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# UV5137

Jun. 1, 2011

## DEVELOPING FINANCIAL INSIGHTS:

USING A FUTURE VALUE (FV) AND A PRESENT VALUE (PV) APPROACH

## Base Case Starting Point

Most everyone is familiar with the concept that money placed in a savings account will
grow to a larger amount as the years pass if the money in that account earns interest at a
specified annual compounded rate. For example, \$500 invested in a savings account that earns
10% interest compounded annually will grow to become \$550 (i.e., \$500 1.10) after one year,
\$605 (i.e., \$550 1.10) after two years, and \$665.50 (i.e., \$605 1.10) after three years.1
Think about the numerical example just depicted. It took three sequential calculations to
arrive at the \$665.50 answerone calculation for each year involved. If the question had been
posed as involving 12 years or even 25 years, a multitude of tedious, repetitive calculations
would have been required. Is there a shortcut? Yes. If we take the 1.10 multiplier amount from
each of the three parenthetical notations above and simply multiply them together1.10 1.10
1.10we get a numerical factor of 1.331. So, if some reference book could provide us with the
1.331 multiplier as being applicable to a 10% situation over three years, all we would have to do
is take the initial \$500 amount put into the savings account and multiply it by 1.331 to get the
Are there reference materials that provide such multipliers for a variety of interest and
years combinations? Yes, there are, and they are referred to as future value (FV) factors. Such
reference materials are useful because no matter the initial amount invested, a specified
combination of time and interest will always have the same multiplier effect. Thus, future value
factor tables are readily available, depicting a number of possible different interest rates along
one axis and a number of different years along the other.2 In fact, Exhibit 1 presents just such a
1

The 1.10 multiplier comes from the fact that in one year there will be 100% of that years starting monetary
amount plus an additional 10% due to a years worth of interest having been accumulated at a 10% rate. Thus, 100%
+ 10% = 110%, which converts to an arithmetic multiplier of 1.10.
2
This case explores cash flows on an annual basis. Appendix 1 explains what to do when cash flows occur on a
monthly or quarterly basis.

This case was prepared by Professor Mark Haskins. It was written as a basis for class discussion rather than to
illustrate effective or ineffective handling of an administrative situation. Copyright 2011 by the University of
sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system,
used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying,
recording, or otherwisewithout the permission of the Darden School Foundation.

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table. In it we can find the 10% column and the three-years row and find the multiplier amount at
the intersection of those two table coordinates, and it is 1.331the same as we determined it
should be. Moreover, if we were using a financial calculator or Excel, the embedded programs in
those tools would derive the exact same multiplier once we entered the data pertaining to years
and interest rate.

## Can We Reverse the Flow of Time?

In business, the basic question posed above often requires us to reverse the focus. For
example, the question might be some form of My customer is willing to pay me \$665.50 in
three years; what is the equivalent monetary amount, as of today, of that future receipt? Pause
for just a momentthe same basic interplay of time and interest described in the first example
must be in play in this scenario alsoright? Of course, but instead of a current invested
monetary amount growing into a larger future amount due to the compounding of interest, we
must now work with a stipulated future monetary amount and in essence, unwind, roll back in
time, reverse the compounding of interest phenomenon. In this instance, we are being asked to
ascertain the present value (PV)the value todayof a future monetary amount, using the
relevant interest and year information.
To do that, the process is simply the reverse of what we did earlier. So, if the relevant
interest environment is 10% and the number of years is three, we execute the following three
calculations:
1. \$665.50 1.10 = \$605
2. \$605 1.10 = \$550
3. \$550 1.10 = \$500
Thus, receiving \$665.50 in three years, when the interest rate environment is 10%, is
equivalent to receiving \$500 today. In short, this has to be true because as we saw earlier, if we
invest \$500 today in a savings account that pays 10% interest, that savings account balance will
grow to become \$665.50 in three years. Another way to state this is this: If, over the next three
years, relevant interest rates are 10%, the economic value of \$665.50 in three years is exactly
equal to \$500 today.
As before, this can become a laborious series of calculations if the number of years
involved is substantial. And, just as before, there is a shortcut. Mathematically, whereas the
compounding of interest phenomenon was a multiplicative mathematical task, the unwinding of
a compounded interest phenomenon must be a divisive mathematical task. Specifically, we find

