TIME VALUE OF MONEY

1) Simple Interest (Future value)

- interest amount remains constant throughout the period

I= Prt I = interest
S= P+ I P = principal
t = period
S = P + Prt = P( 1 + rt)

Example: R200 invested for 2 years at 10% p.a

P=200 r=0,1 t= 2

I = Prt = 200x 0,1 x 2

= 40
S = 200 + 40
= 240

[Please use Financial calculator from hereon . I have used formulae in the
examples below. You are required to familiarise yourself with the use of a
financial calculator]

2) Compound Interest
- the amt. earned on a deposit becomes part of the principal
at the end of a specied period.( Earning interest on interest)

Example: R200 invested for 2 yrs at 10% p.a

Yr 1 = 200 + 0,1(200) = 220
Yr 2 = 220 + 0,1(220) = 242
Total amt received after 2 yrs: Simple int : 240 Compound int: 242
Financial calculator (FC): 2N, 200(-pv), 10i , FV compute?

2)FUTURE VALUE of LUMP SUM

It is the future value of an amount that is invested now.
m-compd period
mxn
F V = PV ( 1+k/m) PV-pres. value
K- int. p.a
n-no.of periods

Ex. Cal. the FV of R10 000 if it is invested for 3 yrs compounded at 18% p.a :
1) Annually
FV = 10 000 ( 1+.18/1)1x3
= 10 000 ( 1.18) 3
1
 = 10 000x 1.643
= 16 430
Using FC: -10 000(PV). 3(n). 18(i), compute FV? =
2) Monthly

FV = 10 000(1 + .18/12)12x3
= 10 000 (1.015) 36
= 17 091

3) Present Value of Lump sum

- the current rand value (discounted value) of a future amount of money

- the amount of money that would have to be invested now at a given interest
rate over a specified period to equal the future amount.

FV = PV (1+ k/m) mn
PV = FV
(1+k/m) mn

= FV (1+k/m) mn

( 1+k/m) mn is called the discount factor

Examples
1) Tom wishes to buy a car in 4 years time which will cost R20 000 then.
How much must he invest now , assuming the bank offers an interest rate
of 12% pa.
PV = 20 000 (1+0.12) 4
= 20 000 x 0.6355
= 12 710
FC: 4N, 20 000 FV, 12i, Compute PV?
2) How much should be deposited now in order to receive R10 000 in 5 years
time, at an interest rate of 16%, compounded:
2.1) Annually
FV = 10 000 ; k= 0.16 ; m=1 ; n=5
PV = 10 000 (1 + 0.16) 5
= 10 000 x 0.47611= 4 761

2.2) semi-annually
m = 2 ; n= 5
PV = 10 000 ( 1 + 0.16/2 ) 2x5
= 10 000 x 0.4632= 4 632

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 2.3) Quarterly
m = 4 ; n= 5
PV = 10 000 ( 1 + 0.16/4) 4x5
= 10 000 x 0.4564 = 4 564

4)Discount Rate
-Often we will want to know what the implied interest rate is in an investment
-Rearrange the basic PV equation and solve for r
FV = PV(1 + r)t
FV = (1+r) t
PV
(FV/PV) 1/t = 1 + r
r = (FV / PV)1/t 1
If you are using formulas, you will want to make use of both the yx and the
1/x keys
Ex. 1
You are looking at an investment that will pay R1200 in 5 years if you
invest R1000 today. What is the implied rate of interest?
r = (1200 / 1000)1/5 1 = 0,03714
= 3,714%
Fin. Calculator the sign convention matters!!!
N=5
PV = -1000 (you pay 1000 today)
FV = 1200 (you receive 1200 in 5 years)
I/YR = 3,714%
Ex.2
Suppose you are offered an investment that will allow you to double your
money in 6 years. You have R10 000 to invest. What is the implied rate of
interest?
r = (20 000 / 10 000)1/6 1 = 12,25%
or FC
N=6
PV = -10 000
FV = 20 000
I/YR = 12,25%

