Review of The Time Value of Money

Professor Medhat Hassanein

Reference: Lawrence J. Gitman

Principles of Managerial Finance (12th edition),
Chapter 4
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Review of: The Time Value of Money

Future value of a single amount:
Example: if you place $ 100 in savings account paying 8%
interest compounded annually. What would be the sum of
money in your account at the end of one year?
Solution
Future value = present value + present value X the annual
interest
= 100 + 100(.08)
= 100 + .08
= $ 108
= 100 [1 + .08]
= principal [1 + interest rate]
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Review of: The Time Value of Money

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Review of: The Time Value of Money

* The difference is due to approximation of decimal points

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Review of: The Time Value of Money

Finding the present value of an ordinary annuityContd
Therefore: 20,000 is a cash flow concept not a profit concept.

The 20,000 each year will include: a return of 10% on your

investment and returning part of your initial investment which
is the $ 49,740.
In order to understand this cash flow concept, refer to the
appendix of this Review.

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Review of: The Time Value of Money

Find the future of an annuity due:
Assume that in the example of the ordinary annuity you
changed the pattern of saving i.e. instead of saving at the end
of each year you decided to save at the beginning of each
year. What will be the amount of savings at the end of three
years?
Solution:
Your savings will increase by (1 + .07) i.e. 3,215 (1 +.07) =
$3,440.05

Let us see how?

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Review of: The Time Value of Money

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Review of: The Time Value of Money

Find the present value of an annuity due:
Suppose that the owner of the accessories shop will generate
the $ 20,000 cash flow at the beginning of each year instead
of the end of each year, what is the amount of initial
investment you have to invest in the purchase of this offer?
Solution:

The answer is 49,740 (1 + .10) = $ 54,714

Let us see how?

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Review of: The Time Value of Money

Appendix: the accessories shop investment exercise:
To see how much of the annual $ 20,000 cash flow contains the 10% return
on your investment and how much each year you return portion of the initial
investment of the $ 49,740. Refer to the loan amortization exercise.

Solution:
Construct the following table:

Years

Principal
(Initial Investment)

Cash flow
(annual)

Return
(10%)

Repay of I.I.

Balance unpaid

49,740

20,000

4,974

15,026

34,714

34,714

20,000

3,471

16,529

18,185

18,185

20,000

1,818

18,183

10,263

49,740
60,003
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