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that: 1 1.10 = 0.90909, and then 0.90909 1.10 = 0.82644, and finally, 0.82644 1.10 =
0.7513.3 And, if we take 0.7513 \$665.50, we get \$500 (with a bit of rounding).
Are there reference materials that provide such factor multipliers for a variety of interest
and year combinations when we are seeking to derive the present value of a future monetary
amount? Yes, and they contain a host of PV factors. Such reference materials are useful because
no matter the future amount to be received, a specified combination of time and interest will
always have the same multiplier effect. Exhibit 2 provides an example of such a reference table.
In it, we can find the 10% column and the three-years row and extract the multiplier factor at the
intersection of those two coordinates and it is, just as we thought it should be, 0.7513. (Please
note that the example depicted at the bottom of the table in Exhibit 2 is an additional one,
different from the one discussed here.) Moreover, if we are using a financial calculator or Excel,
the embedded algorithms in those tools use the same factor once we have entered into those tools
the relevant number of years (three) and interest rate (10%).

## Moving Beyond Single Ending or Starting Monetary Amounts

The two scenarios described above are emblematic of the simplest of situationsthey
both started with single monetary amounts to be compounded (the Exhibit 1-related example) or
discounted (the Exhibit 2-related example). In many personal and business financial situations
the reality is that there are multiple cash amounts coming in or going out over the course of a
stipulated time period that are pertinent to the sought-after FV or PV. Lets lay the foundation for
those sorts of scenarios.
Assume you invest \$80 today and at the beginning of each of the next two years for a
total of three such deposits, in a 6% savings account. At the end of three years, what will that
account have in it? Clearly, we could answer that question by applying the technique and
Exhibit 1 factors we described and used in the very first example. That is, we could find the
future value of three lump sumsone of which is invested for three years, one of which is in the
account for two years, and one of which is invested for only one year. In fact, at the bottom of
Exhibit 3, this approach is depicted. But there is an easier, quicker way. Since this scenario
involves three applications of the Exhibit 1 factors, we can develop reference materials that
accumulate the effects of a variety of multiple applications of Exhibit 1s factors. Indeed, the
Exhibit 3 factors portray such accumulations. Please note that the Exhibit 3 factors are various
summations of sequential Exhibit 1 factor amounts for a given interest rate. For this scenarios
three deposits in a 6% savings account, the Exhibit 3 factor is 3.375, which is the sum of the
Exhibit 1 6% factors associated with one year, two years, and three years (1.06 + 1.1236 +
1.191, subject to minimal rounding). So 3.375 \$80 = \$270, the amount to which three (starting
today) annual invested amounts of \$80 each grow to in a 6% account at the end of three years.
3

Some readers may have anticipated, or be interested to note, that the 0.7513 present value multiplier figure can
also be derived by the following: 1 (1.10), which is the same as 1 1.331, which indeed equals 0.7513.

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As before, lets reverse the direction of the time frame. Assume, for example, you are to
receive \$70 at the end of each of the next three years. The natural question to arise is, what is the
single present value monetary amount, as of today, that is equivalent to that series of three
receipts? Assuming a 12% interest rate environment, this question can be answered by applying
the technique and Exhibit 2 factors that we used in an earlier example. If we were to pursue that
approach, we would have to execute three separate calculations for each of the three \$70
receiptsthat approach is depicted at the bottom of Exhibit 4.4 But as we were able to do in
using Exhibit 1 to develop Exhibit 3, we can use Exhibit 2 to develop Exhibit 4, which in turn
can then be used as a shortcut for PV situations with multiple cash flows in the future. Indeed,
Exhibit 4 is simply the summation of Exhibit 2 factors for a variety of time periods within an
interest rate column. So, in this example, we can easily go to Exhibit 4s 12% column, threeyears row, and find the factor of 2.402, which is the sum (with a bit of rounding) of the pertinent
Exhibit 2 factors (0.8929 + 0.7972 + 0.7118). And 2.402 \$70 = \$168.14. The interpretation of
this present value is as follows: In a 12% interest rate environment, receiving \$168.14 today is
equivalent to receiving three payments of \$70 at the end of each of the next three years.