Ex. 3
Suppose you have a 1-year old son and you want to provide R75 000 in 17
years towards his college education. You currently have R5000 to invest.
What interest rate must you earn to have the R75 000 when you need it?
N = 17
PV = -5000
FV = 75 000 I/YR = 17.27%
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5)Finding the Number of Periods
(from your logs: if x = y t, then (log x/log y) = t)
FV = PV(1 + r)t
FV/PV = (1+r) t
t = log(FV / PV) / log(1 + r)
You can use the financial keys on the calculator as well, just remember the
sign convention.
Ex 1
You want to purchase a new car and you are willing to pay R20 000. If
you can invest at 10% per year and you currently have R15 000, how long
will it be before you have enough money to pay cash for the car?
t = log(FV / PV) / log(1 + r)
t = log(20 000 / 15 000) / log(1 + 0.10)
t = 0.125/0.041
= 3.05 yrs or
Financial calculator
I/YR = 10
PV = -15 000
FV = 20 000
N = 3,02 years

Ex.2
Suppose you want to buy a new house. You currently have R15 000 and you
figure you need to have a 10% down payment plus an additional 5% in closing
costs. If the type of house you want costs about R150 000 and you can earn
7,5% per year, how long will it be before you have enough money for the down
payment and closing costs

How much do you need to have in the future?

Down payment = 0,1(150 000) = 15 000
Closing costs = 0,05(150 000 15 000) = 6 750
Total needed = 15 000 + 6 750 = 21 750
Compute the number of periods
PV = -15 000
FV = 21 750
I/YR = 7,5
N = 5,14 years
Using the formula
t = log(21 750 / 15 000) / log(1,075)
= 5,14 years

6)Mixed Examples

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1)How long will it take R800 to yield R68 in simple interest at 5%.
P=800 ; I = 68; r = 0.05 ; t = ?

I = prt
t = I/pr
= 68
800 x 0.05
= 1.7 yrs ( 20.4 mths)

2)Which of the following 2 year investments will be preferred by an investor:

A: R800 compounded at 12% annually
B: R800 compounded at 12% monthly.
A: FV = PV (1+ k/m) mn
= 800( 1.12) 2
= 800 x 1.254
= 1004
B : FV = 800 (1+ 0.12/12) 24
= 800 x 1.2697
= 1 016

B is preferred , higher FV

3) You are to receive the following payments:(Int = 18% pa)

R300 at the end of year 2 ; R450 at the end of year 3 and R400 at the end of
year 4.
Calculate the lump sum invested to receive the above payments?

PV = FV ( 1+k/m) mn
PV = 300(1+0.18) 2 + 450(1+0.18) 3 + 400(1+0.18) 4
= 300x0.718 + 450x0.609 + 400x0.516
= 215 + 274 + 206
= 695

7)Nominal and Effective rate

- nominal rate is the stated annual rate of interest without compounding
- effective annual rate is the simple interest rate that would give the same
return in 1 yr as the compound
rate.
EAR = ( 1 + k/m )m - 1 k= stated rate , m=compd. period

Ex.1 Find the effective rate if the nominal(stated) rate is 12% pa, compounded
1)semi-annually.
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 EAR = (1 + .12/2) 2 - 1
= (1.06) 2 - 1
= 0,1236
= 12,36%
2) Quarterly compd

EAR = ( 1 + .12/4) 4 - 1
=.1255
= 12.55%

Ex.2 A bank is offering 12% pa, compounded quarterly.

1) How much will you have at the end of 1 year?
This means that the interest rate per quarter
= 12/4=3%.
FV = R100 x (1.03)4
= R100 x 1.1255 = R112,55

2) What is the EAR?

EAR = 12.55% from (1 + 0.1255) or see 2) above

3) How much will you have after 5 years?

