1 + 𝑟)
(1 + 𝑟)
• Notations:
compounding occurs
EXAMPLE
Mang Juan wishes to find the present value of P1,700 that she will receive
8 years from now. Mang Juan’s opportunity cost is 8%. Substituting PV =
P1,700, r = 0.08% and n = 8 into the equation yields to:
−8
𝑃𝑉5 = 𝑃1,700 × (1 + 0.08) = 𝑃1,700 × 0.54057
= 𝐏𝟗𝟏𝟖. 𝟒𝟔

FV = 1,700
0 1 2 3 4 5 6 7 8 9 10
Discounting
Time line showing
P918.46 discounting to find
present value based
on Scenario 4
An increasing required rate of return would reduce the present

value of a future amount, since future pesos would be worth less
today. It should be clear that by increasing the r value, which is the
required return, the present value interest factor or (1 + r)-n would
decrease, thereby reducing the present value of the future sum.

ANNUITIES
An annuity is a stream of equal periodic cash flows, over a
specified time period. These cash flows are usually annual
but can occur at other intervals, such as monthly rent or car
payments. The cash flows in an annuity can be inflows (the
P3,000 received at the end of each of the next 20 years) or
outflows (the P1,000 invested at the end of each of the next
5 years).

TYPES OF ANNUITIES
There are three basic types of annuities.
• For an ordinary annuity, the cash flow occurs at the end
of each period.
• For an annuity due, the cash flow occurs at the
beginning of each period.
• For a perpetuity, the series of payments of a fixed
amount lasts indefinitely. In other words, a perpetuity is
an annuity where n equals infinity.

PRESENT VALUE OF PERPETUITY
(PV OF PERPETUITY)
A perpetuity is an annuity with an infinite life—in other
words, an annuity that never stops providing its holder with
a cash flow at the end of each year (for example, the right
to receive P500 at the end of each year forever).

(PV OF PERPETUITY)
If a perpetuity pays an annual cash flow of CF, starting one
year from now, the present value of the cash flow stream is:
𝐶𝐹
𝑃𝑉𝑃 =
𝑟
Notations:
CF = the annuity payment deposited or received at the beginning or end of
each year
compounding occurs

(PV OF PERPETUITY)
If interest is compounding more frequently than annually…
𝐶𝐹
𝑃𝑉𝑃 = 𝑟
𝑚
Notations:
CF = the annuity payment deposited or received at the beginning or end of
each year
compounding occurs
m = the number of times compounding occurs during the year
EXAMPLE
Marty wishes to endow a chair in finance at his alma mater. The university
indicated that it requires P200,000 per year to support the chair, and the
endowment would earn 10% per year. Using the equation, we can
determine that the present value of a perpetuity is:
𝑃200,000
𝑃𝑉𝑃 = = 𝐏𝟐, 𝟎𝟎𝟎, 𝟎𝟎𝟎
0.10
𝑜𝑟
𝑃200,000
𝑃𝑉𝑃 = = 𝐏𝟐, 𝟎𝟎𝟎, 𝟎𝟎𝟎
0.10
1
FUTURE VALUE OF AN ORDINARY ANNUITY
(FV OF OA)
You can calculate the future value of an ordinary annuity
that pays an annual cash flow equal to CF by using the
equation below:
(1 + 𝑟)𝑛 − 1
𝐹𝑉𝑂𝐴 = 𝐶𝐹 ×
𝑟
Notations:
CF = the annuity payment deposited or received at the beginning or end of each year
n = the number of years until payment will be received or during which compounding occurs

FUTURE VALUE OF AN ORDINARY ANNUITY
(FV OF OA)
𝑟 𝑛 ×𝑚
(1 + ) − 1
𝐹𝑉𝑂𝐴 = 𝐶𝐹 × 𝑚
𝑟
𝑚
Notations:

EXAMPLE
Mang Juan wishes to determine how much money he will have at the end of 5
years if he chooses an ordinary annuity. He will deposit P1,000 annually, at the
end of each of the next 5 years, into a savings account paying 7% annual
interest.
(1 + 0.07)5 − 1
𝐹𝑉𝑂𝐴 = 𝑃1,000 × = 𝑃1,000 × 5.75073 = 𝐏𝟓, 𝟕𝟓𝟎. 𝟕𝟒
0.07
or
0.07 5 ×1
(1 + ) − 1
𝐹𝑉𝑂𝐴 = 𝑃1,000 × 1 = 𝑃1,000 × 5.75073 = 𝐏𝟓, 𝟕𝟓𝟎. 𝟕𝟒
0.07
1