## Practice Your FV and PV Skills

1. You just turned 35 and have been saving for an around-the-world vacation. You want to
take the trip to celebrate your 40th birthday. You have set aside, as of today, \$15,000 for
such a trip. You expect the trip will cost \$25,000. The financial instruments you have
invested the \$15,000 in have been earning, on average, about 8%. (You may ignore
income taxes.)
a. Will you have enough money in that vacation account on your 40th birthday to take
the trip? What will be the surplus, or shortfall, in that account when you turn 40?
(Hint: Exhibit 1 will be useful in answering this question.)
b. If you had to, you could further fund the trip by making, starting today, five annual
\$500 contributions to the account. If you adhered to such a plan, how much will be in
the account on your 40th birthday? (Hint: Exhibit 3 and the answer to part (a) above
will both be useful in answering this question.)
2. Your company has been offered a contract for the development and delivery of a solarpowered military troop transport vehicle. The request for proposal provides all the
necessary technical specifications and it also stipulates that two working, economically
feasible prototypes must be delivered in four years, at which time you will receive your
only customer paymenta single and final payment of \$50 million. Assume a
reinvestment interest rate of 18% for all the monies received over the next four years.
(You may ignore income taxes.)

Appendix 2 shows how to adjust the data in Exhibit 4 for cash flows at the beginning (instead of the end) of
the year.

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a. What lump-sum dollar amount would you be willing to accept today instead of the
\$50 million in four years? (Hint: Exhibit 2 will be useful in answering this question.)
b. Alternatively, what four yearly receipts, starting a year from now, would you be
willing to accept? (Hint: Exhibit 4 and the answer to part (a) above will both be
3. The aged but centrally located golf course you manage does not have an in-ground
automated water sprinkling system. Instead, to properly water the course, sprinklers and
hoses must be repeatedly set, moved, and put away by some of the grounds crewa
tedious and laborious task. If over the next 12 years you project annual savings of about
\$40,000 from having an automated system, what is the maximum price you would be
willing to pay today for an installed, automated golf course sprinkler system? (Assume an
interest rate of 6%, and you may ignore income taxes.)
a. Redo your calculation using a 10-year time period and \$48,000 in annual savings.
b. Redo your initial calculation one more time using \$50,000 in annual savings for the
first six years and \$30,000 in annual savings for the next six years.
4. The cafeteria you operate has a regular clientele for all three meals, seven days a week.
You want to expand your product line beyond what you are currently able to offer. To do
so requires the purchase of some additional specialty equipment costing \$45,000, but you
project a resultant increase in sales (after deducting the cost of sales) of about \$8,000 per
year for each of the next eight years with this new equipment. Assuming a required rate
of return (i.e., a hurdle rate) of 8%, should you pursue this opportunity? Why or why not?
Do the analysis under two conditions:
a. You are part of an income-tax-exempt enterprise.
b. The enterprise you are part of is subject to a 40% corporate income tax rate, and the
straight-line, depreciable life of the equipment you are contemplating purchasing is
five years.
5. You are contemplating the purchase of a one-half interest in a corporate airplane to
facilitate the expansion of your business into two new geographic areas. The acquisition
would eliminate about \$220,000 in estimated annual expenditures for commercial flights,
mileage reimbursements, rental cars, and hotels for each of the next 10 years. The total
purchase price for the half-share is \$6 million, plus associated annual operating costs of
\$100,000. Assume the plane can be fully depreciated on a straight-line basis for tax
purposes over 10 years. The companys weighted average cost of capital (commonly
referred to as WACC) is 8%, and its corporate tax rate is 40%. Does this endeavor
present a positive or negative net present value (NPV)? If positive, how much value is
being created for the company through the purchase of this asset? If negative, what
additional annual cash flows would be needed for the NPV to equal zero? To what
phenomena might those additional positive cash flows be ascribable?
6. The final tally is in: This years operating costs were down \$100,000, a decrease directly
attributable to the \$520,000 investment in the automated materials handling system put in

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place at the beginning of the year. If this level of annual savings continues for five more
years, resulting in six total years of annual savings, what compounded annual rate of
return will that represent? If these annual savings continue for nine more years, what
compounded annual rate of return will that represent? (You may ignore income taxes.)

