TIME VALUE

OF MONEY
▪ Future Value (FV) ▪ FV/PV Factor (FVf / PVf):
▪ Present Value (PV) ✓ Lump Sum
▪ Cash Flow (CF) or Payment (PMT) ✓ Ordinary Annuity
▪ Number of periods (n) ✓ Annuity Due
▪ Interest Rate (i) / Growth Rate (g) [r] ✓ Uneven Cash Flows

Rannie O. Medina, CPA, MBA, CLSSYB

■ Show the timing of cash flows.

0 1 2 3
I%

CF0 CF1 CF2 CF3

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Simple Interest and Compounding Interest

■ Simple interest
– Interest earned during the first year = P30,000 x 12% = P3,600
– Interest earned during the second year = P30,000 x 12% = P3,600
– Interest earned during the third year = P30,000 x 12% = P3,600
– Total interest for the three-year period = P3,600 x 3 = P10,800
– Total money after three years = P30,000 + P10,800 = P40,800
– Total money after three years = P + Prt = P30,000 + (P30,000 x 12% x 3) = P40,800
■ Compounding interest
– Interest earned during the first year = P30,000 x 12% = P3,600
– Interest earned during the second year = P33,600 x 12% = P4,032
– Interest earned during the third year = P37,632 x 12% = P4,515.84
– Total interest for the three-year period = P3,600 + P4,032 + P4,515.84 = P12,147.84
– Total money after three years = P30,000 + P12,147.84 = P42,147.84
– Total money after three years = P x (1+r)^n = P30,000 x (1.12)^3 = P30,000 x 1.12 x 1.12 x 1.12 = P42,147.84
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Compounding and Discounting

■ Compounding
– Total money after three years
= P x (1+r)^n
= P30,000 x (1.12)^3
= P30,000 x 1.12 x 1.12 x 1.12
= P42,147.84
■ Discounting
– Amount to be invested today to get P42,147.84 in three years
= P42,147.84 ÷ 1.12 ÷ 1.12 ÷ 1.12
= P42,147.84 ÷ (1.12)^3
= P30,000
= P ÷ (1+r)^n
= P x (1+r)^–n
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Different Cash Flow Timings

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FUTURE VALUE

■ Future value (FV) is the value of a current asset at a future date based on an assumed
rate of growth (interest rate or growth rate).
■ It is important to investors and financial planners as they use it to estimate how much an
investment made today will be worth in the future.

FV = CF x FVf
■ FV Factor (FVf):
✓ Lump Sum (1+r)^n 1. x =( )
✓ Ordinary Annuity [(1+r)^n – 1] ÷ r 1. x =( ) – 1 ÷
✓ Annuity Due { [(1+r)^n – 1] ÷ r } x (1+r) 1. x =( ) – 1 ÷ x 1.
✓ Uneven Cash Flows (all uneven CF’s are treated as lump sums)

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FUTURE VALUE
– Lump Sum
Example:
Sue now has P100,000. How much would she have after 3 years if she leaves it invested at 8.5% with annual
compounding?

Solution:
FV = CF x FVf
FVf of lump sum = 1. x =( )
FVf of lump sum = 1. x =( )
FVf of lump sum = 1.277289125
FV = 1.2772… x 100,000
FV = 127,728.91

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FUTURE VALUE
– Lump Sum
Example:
Last year, XY Corporation's sales were P225 million. If sales grow at 6% per year, how large will they be 5 years later?

Solution:
FV = CF x FVf
FVf of lump sum = 1. x =( )
FVf of lump sum = 1. x =( )
FVf of lump sum = 1.3382255776
FV = 1.3382… x 225,000,000
FV = 301,100,754.96

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FUTURE VALUE
– Lump Sum
Example:
What’s the future value of P75,000 after 5 years if the appropriate interest rate is 6%, compounded semiannually?

Solution:
= 6% ÷ 2 = 3% = 5 x 2 = 10
FV = CF x FVf
FVf of lump sum = 1. x =( )
FVf of lump sum = 1. x =( )
FVf of lump sum = 1.34391637932…
FV = 1.3439… x 75,000
FV = 100,793.73

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FUTURE VALUE
– Lump Sum
Example:
What’s the future value of P75,000 after 5 years if the appropriate interest rate is 6%, compounded quarterly?

