This document discusses the time value of money concept. It defines key terms like present value, future value, interest rates, and annuities. It provides formulas to calculate future value, present value, and annuities. Examples are given to demonstrate calculating simple and compound interest, present and future value of cash flows over single and multiple periods, and ordinary and due annuities. The document also covers topics like finding interest rates, time periods, and loan amortization.
What is the 'Time Value of Money - TVM'
The time value of money (TVM) is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. TVM is also referred to as present discounted value.
BREAKING DOWN 'Time Value of Money - TVM'
Money deposited in a savings account earns a certain interest rate. Rational investors prefer to receive money today rather than the same amount of money in the future because of money's potential to grow in value over a given period of time. Money earning an interest rate is said to be compounding in value.
BREAKING DOWN 'Compound Interest'
Compound Interest Formula
Compound interest is calculated by multiplying the principal amount by one plus the annual interest rate raised to the number of compound periods minus one.The total initial amount of the loan is then subtracted from the resulting value.
time value of money
,
concept of time value of money
,
significance of time value of money
,
present value vs future value
,
solve for the present value
,
simple vs compound interest rate
,
nominal vs effective annual interest rates
,
future value of a lump sum
,
solve for the future value
,
present value of a lump sum
,
types of annuity
,
future value of an annuity
What is the 'Time Value of Money - TVM'
The time value of money (TVM) is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. TVM is also referred to as present discounted value.
BREAKING DOWN 'Time Value of Money - TVM'
Money deposited in a savings account earns a certain interest rate. Rational investors prefer to receive money today rather than the same amount of money in the future because of money's potential to grow in value over a given period of time. Money earning an interest rate is said to be compounding in value.
BREAKING DOWN 'Compound Interest'
Compound Interest Formula
Compound interest is calculated by multiplying the principal amount by one plus the annual interest rate raised to the number of compound periods minus one.The total initial amount of the loan is then subtracted from the resulting value.
time value of money
,
concept of time value of money
,
significance of time value of money
,
present value vs future value
,
solve for the present value
,
simple vs compound interest rate
,
nominal vs effective annual interest rates
,
future value of a lump sum
,
solve for the future value
,
present value of a lump sum
,
types of annuity
,
future value of an annuity
this is a lecture on time value of money which explains the topic time value of money in a very easy and simple way... it also explains some examples on the topic... plus definition of rate of return, real rate of return, inflation premium, nominal interest rate,market risk, maturity risk,liquidity risk,and default risk,
The Cash Flow Statement translates earnings in the Income Statement into cash inflows. Explained in detail above as a part of the topic “Financial accounting”, is brought to you by Welingkar’s Distance Learning Division.
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this is a lecture on time value of money which explains the topic time value of money in a very easy and simple way... it also explains some examples on the topic... plus definition of rate of return, real rate of return, inflation premium, nominal interest rate,market risk, maturity risk,liquidity risk,and default risk,
The Cash Flow Statement translates earnings in the Income Statement into cash inflows. Explained in detail above as a part of the topic “Financial accounting”, is brought to you by Welingkar’s Distance Learning Division.
For more such innovative content on management studies, join WeSchool PGDM-DLP Program: http://bit.ly/SlideshareFaccounting
Join us on Facebook: http://www.facebook.com/welearnindia
Follow us on Twitter: https://twitter.com/WeLearnIndia
Read our latest blog at: http://welearnindia.wordpress.com
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TVM, Future Value Interest Factor (FVIF), Present Value Interest Factor (PVIF), present value interest factor of an annuity (PVIFA)
Using estimated rates of return, you can compare the value of the annuity payments to the lump sum.
The present value interest factor may only be calculated if the annuity payments are for a predetermined amount spanning a predetermined range of time.
Time Value of Money Formula
FV = PV x [ 1 + (i / n) ] (n x t)
Formula for Future Value Interest factor:
FVIF = (1+r)n
Formula for PVIF
PVIF = 1 / (1 + r)n
Present value: The current worth of a future sum of money or stream of cash flows, given a specified rate of return. Future cash flows are "discounted" at the discount rate; the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to valuing future cash flows properly, whether they be earnings or obligations.[2]
Present value of an annuity: An annuity is a series of equal payments or receipts that occur at evenly spaced intervals. Leases and rental payments are examples. The payments or receipts occur at the end of each period for an ordinary annuity while they occur at the beginning of each period for an annuity due.[3]
Present value of a perpetuity is an infinite and constant stream of identical cash flows.[4]
Compound interest (or compounding interest) is interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan. Thought to have originated in 17th-century Italy, compound interest can be thought of as “interest on interest,” and will make a sum grow at a faster rate than simple interest, which is calculated only on the principal amount. The rate at which compound interest accrues depends on the frequency of compounding; the higher the number of compounding periods, the greater the compound interest. Thus, the amount of compound interest accrued on $100 compounded at 10% annually will be lower than that on $100 compounded at 5% semi-annually over the same time period.