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Exhibit 1
DEVELOPING FINANCIAL INSIGHTS:
USING A FUTURE VALUE (FV) AND A PRESENT VALUE (PV) APPROACH
Future Value Factors for a Single Lump Sum Invested Today for n Years:
Exhibit 1 Factors = (1 + Interest)years

2%
Years
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

1.0200
1.0404
1.0612
1.0824
1.1041
1.1262
1.1487
1.1717
1.1951
1.2190
1.2434
1.2682
1.2936
1.3195
1.3459
1.3728
1.4002
1.4282
1.4568
1.4859

4%
1.0400
1.0816
1.1249
1.1699
1.2167
1.2653
1.3159
1.3686
1.4233
1.4802
1.5395
1.6010
1.6651
1.7317
1.8009
1.8730
1.9479
2.0258
2.1068
2.1911

6%
1.0600
1.1236
1.1910
1.2625
1.3382
1.4185
1.5036
1.5938
1.6895
1.7908
1.8983
2.0122
2.1329
2.2609
2.3966
2.5404
2.6928
2.8543
3.0256
3.2071

AnnualInterestRates
8%
10%
12%
1.0800
1.1664
1.2597
1.3605
1.4693
1.5869
1.7138
1.8509
1.9990
2.1589
2.3316
2.5182
2.7196
2.9372
3.1722
3.4259
3.7000
3.9960
4.3157
4.6610

1.1000
1.2100
1.3310
1.4641
1.6105
1.7716
1.9487
2.1436
2.3579
2.5937
2.8531
3.1384
3.4523
3.7975
4.1772
4.5950
5.0545
5.5599
6.1159
6.7275

1.1200
1.2544
1.4049
1.5735
1.7623
1.9738
2.2107
2.4760
2.7731
3.1058
3.4785
3.8960
4.3635
4.8871
5.4736
6.1304
6.8660
7.6900
8.6128
9.6463

14%

16%

18%

20%

1.1400
1.2996
1.4815
1.6890
1.9254
2.1950
2.5023
2.8526
3.2519
3.7072
4.2262
4.8179
5.4924
6.2613
7.1379
8.1372
9.2765
10.5752
12.0557
13.7435

1.1600
1.3456
1.5609
1.8106
2.1003
2.4364
2.8262
3.2784
3.8030
4.4114
5.1173
5.9360
6.8858
7.9875
9.2655
10.7480
12.4677
14.4625
16.7765
19.4608

1.1800
1.3924
1.6430
1.9388
2.2878
2.6996
3.1855
3.7589
4.4355
5.2338
6.1759
7.2876
8.5994
10.1472
11.9737
14.1290
16.6722
19.6733
23.2144
27.3930

1.2000
1.4400
1.7280
2.0736
2.4883
2.9860
3.5832
4.2998
5.1598
6.1917
7.4301
8.9161
10.6993
12.8392
15.4070
18.4884
22.1861
26.6233
31.9480
38.3376

example(assuming10%):
Toda y

Starthere

\$100
1.10

\$110

1.10

\$121

1.10

\$133.10

OR:\$100.00 1.331

=
\$133.10
(so:PVamountExhibit1factor=FVamount)

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Exhibit 2
DEVELOPING FINANCIAL INSIGHTS:
USING A FUTURE VALUE (FV) AND A PRESENT VALUE (PV) APPROACH
Present Value Factors for a Single Amount n Years in the Future:
Exhibit 2 Factors = 1 Exhibit 1 Table Factor in the Same Cell

2%
Years
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

0.9804
0.9612
0.9423
0.9238
0.9057
0.8880
0.8706
0.8535
0.8368
0.8203
0.8043
0.7885
0.7730
0.7579
0.7430
0.7284
0.7142
0.7002
0.6864
0.6730

4%
0.9615
0.9246
0.8890
0.8548
0.8219
0.7903
0.7599
0.7307
0.7026
0.6756
0.6496
0.6246
0.6006
0.5775
0.5553
0.5339
0.5134
0.4936
0.4746
0.4564

6%
0.9434
0.8900
0.8396
0.7921
0.7473
0.7050
0.6651
0.6274
0.5919
0.5584
0.5268
0.4970
0.4688
0.4423
0.4173
0.3936
0.3714
0.3503
0.3305
0.3118

