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PowerPoint

Presentations for

Finance for
Non-Financial Managers:
Seventh Edition

Prepared by

Pierre Bergeron
University of Ottawa

Copyright 2014 Nelson Education Ltd.

101

CHAPTER 10
Time-Value-of-Money
Concept

Copyright 2014 Nelson Education Ltd.

102

Learning Objectives
1. Define time value of money, inflation, and
risk.
2. Explain the financial tools used to solve
time-value-of-money problems.
3. Differentiate between future values of single
sums and future values of annuities.
4. Distinguish between present values of single
sums and present values of annuities.
5. Make capital investment decisions by using
time-value-of-money tools.

Copyright 2014 Nelson Education Ltd.

103

LO 1

Why Money Has a Time Value


Money has a time value because of the

existence of interest

A dollar earned today will be worth more tomorrow.


This is called compounding.
$1,000

$1,100

A dollar earned tomorrow is worth less today.


This is called discounting.
$1,000
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$1,100
104

An Example10 years @ 10%


Compounding
$5,000
Single sum

Table A (2.594)
$813.72
Annuity

IRR

$ 12,970
$ 12,970
0

Table C (15.937)
Discounting
-$5,000 Single sum

+$5,000 PV
0 NPV
Copyright 2014 Nelson Education Ltd.

LO 1

20%
10 years @ 30%
Table D (4.1925)
(3.0915)
Table
D (6.1446)
1,617.33
$ 1,192.60
$813.72
Annuity

105

IRR

LO 1

Compounding versus Discounting


Insurance
companies
Years 1

20

Yearly premiums (cash inflows) $1,000


$_______ + 57,275

57.275
Money is worth 10% ($1,000 ___________)
Death benefit (cash outflow)
Net cash flow of NFV

$ - 50,000
7,275

$________

_____________companies
Industrial
Years 1

20

A company invests $150,000 (cash outflow) to modernize a plant. As a result,


the company saves $20,000 (cash inflows) each year.
-$ 150,000 cash outflow
present value of the savings if money is worth 10%
8.5136
7.4694
+ 170,272
149,388 $20,000 __________
+$______
20,272
+$______
612

net cash flow or net present value (NPV)

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106

12%

IRR is 11.9%

LO 1

Time Value of Money and Inflation

Inflation is included in the forecast (e.g., revenue, costs, etc.). Once


the cash flow has been determined, then this amount is discounted.
Years
Projected statement of income
Revenue (with inflation)
Cost of sales (with inflation)
Gross profit
Expenses (with inflation)
Profit before taxes
Income tax expense
Profit for the year
Add back depreciation
Cash flow (with inflation)
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107

$100
80
20
10
10
5
5
2
$ 7

$110
85
25
12
13
6
7
2
$ 9

$120
90
30
14
16
8
8
2
$ 10

Time Value of Money and Risk

LO 1

Factors to consider
1. Time value of money
2. Inflation
3. Risk
Types of projects:
High risk, medium risk, low risk, compulsory
LR/C
____
LR
____
____
MR

Modernization
Expansion
New facility
New
equipment/machinery/vehicle
HR New product
____
Anti-pollution equipment
C
____
HR/C
____ Research and development

____
LR

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108

Investment Decisions in Capital Budgeting

TIME

CASH

Cash Inflows (receipts)


Cash Outflows (disbursements)
Lotto 649 win of $100,000
Two options
Option 1 $100,000 today
Option 2
$10,000
$12,000
$14,000
$16,000

$10,000
$12,000
$14,000
$16,000

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$10,000
$12,000
$14,000
$16,000

$10,000
$12,000
$14,000
$16,000

$10,000
$12,000
$14,000
$16,000

$10,000
$12,000
$14,000
$16,000

$10,000
$12,000
$14,000
$16,000
109

$10,000
$12,000
$14,000
$16,000

$10,000
$12,000
$14,000
$16,000

$10,000
$12,000
$14,000
$16,000

LO 1

Tools for Solving TMV of Money Problems

Algebraic Notations
Interest Tables
Financial Calculators and
Spreadsheets
Time Lines

Copyright 2014 Nelson Education Ltd.

1010

LO 2

LO 3

Effect of Compounding
Problem:

If you invest $1,000 in the bank bearing a 10% compound


interest, what is the future value of the investment at the
end of three years?

Year

Beginning
amount

Interest
rate

Amount of
interest

Beginning
amount

Ending
amount

$1,000

.10

$100

$1,000

$1,100

$1,100

.10

$110

$1,100

$1,210

$1,210

.10

$121

$1,210

$1,331

F = P (1 + i)n

F = Future amount

F = $1,000 (1.10)3

P = Principal or initial amount

F = $1,000 X 1.331

i = Interest rate

F = $1,331

n = Number of years

Copyright 2014 Nelson Education Ltd.