Basic Time Value of Money Formula and Example
Depending on the exact situation in question, the TVM formula may change slightly. For example, in the case of annuity or perpetuity payments, the generalized formula has additional or less factors. But in general, the most fundamental TVM formula takes into account the following variables:
FV = Future value of money
PV = Present value of money
i = interest rate
n = number of compounding periods per year
t = number of years
Based on these variables, the formula for TVM is:
FV = PV x (1 + (i / n)) ^ (n x t)
For example, assume a sum of $10,000 is invested for one year at 10% interest. The future value of that money is:
FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000
The formula can also be rearranged to find the value of the future sum in present day dollars. For example, the value of $5,000 one year from today, compounded at 7% interest, is:
PV = $5,000 / (1 + (7% / 1) ^ (1 x 1) = $4,673
Time Value of Money (TVM), also known as present discounted value, refers to the notion that money available now is worth more than the same amount in the future, because of its ability to grow.
The term is similar to the concept of ‘time is money’, in the sense of the money itself, rather than one’s own time that is invested. As long as money can earn interest (which it can), it is worth more the sooner you get it.
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2. Learning Objectives
• Understand how the time value of money works and
why it is important in finance
• Learn how to calculate the present value and future
value of single and lump sums ;
• To know and identify the different types of annuities for
both present value and future value of both an ordinary
annuity and an annuity due;
• Calculate the present value and future value of an
uneven cash flow stream;
• Explain the difference between nominal, periodic and effective
interest rates
• Discuss the basics loan amortization
3. Time Value of Money
• It indicates the relationship between time and
money.
• A peso received today is worth more than a
peso to be received tomorrow."
• This is because the peso amount you received
today can be invested to earn interest.
• The single most important in all financial
concepts.
4. Uses of TMV
• Valuation of Stocks and Bonds
• Setting up loan payment schedules
• Making Corporate Decisions regarding
investments.
5. Time Lines
• An important tool used in time value
analysis;
• It is a graphical representation used to
show the timing of cash flows.
Periods 0 1 2 3
10%
6. Definitions:
• Interest is money paid for the use of money.
Symbol: I
• Principal is the amount of money borrowed or
invested. Symbol P
• Interest Rate is the rate, or percent. Symbol: r
• Maturity Value / Final Value is the increased
amount resulting from the increase process.
Symbol: F
• Time a period of time. Days, monthly, quarterly,
semi-annually, annually.
Symbol: t
7. Simple Interest
• Mr. Lopez invest $10,000 at 5% annual rate for 2 years.
How much will be the interest?
• I = Prt
• P = Principal R= interest Rate t = time
• 0 1 2
Periods 5%
PV =$10,000 I =?
• I=Prt
• = $10,000 x 5% x 2
• =$ 1,000
8. Derived Formulas:
• Interest (I) = Prt
• Principal (P) = I / rt
• Principal (P) = F- i
• Rate (r) = I / Pt
• Time (t) = I / Pr
• Future Value (Fv) = P(1+rt)
• Present Value (Pv) = Fv
1+rt
9. Time Value Concepts
• Future Value
• Present Value
• Future Value of Ordinary Annuity
• Future Value of Annuity Due
• Present Value of Ordinary Annuity
• Present Value of Annuity Due
10. FUTURE VALUE
• The amount to which a cash flow or
series of cash flows will grow over a
given period when compounded at a
given interest rate. – Brigham, 2011
• It is the amount of money that will
grow to at some point in the future. –
Cabrera, 2011
• FV = PV(1+i)n
• PV = Present Value / Principal
• I = interest rate
• n = Number of periods / term
11. Compounding, Simple Interest
and Compound Interest
• Compounding is the arithmetic
process of determining the final
value of cash flow or series of cash
flows when compounded interest is
applied. – Brigham, 2011
• Simple Interest occurs when interest
is not earned on interest. – Brigham,
2011
• Compound Interest occurs when
interest is earned on prior periods’
interest. –Brigham, 2011
12. Simple interest
• Mr. Lopez invest $10,000 at 5%
annual rate for 2 years. How much
will be the Maturity value?
• 0 1 2
Periods
PV = 10,000 FV = ?
• F = P(1+rt)n
• = $10,000(1.1)
• = $11,000
13. Future Value (compounded)
• Mr. Lopez invest $10,000 compounded
at 5% annual rate for 2 years. How
much will be the Maturity value?