AnnualInterestRates
8%
10%
12%
0.9259
0.8573
0.7938
0.7350
0.6806
0.6302
0.5835
0.5403
0.5002
0.4632
0.4289
0.3971
0.3677
0.3405
0.3152
0.2919
0.2703
0.2502
0.2317
0.2145

0.9091
0.8264
0.7513
0.6830
0.6209
0.5645
0.5132
0.4665
0.4241
0.3855
0.3505
0.3186
0.2897
0.2633
0.2394
0.2176
0.1978
0.1799
0.1635
0.1486

0.8929
0.7972
0.7118
0.6355
0.5674
0.5066
0.4523
0.4039
0.3606
0.3220
0.2875
0.2567
0.2292
0.2046
0.1827
0.1631
0.1456
0.1300
0.1161
0.1037

14%

16%

18%

20%

0.8772
0.7695
0.6750
0.5921
0.5194
0.4556
0.3996
0.3506
0.3075
0.2697
0.2366
0.2076
0.1821
0.1597
0.1401
0.1229
0.1078
0.0946
0.0829
0.0728

0.8621
0.7432
0.6407
0.5523
0.4761
0.4104
0.3538
0.3050
0.2630
0.2267
0.1954
0.1685
0.1452
0.1252
0.1079
0.0930
0.0802
0.0691
0.0596
0.0514

0.8475
0.7182
0.6086
0.5158
0.4371
0.3704
0.3139
0.2660
0.2255
0.1911
0.1619
0.1372
0.1163
0.0985
0.0835
0.0708
0.0600
0.0508
0.0431
0.0365

0.8333
0.6944
0.5787
0.4823
0.4019
0.3349
0.2791
0.2326
0.1938
0.1615
0.1346
0.1122
0.0935
0.0779
0.0649
0.0541
0.0451
0.0376
0.0313
0.0261

example(assuming8%):
Toda y

\$200.00 Starthere
\$158.77 1.08 \$171.47 1.08 \$185.19 1.08

OR:\$200.00 0.7938

=
158.76*
(So:PVamount=Exhibit2factorFVamount)

*differencebetween\$158.77and\$158.76duetorounding

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Exhibit 3
DEVELOPING FINANCIAL INSIGHTS:
USING A FUTURE VALUE (FV) AND A PRESENT VALUE (PV) APPROACH
Future Value Factors for a Series of Invested Amounts at the Beginning of n Years:
Table Factors = Sum of Exhibit 1 Factors for Corresponding Cell
and All Preceding Cells for that Interest Rate
2%
Years
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

1.020
2.060
3.122
4.204
5.308
6.434
7.583
8.755
9.950
11.169
12.412
13.680
14.974
16.293
17.639
19.012
20.412
21.841
23.297
24.783

4%
1.040
2.122
3.246
4.416
5.633
6.898
8.214
9.583
11.006
12.486
14.026
15.627
17.292
19.024
20.825
22.698
24.645
26.671
28.778
30.969

6%
1.060
2.184
3.375
4.637
5.975
7.394
8.897
10.491
12.181
13.972
15.870
17.882
20.015
22.276
24.673
27.213
29.906
32.760
35.786
38.993

AnnualInterestRates
8%
10%
12%
1.080
2.246
3.506
4.867
6.336
7.923
9.637
11.488
13.487
15.645
17.977
20.495
23.215
26.152
29.324
32.750
36.450
40.446
44.762
49.423

1.100
2.310
3.641
5.105
6.716
8.487
10.436
12.579
14.937
17.531
20.384
23.523
26.975
30.772
34.950
39.545
44.599
50.159
56.275
63.002

1.120
2.374
3.779
5.353
7.115
9.089
11.300
13.776
16.549
19.655
23.133
27.029
31.393
36.280
41.753
47.884
54.750
62.440
71.052
80.699

14%

16%

18%

20%

1.140
2.440
3.921
5.610
7.536
9.730
12.233
15.085
18.337
22.045
26.271
31.089
36.581
42.842
49.980
58.118
67.394
77.969
90.025
103.768

1.160
2.506
4.066
5.877
7.977
10.414
13.240
16.519
20.321
24.733
29.850
35.786
42.672
50.660
59.925
70.673
83.141
97.603
114.380
133.841

1.180
2.572
4.215
6.154
8.442
11.142
14.327
18.086
22.521
27.755
33.931
41.219
49.818
59.965
71.939
86.068
102.740
122.414
145.628
173.021