1011

LO 3

Future Value of a Single SumTable A


Compounding Discounting
Single sum
A
B
Annuity
C
D
N9% 10% 11%
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

1.090
1.188
1.295
1.412
1.539
1.677
1.828
1.993
2.172
2.367
2.580
2.813
3.066
3.342
3.642
3.970
4.328
4.717
5.142
5.604
6.109
6.659
7.258
7.911
8.623

Copyright 2014 Nelson Education Ltd.

1.100
1.210
1.331
1.464
1.611
1.772
1.949
2.144
2.358
2.594
2.853
3.138
3.452
3.798
4.177
4.595
5.054
5.560
6.116
6.728
7.400
8.140
8.954
9.850
10.835

1.110
1.232
1.368
1.518
1.685
1.870
2.076
2.305
2.558
2.839
3.152
3.498
3.883
4.310
4.785
5.311
5.895
6.544
7.263
8.062
8.949
9.934
11.026
12.239
13.586

12%

14%

16%

18%

20%

1.120
1.254
1.405
1.574
1.762
1.974
2.211
2.476
2.773
3.106
3.479
3.896
4.363
4.887
5.474
5.130
6.866
7.690
8.613
9.646
10.804
12.100
13.552
15.179
17.000

1.140
1.300
1.482
1.689
1.925
2.195
2.502
2.853
3.252
3.707
4.226
4.818
5.492
6.261
7.138
8.137
9.276
10.575
12.056
13.744
15.668
17.861
20.362
23.212
26.462

1.160
1.346
1.561
1.811
2.100
2.436
2.826
3.278
3.803
4.411
5.117
5.936
6.886
7.988
9.266
10.748
12.468
14.463
16.777
19.461
22.575
26.186
30.376
35.236
40.874

1.180
1.392
1.643
1.939
2.288
2.700
3.185
3.759
4.435
5.234
6.176
7.288
8.599
10.147
11.974
14.129
16.672
19.673
23.214
27.393
32.324
38.142
45.008
53.109
62.669

1.200
1.440
1.728
2.074
2.488
2.986
3.583
4.300
5.160
6.192
7.430
8.916
10.699
12.839
15.407
18.488
22.186
26.623
31.948
38.338
46.005
55.206
66.247
79.497
95.396

1012

LO 3

Future Value of an Annuity

An annuity is defined as a series of payments of fixed amount for a specified


number of years. Examples of annuities are mortgages, RRSPs, whole-life
insurance premiums.
Problem:
If you were to receive $1,000 at the end of each year, for the
next five years, what would be the value of the receipts if the
interest rate is compounded annually at 10%?
Year
1
2
3
4
5

Amount
Interest
received
factors
$1,000
1.464
$1,000
1.331
$1,000
1.210
$1,000
1.100
$1,000
1.000
$5,000
$1,105

W=R

Future
Interest
$464
$331
$210
$100
---$6,105

value
$1,464
$1,331
$1,210
$1,100
$1,000

(1 + i)n - 1

W = Value of annuity

R = Sum of receipts

W = $1,000 X 6.105

i = Interest rate

F = $6,105

n = Number of years

Copyright 2014 Nelson Education Ltd.

1013

LO 3

Future Value of an AnnuityTable C


Compounding Discounting
Single sum
A
B
Annuity
C
D
N9% 10% 11%
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

1.000
2.090
3.278
4.573
5.985
7.523
9.200
11.029
13.021
15.193
17.560
20.141
22.953
26.019
29.361
33.003
36.974
41.301
46.019
51.160
56.765
62.873
69.532
76.790
84.701

Copyright 2014 Nelson Education Ltd.

1.000
2.100
3.310
4.641
6.105
7.716
9.487
11.436
13.580
15.937
18.531
21.384
24.523
27.975
31.773
35.950
40.545
45.599
51.159
57.275
64.003
71.403
79.543
88.497
98.347

1.000
2.110
3.342
4.710
6.228
7.913
9.783
11.859
14.164
16.722
19.561
22.713
26.212
30.095
34.405
39.190
44.501
50.396
56.940
64.203
72.265
81.214
91.148
102.174
114.413

12%

14%

16%

18%

20%

1.000
2.120
3.374
4.779
6.353
8.115
10.089
12.300
14.776
17.549
20.655
24.133
28.029
32.393
37.280
42.753
48.884
55.750
63.440
72.052
81.699
92.503
104.603
118.155
133.334