FV = R100 x (1,03) 4x5 = 100 x 1,806 =R180,60
Or
FV = R100 x (1.1255) 5 = R180,60

Ex.3 Suppose a bank states that the EAR , based on monthly compounding is
18%, what is the nominal or what monthly rate can it quote?
0.18 =(1 + k/12) 12 -1
1.18 (1/12) = 1 + k/12
1.18 0,083 = 1+ k/12
(1,0139 -1) x 12 = k
k = 16,68%

8)Future Value of an Annuity

Annuity is a level stream of cash flows for a fixed period of time.Annuity due is
an annuity for which the cash flows occur at the beginning of the period, whereas
ordinary annuity cash flows occur at the end of the period.
Perpetuity is an annuity in which cash flows continue forever.

FVA = PMT [ (1+k) n 1]

K
= PMT (FVIFA k,n)

Ex 1) You invest R1000 a year for 20 years , compounded annually at 8% pa.

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What amount will you receive at maturity?

FVA = 1 000 [ (1 + 0.08) 20 - 1]

0.08
= 45 762

OR FVA = 1 000 x (FVIFA 8%, 20)

= 1 000 x 45.762
= 45 762
FC: 0(PV), 20N, 8i, 1000pmt, Compute FV?
2) Suppose that over the next 5 years you want to accumulate R45 000 to buy an
equipment. How much must you deposit every year if you can earn 10% pa.

FVA = Pmt (FVIFA 10%,5yr)

45 000 = Pmt x 6.105
Pmt = 7 371

Or 45 000 = pmt [(1+ 0.10) 5 1]

0.10
pmt = 7 371

9)Present Value of Annuity

Annuity present value:PVA = C [(1- PV factor)/r]
Or
PVA = pmt [1 (1+ k) n ]
K

= pmt x (PVIFA k,n)

Example1
A pensioner receives R1 500 a year for 20 years. If the discount rate was 12%
pa, what lump sum did he invest in order to receive the above payments.
PVA = 1 500 x (PVIFA 12%,20yr)
= 1 500 x 7.4694
= 11 204

or PVA = 1 500 [1 (1+ 0.12) 20]

0.12
= 11 204
2) You purchased a house for R300 000.The bank offers you an interest rate of
10%pa over a 20 year term.What are the monthly payments if interest is
compounded monthly.

300 000 = pmt [1 (1 + 0.10/12) -12x20 ]

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 0.10/12
300 000 = pmt [ 1 (1.0083) 240 ]
0.0083
300 000 = pmt x 103.9098
pmt = 2 887 per month
FC: -300 000(PV). 10/12=0,833(i), 20x12=240(n),0(FV), compute pmt?(2
894)
4)In ex. 2 above, suppose you increase your monthly payment by R300, how
long will it take to settle the
loan?
New pmt = 2 887 + 300 = 3 187
300 000 = 3 187 [ 1 (1.0083) n ]
0.0083
300 000 x 0.0083 = 1 (1.0083) n
3 187
0.7813 1 = (1.0083) n
0.2187 = (1.0083) n
Log 0.2187 = -n
Log 1.0083
- 0,66/0,0036 = - 183
Therefore n= 183 months or 183/12 = 15,25 yr
Class examples (additional)[use financial calculator]

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 1. CalculatethefuturevalueofR4,600receivedtodayifitisdepositedat9
%forthreeyears.

Answer: FVR4,600(1.295)R5,957
OrFV=4600(1.09)+3=R5957
2. EcoSystems,Inc.ispreparingafiveyearplan.Today,salesare
R1,000,000.Ifthegrowthrateinsalesisprojectedtobe10%overthe
nextfiveyears,whatwilltherandamountofsalesbeinyearfive?
Answer:
FV=1000000(1.10)5

FV1,000,000(1.611)R1,611,000

3. CalculatethefuturevalueofanannuityofR5,000eachyearforeightyears,
depositedat6%.
Answer: FV5,000(9.897)R49,485
8
OrFVA=5000[(1,06)

1]
0.06
= R49 485

4. Mr. Handyman has been awarded a bonus for his outstanding work. His
employer offers him a choice of a lump-sum of R5,000 today, or an
annuity of R1,250 a year for the next five years. Which option should Mr.
Handyman choose if his opportunity cost is 9 %?
Answer:
PVA R1,250(PVIFA) 1,250(3.890) R4,862.50

Or PVA = 1 250 [ 1- (1.09) -5]

0.09
= 4 863
Mr. Handyman should choose a lump-sum of R5,000 today.

