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Time Value of Money

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.
Present Value of a Single Amount (PV of 1)
Present Value Factor Computation
Ordinary Calculator Scientific Calculator
Enter 1+r (1+r)^-n
Press division sign twice
Press equal sign for number of
periods

Sample Problem 1: Pam wishes to find the present value of P1,700 that
she will receive 8 years from now. Pam’s opportunity cost is 8%. Hint: You
should find the present value to be P918.46
Future Value of a Single Amount (FV of 1)
Future Value Factor Computation
Ordinary Calculator Scientific Calculator
Enter 1+r (1+r)^n
Press multiplication sign twice
Press equal sign for number of
periods minus 1
Sample Problem 2.1: If Fred Moreno places P100 in a savings account
paying 8% interest compounded annually, how much will he have at the
end of year 2? Hint: P108 future value for year 1 and P116.64 for year 2.
Sample Problem 2.2: Jane Farber places P800 in a savings account paying 6% interest
compounded annually. She wants to know how much money will be in the account at the end of 5
years. Hint: The future value of Jane’s savings is P1,070.58.
Present Value of a Ordinary Annuity(PV of OA)
Present Value Factor Computation
Ordinary Calculator Scientific Calculator
Enter 1+r 1-(1+r)^-n
Press division sign twice r

Press equal sign for number of periods

Minus 1
Divide it by rate

Sample Problem 3: Braden Company, a small producer of plastic toys, wants to determine the
most it should pay to purchase a particular ordinary annuity. The annuity consists of P700 at the
end of each year for 5 years. The firm requires the annuity to provide a minimum return of 8%. Hint:
The present value should be P2,794.90
Future Value of Ordinary Annuity (FV of OA)
Future Value Factor Computation
Ordinary Calculator Scientific Calculator
Enter 1+r (1+r)^n-1
Press multiplication sign twice r
Press equal sign for number of
periods minus 1
Divide it by rate

Sample Problem 4: Fran Abrams wishes to determine how much money she will have
at the end of 5 years if she chooses annuity A, the ordinary annuity. She will deposit
P1,000 annually, at the end of each of the next 5 years, into a savings account paying
7% annual interest. Hint: The future value of the ordinary annuity equals P5,750.74.
Present Value of Annuity Due(PV of Annuity in Advance)
Present Value Factor Computation
Ordinary Calculator Scientific Calculator
Enter 1+r 1-(1+r)^-n
Press division sign twice r

Press equal sign for number of periods *(1+r)


minus 1
Minus 1
Divide it by rate
Plus 1

Sample Problem 5: In sample problem 3 of Braden Company, we found the present value of Braden’s P700, 5-
year ordinary annuity discounted at 8% to be P2,794.90. If we now assume that Braden’s P700 annual cash flow
occurs at the start of each year and is thereby an annuity due, what is its present value? Hint: You will find the
annuity in advance to be P3,018.49.
Future Value of Annuity Due (FV of Annuity in Advance)
Future Value Factor Computation
Ordinary Calculator Scientific Calculator
Enter 1+r (1+r)^n-1
r
Press multiplication sign twice
Press equal sign for number of periods *(1+r)

Minus 1

Divide it by rate

Minus 1

Sample Problem 6: Fran Abrams wishes to determine how much money she will have at the end of 5 years if she chooses annuity
B, the annuity due. She will deposit P1,000 annually, at the beginning of each of the next 5 years, into a savings account paying 7%
annual interest. Hint: The future value of the annuity due equals P6,153.29.
Perpetuities
Perpetuity is an annuity with an infinite life, in
other words an annuity that never stops
providing its holder with a cash flow at the end
of each year.
PV of a perpetuity= PMT
I
Sample Problem 7: A preferred stock was bought in a company that pays a fixed dividend of P2,500 each year
the company is in business. If the company goes on indefinitely, the preferred stock can be valued as perpetuity.
The company has a 10% interest rate.
Hint: PV of perpetuity= P25,000.
Mixed stream
Sample Problem 8: What is the PV of a 5-year
ordinary annuity of P1,000 plus an additional
P5,000 at the end of year 5 if the interest rate
is 6%? Answer: P7948.65
Mixed stream
Sample Problem 9: What is the PV of the
following uneven cash flow stream: P1,000 in
Year 1, P2,000 in Year 2, P0 in Year 3, and
P4,000 in Year 4 if the interest rate is 8%?
Answer: P5,580.72
Compounding Periods
Annual compounding is the arithmetic process of
determining the final value of cash flow or series
of cash flows when interest is added once a year.
(Same computation as future value of 1)

Sample Problem 10: Assume that P1,000 is


deposited in account that pays 5% for 10 years.
Compounded value is P1,628.89.
Compounding Periods
Semi-annual compounding is the arithmetic process of
determining the final value of cash flow or series of cash
flows when interest is added twice a year.

Sample Problem 10: What is the future value of P1,000


after three (3) years if the appropriate interest rate is 8%
(1)compounded annually? (2)If compounded monthly?
Answers: (1)P1,259.71 and (2)P1,271.75
Comparing interest rate
Nominal (stated) annual rate is the contractual
annual rate of interest charged by a lender or
promised by a borrower.
r = m × [ ( 1 + i)1/m - 1 ]
i=the effective rate
r=the stated rate
m=the number of compounding periods
Comparing interest rate
Effective (true) annual interest rate is the
interest rate that is actually earned or paid.
EAR=[1+(i/n)]^n-1

i=nominal interest rate


n=number of periods
Amortized Loans
Sample Problem 11: Say you borrow P6,000 at 10 percent
and agree to make equal annual end-year payments over
4 years. Prepare a loan amortization schedule.

1 2 3 4 5
Year Beg. Amount Payment Interest Principal (2-3) End. Balance
(%*1) (1-4)
1 P6,000 P1,892.82 P600 P1,292.82 P4,707.18
2 4,707.18 1,892.82 470.72 1,422.10 3,285.08
3 3,285.08 1,892.82 328.51 1,564.31 1,721.77
4 1,720.77 1,892.82 172.08 1,720.74 ---

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