1.200
2.640
4.368
6.442
8.930
11.916
15.499
19.799
24.959
31.150
38.581
47.497
58.196
71.035
86.442
104.931
127.117
153.740
185.688
224.026

example(using6%):
Toda y

\$80

\$80

\$80

Starthere

fromExhibit1

1.06=

\$84.80

1.1236 \$89.89
1.191= \$95.28
\$269.97

OR:\$80.00

3.375
=
270.00*
(So:PVamountsExhibit3factor=FVamount)

## *di fferencebetween\$269.97a nd\$270.00duetoroundi ng

^Thi s exhi bi tdepi cts fa ctors forannuitiesdue (wheretheca s hfl ows occuratthes tartofea chyea r)a s oppos edtoan
ordinaryannuity s i tuati on(wheretheca s hfl ows occura ttheendoftheyea r).Mos tpubl i s hedta bl es ofthis s ort
a reforthel a tter.

This document is authorized for use only in PGPM - 02252013 by Aniket Khera at Anytime Learning from February
2013 to August 2013.

-10-

UV5137

Exhibit 4
DEVELOPING FINANCIAL INSIGHTS:
USING A FUTURE VALUE (FV) AND A PRESENT VALUE (PV) APPROACH
Present Value Factors for a Series of Amounts n Years in the Future:
Exhibit 4 Factors = Sum of Exhibit 2 Factors for Corresponding Cell
and All Preceding Cells for that Interest Rate
2%
Years
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

0.980
1.942
2.884
3.808
4.713
5.601
6.472
7.325
8.162
8.983
9.787
10.575
11.348
12.106
12.849
13.578
14.292
14.992
15.678
16.351

4%
0.962
1.886
2.775
3.630
4.452
5.242
6.002
6.733
7.435
8.111
8.760
9.385
9.986
10.563
11.118
11.652
12.166
12.659
13.134
13.590

6%
0.943
1.833
2.673
3.465
4.212
4.917
5.582
6.210
6.802
7.360
7.887
8.384
8.853
9.295
9.712
10.106
10.477
10.828
11.158
11.470

AnnualInterestRates
8%
10%
12%
0.926
1.783
2.577
3.312
3.993
4.623
5.206
5.747
6.247
6.710
7.139
7.536
7.904
8.244
8.559
8.851
9.122
9.372
9.604
9.818

0.909
1.736
2.487
3.170
3.791
4.355
4.868
5.335
5.759
6.145
6.495
6.814
7.103
7.367
7.606
7.824
8.022
8.201
8.365
8.514

0.893
1.690
2.402
3.037
3.605
4.111
4.564
4.968
5.328
5.650
5.938
6.194
6.424
6.628
6.811
6.974
7.120
7.250
7.366
7.469

14%
0.877
1.647
2.322
2.914
3.433
3.889
4.288
4.639
4.946
5.216
5.453
5.660
5.842
6.002
6.142
6.265
6.373
6.467
6.550
6.623

16%
0.862
1.605
2.246
2.798
3.274
3.685
4.039
4.344
4.607
4.833
5.029
5.197
5.342
5.468
5.575
5.668
5.749
5.818
5.877
5.929

18%
0.847
1.566
2.174
2.690
3.127
3.498
3.812
4.078
4.303
4.494
4.656
4.793
4.910
5.008
5.092
5.162
5.222
5.273
5.316
5.353

20%
0.833
1.528
2.106
2.589
2.991
3.326
3.605
3.837
4.031
4.192
4.327
4.439
4.533
4.611
4.675
4.730
4.775
4.812
4.843
4.870

example(using12%):
Toda y

fromExhibit2

\$62.50

.8929

\$55.80

.7972

\$49.83

.7118

\$70

\$70

\$70

Starthere

\$168.13

OR:\$70.00

2.402
=
168.14*
(So:PVamount=Exhibit4factorFVamounts)

*differencebetween\$168.13and\$168.14duetorounding

This document is authorized for use only in PGPM - 02252013 by Aniket Khera at Anytime Learning from February
2013 to August 2013.