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5.Jayis30yearsoldandwillretireatage65.Hewillreceiveretirement
benefitsbutthebenefitsarenotgoingtobeenoughtomakeacomfortable
retirementlifeforhim.JayhasestimatedthatanadditionalR25,000ayear
overhisretirementbenefitswillallowhimtohaveasatisfactorylife.How
muchshouldJaydepositannuallyinanaccountpaying6%interesttomeet
hisgoal?AssumeJaywillhave15yearsofretirement.
Answer: PMTR25,000,n15,i6%
PV(65)25,000(PVIFA)25,000(9.712)R242,806
FVR242,806,n35,i6%

Or PVA at age 65 = 25 000 [1-(1.06) -15]

0.06
= 242 806
PVA at age 65 will have to be discounted to age 30.We need to find what
annuity payments will arrive at a FV of 242 806.
242 806 = pmt [(1.06) 35 1]
0.06
pmt = 2178.90
5. During her four years at college, Rose received the following amounts of money at the end of each
year from her grandmother. She deposited her money in a saving account paying 6 % rate of interest.
How much money will Rose have on graduation day?
Yr 1 2 3 4
amt 100 200 300 400
Answer:

Year R n FVIF FV
1 R100 3 1.191 R119.10
2 200 2 1.124 224.80
3 300 1 1.060 318.00
4 400 0 1.000 400.00
R1,061.90

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7. CalculatethepresentvalueofR800receivedatthebeginningofyear1,
R400receivedatthebeginningofyear2,andR700receivedatthe
beginningofyear3,assuminganopportunitycostof9%.
Answer:
PV=800+400(1.09)1+700(1.09)2
PV800400(0.917)700(0.842)R1,756.20

8. CalculatethefuturevalueofR10,000receivedtodayanddepositedforsix
yearsinanaccountwhichpaysinterestof12%compoundedquarterly.
Answer:FV=10000(1.03)24
FV10,000(2.033)R20,330

9. JaniceborrowsR25,000fromthebankat15%toberepaidin10equal
annualinstallments.Calculatetheendofyearpayment.
Answer:PVA=PMTxPVIFA
PMT25,000/5.019R4,981.07

10. JohnborrowedR12,000tobuyanewcarandexpectstopayR564.87per
monthforthenext2yearstopayofftheloan.Whatistheloansrateof
interest?
Answer: PVAR12,000,PMTR564.87,n2,m12
PVIFAPVA/PMT12,000/564.8721.244
12%
FromtableA4i/m1%i
11. Herberthasopenedaretirementfundaccountwhichpays7%interestand
requiresR5,000annualdeposits.Herbertwillretirein15yearsandexpects
10yearsofretirementlife.Whatisthemaximumannualretirementbenefit
Herbertcangetduringhisretirementyears?
Answer: i7%,PMTR5,000,n15
Atthebeginningofretirement:
FVA5,000(FVIFA)5,000(25.129)R125,645
Annualretirementbenefit:i7%,n10,PR125,645
PMTPVA/PVIFA125,645/7.024R17,887.96
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12. BrianborrowsR5,000fromabankat8%annuallycompoundedinterestto
berepaidinfiveannualinstallments.Calculatetheprincipalpaidinthe
thirdyear.
Answer: PMT5,000/3.993R1,252.19
Year Payment Principal Interest Balance
0 0 R5,000.00
1 R1,252.19 R852.19 R400.00 4,147.81

2 1,252.19 920.37 331.83 3,227.44

3 1,252.19 993.99 258.20

TheprincipalpaidinthethirdyearisR993.99

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