PRESENT VALUE OF AN ORDINARY ANNUITY
(PV OF OA)
The algebraic shortcut for finding the present value of an ordinary annuity that makes an
annual payment of CF for n years looks like this:
−𝑛
1− 1+𝑟
𝑃𝑉𝑂𝐴 = 𝐶𝐹 ×
𝑟
Notations:

PRESENT VALUE OF AN ORDINARY ANNUITY
(FV OF OA)
𝑟 −𝑛 × 𝑚
1− 1+
𝑃𝑉𝑂𝐴 = 𝐶𝐹 × 𝑚
𝑟
𝑚
Notations:

EXAMPLE
Universal Robina Corporation (URC), the largest branded consumer food and
beverage product companies in the Philippines, wants to determine the most it
should pay to purchase a particular ordinary annuity. The annuity consists of
cash flows of P700 at the end of each year for 5 years. The firm requires the
annuity to provide a minimum return of 8%.
1 − (1 + 0.08)−5
𝑃𝑉𝑂𝐴 = 𝑃700 × = 𝑃700 × 3.99271 = 𝐏𝟐, 𝟕𝟗𝟒. 𝟗𝟎
0.08
𝑜𝑟
0.08 −5 ×1
1− 1+
𝑃𝑉𝑂𝐴 = 𝑃700 × 1 = 𝑃700 × 3.99271 = 𝐏𝟐, 𝟕𝟗𝟒. 𝟗𝟎
0.08
1
FUTURE VALUE OF AN ANNUITY DUE
(FV OF AD)
The algebraic shortcut for the future value of an annuity due that makes annual payments of
CF for n years is:
(1 + 𝑟)𝑛 − 1
𝐹𝑉𝐴𝐷 = 𝐶𝐹 × × (1 + 𝑟)
𝑟
Notations:

FUTURE VALUE OF AN ANNUITY DUE
(FV OF AD)
𝑟 𝑛 ×𝑚
(1 + ) − 1 𝑟
𝐹𝑉𝐴𝐷 = 𝐶𝐹 × 𝑚 × (1 + )
𝑟 𝑚
𝑚
Notations:

EXAMPLE
Mang Juan wishes to determine how much money he will have at the end of 5
years if he chooses an annuity due. He will deposit P1,000 annually, at the
beginning of each of the next 5 years, into a savings account paying 7% annual
interest, with the first deposit starting today.
(1 + 0.07)5 − 1
𝐹𝑉𝐴𝐷 = 𝑃1,000 × × 1 + 0.07
0.07
= 𝑃1,000 × 5.75073 × 1.07 = 𝐏𝟔, 𝟏𝟓𝟑. 𝟐𝟗
𝑜𝑟
0.07 5 ×1
(1 + ) − 1
𝐹𝑉𝐴𝐷 = 𝑃1,000 × 1 × 1 + 0.07
0.07
1
= 𝑃1,000 × 5.75073 × 1.07 = 𝐏𝟔, 𝟏𝟓𝟑. 𝟐𝟗
PRESENT VALUE OF AN ANNUITY DUE
(PV OF AD)
The algebraic formula for the present value of an annuity due looks like this:
−𝑛
1− 1+𝑟
𝑃𝑉𝐴𝐷 = 𝐶𝐹 × × (1 + 𝑟)
𝑟
Notations:

PRESENT VALUE OF AN ANNUITY DUE
(PV OF AD)
𝑟 −𝑛 × 𝑚
1− 1+ 𝑟
𝑃𝑉𝐴𝐷 = 𝐶𝐹 × 𝑚 × 1+
𝑟 𝑚
𝑚
Notations:

EXAMPLE
Universal Robina Corporation (URC), the largest branded consumer food and beverage
product companies in the Philippines, wants to determine the most it should pay to purchase a
particular annuity due. The annuity consists of cash flows of P700 at the beginning of each year
for 5 years with the first payment starting today. The firm requires the annuity to provide a
minimum return of 8%.
1 − 1 + 0.08 −5
𝑃𝑉𝐴𝐷 = 𝑃700 × × (1 + 0.08) = 𝑃700 × 3.99271 × (1.08)
0.08
= 𝐏𝟑, 𝟎𝟏𝟖. 𝟒𝟗
𝑜𝑟
0.08 −5 ×1
1− 1+
𝑃𝑉𝐴𝐷 = 𝑃700 × 1 × (1 + 0.08)
0.08
1
= 𝑃700 × 3.99271 × (1.08) = 𝐏𝟑, 𝟎𝟏𝟖. 𝟒𝟗
(PV OF PERPETUITY)
• In general, the value (present or future) of an annuity due is always greater
than the value of an otherwise identical ordinary annuity. Because ordinary
annuities are more frequently used in finance, unless otherwise specified,
the term annuity is intended throughout this module to refer to ordinary
annuities.
• Annual compounding (which is represented by m) means that interest is paid

once a year. In semiannual, quarterly, monthly, and daily compounding,
interest is paid 2, 4, 12, and 365 times per year respectively. When
compounding occurs more frequently than once a year, you earn interest on
interest more often, thus increasing the future value. The more frequent the
compounding, the higher the future value.