Solution:
= 6% ÷ 4 = 1.5% = 5 x 4 = 20
FV = CF x FVf
FVf of lump sum = 1. x =( )
FVf of lump sum = 1. x =( )
FVf of lump sum = 1.34685500644…
FV = 1.3468… x 75,000
FV = 101,014.13

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FUTURE VALUE
– Lump Sum
Example:
What’s the future value of P75,000 after 5 years if the appropriate interest rate is 6%, compounded monthly?

Solution:
= 6% ÷ 12 = 0.5% = 5 x 12 = 60
FV = CF x FVf
FVf of lump sum = 1. x =( )
FVf of lump sum = 1. x =( )
FVf of lump sum = 1.34885015223…
FV = 1.3488… x 75,000
FV = 101,163.76

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FUTURE VALUE
– Ordinary Annuity
Example:
You want to buy a new car 3 years from now, and you plan to save P420,000 per year, beginning one year from today. You will deposit
your savings in an account that pays 5.2% interest. How much will you have just after you make the 3rd deposit, 3 years from now?

Solution:
FV = CF x FVf
FVf of OA = 1. x =( ) – 1 ÷
FVf of OA = 1. x =( ) – 1 ÷
FVf of OA = 3.158704
FV = 3.1587… x 420,000
FV = 1,326,655.68

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FUTURE VALUE
– Annuity Due
Example:
You want to quit your job and go back to school for a law degree 4 years from now, and you plan to save P250,000 per year,
beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. Under these assumptions, how much will you
have 4 years from today?

Solution:
FV = CF x FVf
FVf of AD = 1. x =( ) – 1 ÷ x 1.
FVf of OA = 1. x =( ) – 1 ÷ x 1.
FVf of OA = 4.60342652097…
FV = 4.6034… x 250,000
FV = 1,150,856.63

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FUTURE VALUE
– Uneven Cash Flows
Example:
At a rate of 4%, what is the future value of the following cash flow stream?

Solution:
FV = CF x FVf
FVf of LS = 1. x =( )
FV of CF(0) = 1. x =( ) x 100 = 116.99
FV of CF(1) = 1. x =( ) x 150 = 168.73
FV of CF(2) = 1. x =( ) x 200 = 216.32
FV of CF(3) = 1. x =( ) x 250 = 260
FV of CF(4) = 1. x -50 = -50
FV = 116.99 + 168.73 + 216.32 + 260 + (-50)
FV = 712.04

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FUTURE VALUE

■ Future value (FV) is the value of a current asset at a future date based on an assumed
rate of growth (interest rate or growth rate).
■ It is important to investors and financial planners as they use it to estimate how much an
investment made today will be worth in the future.

FV = CF x FVf
■ FV Factor (FVf):
✓ Lump Sum (1+r)^n 1. x =( )
✓ Ordinary Annuity [(1+r)^n – 1] ÷ r 1. x =( ) – 1 ÷
✓ Annuity Due { [(1+r)^n – 1] ÷ r } x (1+r) 1. x =( ) – 1 ÷ x 1.
✓ Uneven Cash Flows (all uneven CF’s are treated as lump sums)

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PRESENT VALUE

■ Present value (PV) is the current value of a future sum of money or stream of cash flows
given a specified rate of return (interest rate or growth rate).
■ Future cash flows are discounted at the discount rate (interest rate or growth rate), and
the higher the discount rate, the lower the present value of the future cash flows

PV = CF x PVf
■ PV Factor (PVf):
✓ Lump Sum (1+r)^–n 1. ÷ =( )
✓ Ordinary Annuity [1 – (1+r)^–n] ÷ r 1. ÷ =( ) GT
✓ Annuity Due { [1 – (1+r)^–n] ÷ r } x (1+r) 1. ÷ =( ) GT x 1.
✓ Uneven Cash Flows (all uneven CF’s are treated as lump sums)

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PRESENT VALUE
– Lump Sum
Example:
Suppose an ABC Corporation bond will pay P120,000 ten years from now. If the going interest rate on safe
10-year bonds is 4.25%, how much is the bond worth today?

Solution:
PV = CF x PVf
PVf of lump sum = 1. ÷ =( )
FVf of lump sum = 1. ÷ =( )
FVf of lump sum = 0.65953730227…
PV = 0.6595… x 120,000
PV = 79,144.48

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PRESENT VALUE
– Lump Sum
Example:
What’s the present value of P200,000 discounted back 5 years if the appropriate interest rate is 4.5%, compounded semiannually?