1.000
2.140
3.440
4.921
6.610
8.536
10.731
13.233
16.085
19.337
23.045
27.271
32.089
37.581
43.842
50.980
59.118
68.394
78.969
91.025
104.768
120.436
138.297
158.659
181.871

1.000
2.160
3.506
5.066
6.877
8.977
11.414
14.240
17.519
21.322
25.733
30.850
36.786
43.672
51.660
60.925
71.673
84.141
98.603
115.380
134.840
157.415
183.601
213.977
249.214

1.000
2.180
3.572
5.215
7.154
9.442
12.142
15.327
19.086
23.521
28.755
34.931
42.219
50.818
60.965
72.939
87.068
103.740
123.413
146.628
174.021
206.345
244.487
289.494
342.603

1.000
2.200
3.640
5.368
7.442
9.930
12.916
16.499
20.799
25.959
32.150
39.581
48.497
59.196
72.035
87.442
105.931
128.117
154.740
186.688
225.026
271.031
326.237
392.404
471.981

1014

LO 4

Effect of Discounting
Problem:

If you were to receive $1,000 three years from now, what


would be the present value of that amount if you were to
discount it at 10%?
Year

Beginning
amount

Discount
rate

Present
value

$1,000

0.75131

$751.3

P=F

(1 + i)n
P = $1,000

(1 + .10)3
F = $1,000

1
1.331

P = $1,000 x .75131

P = Present value
F = Sum to be received
i = Interest rate
n = Number of years

P = $751.31
Copyright 2014 Nelson Education Ltd.

1015

LO 4

Present Value of a Single SumTable B


Compounding Discounting
Single sum
A
B
Annuity
C
D
N9% 10% 11%
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

0.91743
.84168
.77218
.70843
.64993
.59627
.54703
.50187
.46043
.42241
.38753
.35553
.32618
.29925
.27454
.25187
.23107
.21199
.19449
.17843
.16370
.15018
.13778
.12640
.11597

Copyright 2014 Nelson Education Ltd.

0.90909
.82645
.75131
.68301
.62092
.56447
.51316
.46651
.42410
.38554
.35049
.31863
.28966
.26333
.23939
.21763
.19784
.17986
.16351
.14864
.13513
.12285
.11168
.10153
.09230

0.90090
.81162
.73119
.65873
.59345
.53464
.48166
.43393
.39092
.35218
.31728
.28584
.25751
.23199
.20900
.18829
.16963
.15202
.13768
.12403
.11174
.10067
.09069
.08170
.07361

12%
0.89286
.7971
.71178
.63552
.56743
.50663
.45235
.40388
.36061
.32197
.28748
.25667
.22917
.20462
.18270
.16312
.14564
.13004
.11611
.10367
.09256
.08264
.07379
.06588
.05882

13%14%
0.88496
.78315
.69305
.61332
.54276
.48032
.42506
.37616
.33288
.29459
.26070
.23071
.20416
.18068
.15989
.14150
.12522
.11081
.09806
.08678
.07680
.06796
.06014
.05322
.04710

0.87719
.76947
.67497
.59208
.51937
.45559
.39964
.35056
.30751
.26974
.23662
.20756
.18207
.15971
.14010
.12289
.10780
.09456
.08295
.07276
.06383
.05599
.04911
.04308
.03779
1016

15%

16%

0.86957
.75614
.65752
.57175
.49718
.43233
.37594
.32690
.28426
.24718
.21494
.18691
.16253
.14133
.12289
.10686
.09293
.08080
.07026
.06110
.05313
.04620
.04017
.03493
.03038

0.86207
.74316
.64066
.55229
.47611
.41044
.35383
.30503
.26295
.22668
.19542
.16846
.14523
.12520
.10793
.09304
.08021
.06914
.05961
.05139
.04430
.03819
.03292
.02838
.02447

LO 4

Present Value of an Annuity


Problem:

Year
1
2
3
4
5

B=

Suppose your company deposits $1,000 in your bank account


at the end of each year during the next five years, what is the
present value of that gift if the interest rate is 10%?
Beginning
amount
$1,000
$1,000
$1,000
$1,000
$1,000
$5,000

1- (1 + i)-n
i

W = $1,000 X 3.7908
F = $3,790.80
Copyright 2014 Nelson Education Ltd.

Interest
factors
0.9091
0.8264
0.7513
0.6830
0.6209

Present
value
$909
$826
$751
$683
$621
$3,790

B = Present value of annuity


R = Fixed annuity
i = Interest rate
n = Number of years
1017

LO 4

Present Value of an AnnuityTable D


Compounding Discounting
Single sum
A
B
Annuity
C
D
N9% 10% 11%
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

0.9174
1.7591
2.5313
3.2397
3.8896
4.4859
5.0329
5.5348
5.9852
6.4176
6.8052
7.1607
7.4869
7.7861
8.0607
8.3125
8.5436
8.7556
8.9501
9.1285
9.2922
9.4424
9.5802
9.7066
9.8226

Copyright 2014 Nelson Education Ltd.