• 0 1 2
PV = $10,000 FV= ?
• FV= PV(1+i)n
• PV = Present Value
• i = interest rate
• N= number of years / time
14. Future Value (compounded)
• 0 1 2
PV=$10,000 $10,500 $11,025
• PV = 10,000
• i = .05
• N= 2
• FV= PV(1+i)n FV = PV(1+i)n
• =$10,000(1+.05) = $10,500(1.05)
• = $10,500 = $11,025
• FV = PV(1+i)n
• = $10,000(1.0250)
• =$ 11,025 the maturity value after 2 years
15. Mr. Lopez invest $10,000 compounded at
5% annual rate for 2 years. How much
will be the Maturity value? (table 1)
• FV= PV(1+i)n
• PV = $10,000
• i = .05
• N= 2
• FV = $10,000(1.10250)
= $11,025
22. Present Value
• The value today of a future cash
flow or series of cash flows. –
Brigham, 2011
• It is the amount of money today
that is equivalent to a given
amount to be received or paid in
the future. –Cabrera, 2011
• it is just a reverse of the future
value, in a way that instead of
compounding the money forward
into the future, we discount it back
to the present.
23. Formula:
• PV = F V
(1+i)n
• FV = Future Value
• i = interest rate
• n = number of years
24. Single-Period Case
• Suppose you need $50,000.00 to buy laptop
next year. You can earn 10% on your money by
putting in on the bank. How much do you have
to put up today?
• 0 1
PV =? FV = $50,000
• PV= FV
(1+i)n
• = $50,000
(1+.10)1
• = $45,454.545 the amount needed to invest
today
25. Single-Period Case
• Suppose you need $50,000.00 to buy
laptop next year. You can earn 10%
on your money by putting in on the
bank. How much do you have to put
up today? (table 2)
• PV= FV
(1+i)n
• FV = $50,000 i=.10 n=1
• PV = $50,000 (.090909)
=$45,454.5
27. Multiple Period Case
• Angelo would like to buy a new automobile. He
has $600,000, but the car costs $800,000. If he
can earn 12%, how much does he need to
invest today in order to buy the car in two
years? Does he have enough money, assuming
the price will still the same?
• 0 1 2
PV = ? $800,000
• FV = Future Value
• i = Interest Rate
• N = Number of years / Time
28. Multiple Period Case
• PV= FV
(1+i)n
• = $800,000
(1+.12) 2
• =$637,755.102 the amount
Angelo must invest today.
• = $600,000 - $637,755.102
• = $37,755.102
• Angelo is still short of $37,755.102
29. Angelo would like to buy a new automobile. He
has $600,000, but the car costs $800,000. If he
can earn 12%, how much does he need to
invest today in order to buy the car in two
years? Does he have enough money,
assuming the price will still the same? (table 2)
• PV= FV
(1+i)n
• FV = $800,000 i=.12 n=2
• PV = $800,000 ( 0.79719)
= $637,752
30. ANNUITIES
• It is a series of equal sized cash
flows occurring over equal
intervals of time. –Cabrera,
2011
• A series of equal payment at
fixed intervals for a specified
number of periods – Brigham,
2011
31. Two types of Annuity
Ordinary Annuity – exists when the
cash flows occur at the end of each
period.
• 0 1 2 3
Periods
Payments -100 -100 -100
Annuity Due – exists when the cash
flows occur at the beginning of each
period.
0 1 2 3
Periods
Payments -100 -100 -100
32. Future Value of Ordinary Annuity
• It is the future value of a series of equal
sized cash flows with the first payment
taking place at the end of the first
compounding period. The last payment
will not earn any interest since it is
made at the end of the annuity period. –
Cabrera, 2011
• FVA = R (1+i)n-1
i
• R = Periodic Payment
• i = Interest Rate
• n = time / term
33. Future Value of Ordinary Annuity (FVA)
• Suppose you deposit $2,000 at the end
of year 1, another $2,000 at the end of
year 2, how much will you have in 5
years, if you deposit ₱2,000 at the end
of each year? Assume a 10% interest
rate throughout. (table 3)
• FVA = R (1+i)n-1
I
• R = $2,000 i=.10 n=5
• FVA = $2,000(6.10510)
• = $12,210.2
35. FUTURE VALUE OF AN ANNUITY DUE
• The future value of a series of equal
sized cash flows with the first
payment taking place at the
beginning of the annuity period.