Solution:
= 4.5% ÷ 2 = 2.25% = 5 x 2 = 10
PV = CF x PVf
PVf of lump sum = 1. ÷ =( )
FVf of lump sum = 1. ÷ =( )
FVf of lump sum = 0.8005101321
PV = 0.8005… x 200,000
PV = 160,102.03

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PRESENT VALUE
– Ordinary Annuity
Example:
You just inherited some money, and a broker offers to sell you an annuity that pays P250,000 at the end of each year for 5 years. You
could earn 5% on your money in other investments with equal risk. What is the most you should pay for the annuity?

Solution:
PV = CF x PVf
PVf of OA = 1. ÷ =( ) GT
PVf of OA = 1. ÷ =( ) GT
PVf of OA = 4.32947667058…
PV = 4.3294… x 250,000
PV = 1,082,369.17

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PRESENT VALUE
– Annuity Due
Example:
You have a chance to buy an annuity that pays P30,000 at the beginning of each year for 3 years. You could earn
5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity?

Solution:
PV = CF x PVf
PVf of AD = 1. ÷ =( ) GT x 1.
PVf of OA = 1. ÷ =( ) GT x 1.
PVf of OA = 2.84631971425…
PV = 2.8463… x 30,000
PV = 85,389.59

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PRESENT VALUE
– Uneven Cash Flows
Example:
At a rate of 4%, what is the present value of the following cash flow stream?

Solution:
PV = CF x PVf
PVf of LS = 1. ÷ =( )
PV of CF(0) = 1. x -100 = -100
PV of CF(1) = 1. ÷ =( ) x 150 = 144.23
PV of CF(2) = 1. ÷ =( ) x 200 = 184.91
PV of CF(3) = 1. ÷ =( ) x 250 = 222.25
PV of CF(4) = 1. ÷ =( ) x 50 = 42.74
PV = (-100) + 144.23 + 184.91 + 222.25 + 42.74
PV = 494.13

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PRESENT VALUE

■ Present value (PV) is the current value of a future sum of money or stream of cash flows
given a specified rate of return (interest rate or growth rate).
■ Future cash flows are discounted at the discount rate (interest rate or growth rate), and
the higher the discount rate, the lower the present value of the future cash flows

PV = CF x PVf
■ FV Factor (FVf):
✓ Lump Sum (1+r)^–n 1. ÷ =( )
✓ Ordinary Annuity [1 – (1+r)^–n] ÷ r 1. ÷ =( ) GT
✓ Annuity Due { [1 – (1+r)^–n] ÷ r } x (1+r) 1. ÷ =( ) GT x 1.
✓ Uneven Cash Flows (all uneven CF’s are treated as lump sums)

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PERPETUITIES

■ A perpetuity is a type of annuity that lasts forever, into perpetuity. The stream of cash
flows continues for an infinite amount of time.
■ In finance, a person uses the perpetuity calculation in valuation methodologies to find
the present value of a company's cash flows when discounted back at a certain rate.

PV = CF ÷ r
r = CF ÷ PV
CF = PV x r

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PERPETUITIES
– PV
Example:
What’s the present value of a perpetuity that pays P25,000 per year if the appropriate
interest rate is 5%?

Solution:
PV = CF ÷ r
PV = 25,000 ÷ 5%
PV = 500,000

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PERPETUITIES
–r
Example:
What’s the rate of return you would earn if you paid P95,000 for a perpetuity that pays P8,500 per
year?

Solution:
PV = CF ÷ r
r = CF ÷ PV
r = 8,500 ÷ 95,000
r = 8.95%

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PERPETUITIES
– CF
Example:
What annual payment must you receive in order to earn a 6.5% rate of return on a perpetuity
that has a cost of P125,000?

Solution:
PV = CF ÷ r
CF = PV x r
CF = 125,000 x 6.5%
CF = 8,125

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PERPETUITIES

■ A perpetuity is a type of annuity that lasts forever, into perpetuity. The stream of cash
flows continues for an infinite amount of time.
■ In finance, a person uses the perpetuity calculation in valuation methodologies to find
the present value of a company's cash flows when discounted back at a certain rate.

PV = CF ÷ r
r = CF ÷ PV
CF = PV x r

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