0.9091
1.7355
2.4868
3.1699
3.7908
4.3553
4.8684
5.3349
5.7590
6.1446
6.4951
6.8137
7.1034
7.3667
7.6061
7.8237
8.0215
8.2014
8.3649
8.5136
8.6487
8.7715
8.8832
8.9847
9.0770

0.9009
1.7125
2.4437
3.1024
3.6959
4.2305
4.7122
5.1461
5.5370
5.8892
6.2065
6.4924
6.7499
6.9819
7.1909
7.3792
7.5488
7.7016
7.8393
7.9633
8.0751
8.1757
8.2664
8.3481
8.4217

12%
0.8929
1.6901
2.4018
3.0373
3.6048
4.1114
4.5638
4.9676
5.3282
5.6502
5.9377
6.1944
6.4235
6.6282
6.8109
6.9740
7.1196
7.2497
7.3658
7.4694
7.5620
7.6446
7.7184
7.7843
7.8431

13%

14%

15%

0.8772
1.6467
2.3216
2.9137
3.4331
3.8887
4.2883
4.6389
4.9464
5.2161
5.4527
5.6603
5.8424
6.0021
6.1422
6.2651
6.3729
6.4674
6.5504
6.6231
6.6870
6.7429
6.7921
6.8351
6.8729

0.8696
1.6257
2.2832
2.8550
3.3522
3.7845
4.1604
4.4873
4.7716
5.0188
5.2337
5.4206
5.5831
5.7245
5.8474
5.9542
6.0472
6.1280
6.1982
6.2593
6.3125
6.3587
6.3988
6.4338
6.4641

0.8850
1.6681
2.3612
2.9745
3.5172
3.9976
4.4226
4.7988
5.1317
5.4262
5.6869
5.9176
6.1218
6.3025
6.4624
6.6039
6.7291
6.8399
6.9380
7.0248
7.1016
7.1695
7.2297
7.2829
7.3300
1018

16%
0.8621
1.6052
2.2459
2.7982
3.2743
3.6847
4.0386
4.3436
4.6065
4.8332
5.0286
5.1971
5.3423
5.4675
5.5755
5.6685
5.7487
5.8178
5.8775
5.9288
5.9731
6.0113
6.0442
6.0726
6.0971

Using Interest Tables in Capital Budgeting


1.
2.
3.
4.

You invest $25,000 in an asset.


It generates $1,000 in savings each year.
The expected life of the asset is 25 years.
Your cost of capital is 10%.

1. Investment

-$ 25,000

LO 5

How much must you save each year if


you want to make 10% on your asset?

-$ 25,000

1. Investment

2. Annual savings: $1,000

2. Annual savings:2,754
+$_______

3. Total savings: $25,000


4. Present value of savings

3. Total savings:68,850
+$_______
4. Present value of savings

(_________
9.0770 X $_______)
1,000
Net present value

(_________
X $_______)
2,754
9.0770
Net present value

9,077
+$______
15,923
-$______

+$______
25,000
$______0

When the discount rate makes the


inflows (savings) equal to the outflow
(investment), it is called the_________.
IRR
In this case, the IRR is ______
10%. .
Copyright 2014 Nelson Education Ltd.

1019

An Example of a Capital Project

LO 5

But, if you want to make 16% on the $25,000 asset, how much must
your asset generate in savings or cash each year?

1. Investment

- $ 25,000

2. Annual savings:
$ _______
4,100
3. Total savings:
$________
102,500
4. Present value of savings
(________4,100
x $________ )
6.0971
Net present value

Here, the discount rate that makes


your savings equal to your investment
16. %
is__________

Therefore this is your_______.


IRR
25,000
+$________
0
+$________

The hurdle rate is . . .


10 %
_____

1.

The cost of capital

2.

Adjusted for the projects risk6 %


_____

3.

Hurdle rate

Copyright 2014 Nelson Education Ltd.

_____
16 %
1020

The Statement of Financial Position


Assets

$25,000

Loan

$25,000

2,754
4,100
Savings $ ________
Payments $ _________
16
Gives _________%
Per year

10
Costs __________%

Per year

The company earns


6
______%
or $ 1,346
_____
each year after
paying the loan.
Copyright 2014 Nelson Education Ltd.

1021

LO 5

LO 5

How to Use the Interest Tables

These two tables


are used in
capital budgeting

To compound

To discount

Single sum

Table A

Table B

Annuity

Table C

Table D

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