-11-

UV5137

Appendix 1
DEVELOPING FINANCIAL INSIGHTS:
USING A FUTURE VALUE (F) AND A PRESENT VALUE (PV) APPROACH
What to Do When Cash Flows Occur on a Monthly or Quarterly Basis

All the examples in this case involve annual time periods. It is not unusual for payments
or receipts of cash to occur on a monthly or even a quarterly basis. There is an easy adjustment
process to accommodate such alternative time frames. All that is required is to note that, unless
stated otherwise, interest rates are always assumed to involve annual compounding. Thus, if the
scenario under consideration involves quarterly cash flows, the vertical axes of the tables in
Exhibit 1 through Exhibit 4 can be assumed to pertain to the number of quarters (instead of
years) and the stated annual interest rate must be divided by 4 (because there are four quarters
per year) before picking the appropriate interest rate column to use in the tables. So, if the desire
is to ascertain the PV of a series of quarterly payments, beginning at the end of the first quarter,
for the next three years, and the pertinent annual interest rate is 16%, these are the two required
1. The number of periods to use on the tables vertical axes is 12 (3 years 4 quarters per
year).
2. The interest rate to use on the tables horizontal axes is 4% (16% annual rate 4
compounding quarters per year).
In short, for a quarterly series of cash flows, we adjust the table axes coordinates by
scaling up the number of periods by a multiple of 4 and scaling down the interest rate by a
divisor of 4. Similarly, for a monthly series of cash flows, we adjust the table axes coordinates by
scaling up the number of periods by a multiple of 12 and scaling down the interest rate by a
divisor of 12.1

Note: Technically, an interest rate of 16% compounded annually is not equivalent to a 4% rate compounded
quarterly. The reason is that the interest earned on a quarterly basis is itself subject to the next quarters
compounding, quarter after quarter. For example, \$100 earning interest at a 16% annually compounded rate will
grow to \$116 at the end of one year. On the other hand, \$100 earning interest at the rate of 4% compounded
quarterly will grow to \$117 at the end of one year. The fact that the two scenarios are not identical is assumed to be
immaterial, and thus the adjustments described above are common when using FV and PV tables.
\$100
\$104
\$108.16
\$112.49

1.04
1.04
1.04
1.04

=
=
=
=

\$104
\$108.16
\$112.49
\$117

This document is authorized for use only in PGPM - 02252013 by Aniket Khera at Anytime Learning from February
2013 to August 2013.

-12-

UV5137

Appendix 2
DEVELOPING FINANCIAL INSIGHTS:
USING A FUTURE VALUE (FV) AND A PRESENT VALUE (PV) APPROACH
Adjusting Exhibit 4 for Cash Flows at the Beginning (Instead of the End) of the Year

example(using12%):
Toda y

\$70

\$70

\$70

Starthere

fromExhibit2

\$62.50

.8929

\$55.80 .7972
_______
\$188.30

fromExhibit4

OR:\$70.00 (1.69+1)
\$70.00 2.69

=
=

\$188.30
\$188.30

At times, the series of cash flows for which a present value amount needs to be calculated
begins at the start of each year as opposed to the end of each year. The discussion and example
depicted in Exhibit 4 identifies the cash flows according to this latter pattern. It is not unusual,
however, for the series of cash flows to begin immediately as depicted in the following revised
Exhibit 4 example. Please note there are still three annual cash flows, they simply now begin at
the start of their respective years.
Exhibit 4 can still be used to ascertain todays PV of this series of cash flows. The way to do
that involves two steps. First, use the appropriate interest rate column (12% in this example) and
use the two-years row, instead of the three-years row as originally done. In Exhibit 4, that factor
is 1.69, and it will be used to PV all the cash flow amounts except the very first one. Second,
because the first cash flow item occurs today, its PV is equivalent to the cash flow amount itself.
So, to value it, we simply add 1.0 to the 1.69 factor pertaining to the other cash flow amounts in
the example, arriving at an adjusted table factor of 2.69. Using that adjusted factor in the
following fashion, \$70.00 2.69 = \$188.30, we get the PV of a series of three annual amounts of
\$70 each, where the series begins today (immediately), as equaling \$188.30. In the above
depiction, this is verified by discounting each of the three amounts separately (using Exhibit 2
factors) and obtaining the same total PV amount.

This document is authorized for use only in PGPM - 02252013 by Aniket Khera at Anytime Learning from February
2013 to August 2013.