Time Value

of Money
Pages 209 - 210

Prepared by:
John Kenneth S. Villarama
Arwin Ferrer
 CHAPTER 4 CASE: Finding Jill Moran’s
Retirement Annuity
Sunrise Industries wishes to accumulate funds to
provide a retirement annuity for its vice president of
research, Jill Moran. Ms. Moran by contract will retire at the
end of exactly 12 years. Upon retirement, she is entitled to
receive an annual end-of-year payment of $42,000 for
exactly 20 years. If she dies prior to the end of the 20-year
period, the annual payments will pass to her heirs.
During the 12-year “accumulation period” Sunrise wishes
to fund the annuity by making equal annual end-of-year
deposits into an account earning 9% interest. Once the 20-
year “distribution period” begins, Sunrise plans to move
the accumulated monies into an account earning a
guaranteed 12% per year. At the end of the distribution
period, the account balance will equal zero. Note that the
first deposit will be made at the end of year 1 and that the
first distribution payment will be received at the end of
year 13.
REQUIRED:
A. Draw a time line depicting all of the cash
flows associated with Sunrise’s view of the
retirement annuity.

B. How large a sum must Sunrise accumulate

by the end of year 12 to provide the 20-
year, $42,000 annuity?
C. How large must Sunrise’s equal annual end-
of-year deposits into the account be over the
12-year accumulation period to fund fully
Ms. Moran’s retirement annuity?

D. How much would Sunrise have to deposit

annually during the accumulation period if
it could earn 10% rather than 9% during the
accumulation period?
E. How much would Sunrise have to
deposit annually during the
accumulation period if Ms. Moran’s
retirement annuity were a perpetuity
and all other terms were the same as
initially described?
 Time Value of Money
• The time value of money (TVM) is the
concept that money available at the
present time is worth more than the
identical sum in the future due to its
potential earning capacity.
 2 Views of Time Value of Money
 Present Value (PV)
-The current monetary value of a future amount—the
amount of
money that would have to be invested today at a given
interest rate over a specified period to equal the
future amount.

 Future value (FV)

-The value of a present amount at a future date, found
by applying compound interest over a
specified period of time
 TIMELINE
• A horizontal line on which time
zero appears at the leftmost end
and future periods are marked
from left to right; can be used to
depict investment cash flows.
 Annuity
• a fixed sum of money paid to
someone each year, typically
for the rest of their life.
 2 Basic Type of Annuity
Ordinary annuity - an annuity for which the
cash flow occurs at the end of each period.

Annuity due - an annuity for which the cash

flow occurs at the beginning of each period.
 Future Value of Ordinary Annuity
• FVA = P X {[(1+i)^n]-1 / i}
-P= principal amount
-i= interest rate
-n= number of period/s
 Present Value of Ordinary Annuity
• PVA = P X {[1 - (1+i)^-n] /i}
P= principal amount
i= interest rate
n= number of period/s
 PERPETUITY
• An annuity with an infinite life, providing
continual annual cash flow

Formula:
PV= P X [1/i]
P= principal amount
i= interest rate
 Answer
A.
B.
Total amount to accumulate by end of year 12
• PVA = P X {[1 - (1+i)^-n] /i}
– P= $42,000
– i = 12%
– n =20
PVA = 42,000 X {[1 - (1+.12)^-20] /.12}
=42,000 X 7.469
=$ 313,698
C.
• End-of-year deposits, 9% interest:
• P= PVA / FVIFA
-P = $313,698 ÷ {[(1+.09)^12]-1 / .09}
-P = $313,698 ÷ 20.141
-P= $15,575

Sunrise Industries must make a $15,575.31 annual end-

of-year deposit in years 1-12 in order to provide Ms.
Moran a retirement annuity of $42,000 per year in
years 13 to 32.
D.

End-of-year deposits, 10% interest

P= PVA / FVIFA
P = $313,698 ÷ {[(1+.10)^12]-1 / .10}
P = $313,698 ÷ 21.384
P = $14,670

The corporation must make a $14,669.56 annual end-

of-year deposit in years 1-12 in order to provide Ms.
Moran a retirement annuity of $42,000 per year in
years 13 to 32.
E.
Initial deposit if annuity is a perpetuity and initial deposit earns
9%:
PVP = P x (1 ÷ i)
PVP = $42,000 x (1 ÷ .12)
PVP= $42,000 x 8.333
PVP= $349,986

End-of-year deposit:
PMT = PVP ÷ (FVIFA)
PMT = $349,986 ÷ {[(1+.09)^12]-1 / .09}
PMT = $349,986 ÷ 20.141
PMT = 17,377
THANK YOUUU!!!