NOMINAL RATE VS. EFFECTIVE INTEREST RATE
The nominal annual rate is the contractual rate that is quoted to the borrower
by the lender. The effective annual rate (EAR), sometimes called the true
rate, is the actual rate that is paid by the borrower to the lender.
𝑟 𝑚
𝐸𝐴𝑅 = 1 + −1
𝑚

The nominal annual interest rate is also called the annual percentage rate, or
APR. The periodic rate, PIR, is the rate charged by a lender or paid by a
borrower each period. It can be a rate per year, per 6-month period, per
quarter, per month, per day, or per any other time interval (usually one year or
less).
𝑟
𝑃𝐼𝑅 =
𝑚

If the compounding occurs annually, the effective annual rate
and the nominal rate are the same. If compounding occurs
more frequently, the effective annual rate is greater than the
nominal rate. The difference between the two rates is due to
the compounding of interest at a frequency greater than
once per year.

ABM Department
Accountancy, Business and Management Department
PRACTICE PROBLEMS
1) The amount of money that would have
to be invested today at a given interest
rate over a specified period in order to
equal a future amount is called
•(a)future value.
•(b)present value.
•(c) future value interest factor.
•(d)present value interest factor.
2) An annuity with an infinite life is called
a(n)
•(a)perpetuity.
•(b)ordinary annuity.
•(c) annuity due.
•(d)indefinite annuity.

3) In future value or present value
problems, unless stated otherwise, cash
flows are assumed to be
•(a)at the end of a time period.
•(b)at the beginning of a time period.
•(c) in the middle of a time period.
•(d)spread out evenly over a time period.

4) In comparing an ordinary annuity and an annuity due, which of
the following is true?
• (a) The future value of an annuity due is always greater than the
future value of an otherwise identical ordinary annuity.
• (b) The future value of an ordinary annuity is always greater than
the future value of an otherwise identical annuity due.
• (c) The future value of an annuity due is always less than the
future value of an otherwise identical ordinary annuity, since one
less payment is received with an annuity due.
• (d) All things being equal, one would prefer to receive an ordinary
annuity compared to an annuity due.

•5) The present value of P200 to be received 10 years from
today, assuming an opportunity cost of 10 percent, is ___.
•6) The present value of P25,000 at a 14 percent discount
rate is ____.
•7)
YEAR CASH FLOWS
1 Php 5,000.00
2 Php 10,000.00
3 Php 15,000.00
4 Php 20,000.00
• 8) Gina has planned to start her college education four years from
now. To pay for her college education, she has decided to save
P1,000 a quarter for the next four years in a bank account paying
12 percent interest. How much will she have at the end of the
fourth year?
• 9) You recently received a letter from Philippine National Bank that
offers you a new credit card that has no annual fee. It states that
the annual percentage rate is 15% on outstanding balances. What
is the effective annual interest rate? (Hint: Remember these
companies bill you monthly.)

• 10) You have the opportunity to buy a perpetuity that pays Php
3,500.00 annually. Your required rate of return on this investment
is 12%. You should be essentially indifferent to buying or not
buying the investment if it were offered at a price of
_______________________.
• 11) Your father is about to retire, and he wants to buy an annuity
that will provide him with Php 100,000.00 of income a year for 20
years, with the first payment coming immediately. The going rate
on such annuities is 6%. How much would it cost him to buy the
annuity today?

4) Your father is about to retire, and he
wants to buy an annuity that will
provide him with Php 100,000.00 of
income a year for 20 years, with the
first payment coming immediately. The
going rate on such annuities is 6%.
How much would it cost him to buy the
annuity today?
•5) You are contributing money to an
investment account so that you can purchase
a car in five years. You plan to contribute five
payments of Php 7,000.00 a year. The first
payment will be made today. If you earn 11%
in your investment account, how much money
will you have in the account four years from
now?

Time Value of Money: ABM Department

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ABM Department

Accountancy, Business and Management Department

Ateneo de Zamboanga University | ABM Department 3

Ateneo de Zamboanga University | ABM Department 4

Ateneo de Zamboanga University | ABM Department 6

•𝐹𝑉5 = 𝑃500 × (1 + 0.06)5 = 𝑃500 × 1.33823 =

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An increasing required rate of return would reduce the present

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• Annual compounding (which is represented by m) means that interest is paid

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