– Cabrera, 2011
• FVAD = R [(1+i)n-1] x (1+i)
I
• R= Periodic Payments
• i= interest rate
• N= number of years / periods
36. FUTURE VALUE OF AN ANNUITY DUE
• Jose deposits $3,500 every beginning of the
month at his bank that credits 3% monthly for
a year. How much he will have at the end of
the term? (table 5)
• FVAD = R [(1+i)n-1] x (1+i)
I
• R = $3,500 i=.03 n=12
• FVAD = $3,500 (14.61779)
= $51,162.265
38. Future Value of Annuity Due (FVAD) (uneven cash flows)
• Suppose you deposit today $100 in an account paying
8%. In one year, you will deposit another $200 and
₱300 at the beginning of the third year, how much will
you have in three years?
• FVAD = R [(1+i)n-1] x (1+i)
• FVAD = $100 (1.0800)
= $108.00
• FVAD = $308 ( 1.0800)
= $332.64
• FVAD = $632.64(1.0800)
= $683.25
• FVAD = $683.25
39. Present Value of Ordinary Annuity
• The Present Value of a series of
equal sized cash flows with the
first payment taking place at the
end of the first compounding
period. –Cabrera, 2011
• PVA = R 1-/(1+i)n
i
• R = Periodic Payment
• i = Interest Rate
• n = time / term
40. Present Value of Ordinary Annuity
• How much is the cash equivalent of the IPAD
that can be purchased by giving a down
payment of $3,000 and $2,500 payable at the
end of each period for 5 months at 5%?
(table 4)
• PVA = R 1-/(1+i)n
I
• R = $2,500 i=.05 n=5
• PVA = $2,500 (4.32948)
= $10,823.7
• Cash equivalent = PVA + down payment
• = $10,823.7 + $3,000
• = $13,823.7
42. Present Value of Ordinary Annuity (uneven cash flows)
• You are offered an investment that will pay you $200
in one year, $400 the next year, $600 the next year
and $800 at the end of the next year. You can earn
12% on very similar investments. What is the most
you should pay for this one?
• PVA = R 1-/(1+i)n
i
• PVA = $200 ( 0.89286)
= $178.572
• PVA = $578.572 (0.89286)
= $559.4398
• PVA = $1,159.44 (0.89286)
= $1,035.217
• PVA = $1,835.217 (0.89286)
= $1,638.592
• PVA = $ 1,638.592
43. Present Value of Annuity Due
• It is the present value of a series of
equal sized cash flows with the first
payment taking place at the
beginning of the annuity period. –
Cabrera,2011
• PVAD = R [1- 1/(1+I)n] x (1+i)
i
• R = Periodic Payment
• i = Interest Rate
• n = time / term
44. Present Value of Annuity Due
• A machine can be bought for $4,000 down payment
and 8 equal monthly payments of $1,200 payable
every beginning of the month. If money is worth 6%
compounded monthly, what is the cash equivalent of
the machine? (table 6)
• PVAD = R [1- 1/(1+I)n] x (1+i)
I
• R = $1,200 i=.06 n=8 dp = $4,000
• PVAD = $1,200 (6.58238)
= 7,898.856
• Down payment + PVAD
• = $4,000+ $7898.856
• = $11,898.856
46. FINDING ANNUITY PAYMENTS
• What is the annuity payment if the present value is
$100,000, the interest rate is 10% and there are 8 periods?
• Present value = $18,744.40176
47. Finding the Interest Rate, r
• Suppose your parents will retire in 18 years. They
currently have $250,000, and they think they will need
$1,000,000 at retirement. What annual interest rate
must they earn to reach their goal, assuming they
don't save any additional funds?
• R = I / Pt
• Interest rate = 8%
48. Finding the number of years, n
• Sometimes, we need to know how long it will
take to accumulate a certain some of money
• Ex. How long will it take $10,000 to double if it
was invested in the bank that paid 6% per
year?
• T = I /Pr
49. Types of Interest Rates
• Nominal Interest Rate (Quoted or
stated) – The contracted, or quoted or
stated interest rate. It is also called
annual percentage rate (APR); the
periodic rate times the number of
periods per year.
• Effective Annual Rate – The annual rate
of interest actually being earned, as
opposed to the quoted rate. This is the
rate that would produce the same future
value under annual compounding as
would more frequent compounding at a
given nominal rate.
50. Amortization
• A method of repaying an interest bearing debt by a
series of equal payments at expected time interval.
• A = R [1-(1+i)-n]
i
• R = Periodic Payment
• i = Interest Rate
• n = time / term
• Amortized loan – a loan that is to be repaid in
equal amounts on a monthly, quarterly, or annual
basis.
• Amortization Schedule - a table showing how a
loan will be repaid.
51. Sample Problem:
• A homeowner borrows $100,000 on a mortgage loan.
The loan is to be repaid in five equal payments at the
end of each of the next 5 years. The lender charges 6%
on the balance at the beginning of each year.
• Annuity Payment = $23,739.64