TIME VALUE

OF MONEY
What is Time Value of Money?
• The concept that a sum of money is worth more now than the same
sum will be at a future date due to its earnings potential in the
interim.
• Also referred to as the Present Discounted Value
• The principle of TVM means that it can grow only through investing so
a delayed investment is a lost opportunity.
Annuity
❑ A series of equal payments at fixed intervals for a specified number
of periods.
❑Payment Interval: The time between successive payment of an
annuity. (Monthly, quarterly, semi-annually, and annually)
❑Terms of an annuity: The time from the beginning of the first
payment interval through the day of the last payment interval.
Types of Annuities
1. Annuity Certain
- An annuity whose term is fixed, when the term starts and ends
on definite dates. (E.g. Loans)
2. Contingent Annuity
- An annuity whose term depends upon some fortuitous or
uncertain events. (E.g. Life insurance premiums and pensions)
Classifications of Annuities
1. Ordinary Annuity
- An annuity whose payments are made at the end of each payment
interval.
2. Annuity Due
- An annuity whose payments are made at the beginning of each
payment interval.
3. Perpetuity
- An annuity whose payments begins on a fixed date and continues
forever. (Indefinitely)
Present Value
o The value of the annuity at the beginning of the first payment interval.
oThe value today of a future cash flow or series of cash flow.

Future Value
o The value of the annuity at the end of the last payment interval.
oThe amount to which a cash flow or series of cash flows will grow over a
given period of time when compounded at a given interest rate.
Future Value of an Ordinary Annuity
o The total value of all periodic payments due at the end of the term.
oThe sum of the accumulated payments at the end of term
Formula:

PMT
Where:
PMT = periodic payment
i = interest per conversion period or payment period
n = total number of payment period
Interest per conversion (i)
Formula: Where: r = annual rate
i=r÷m m = measurement

Total number of payment period (n)

Formula: Where: t = terms
i=t*m m = measurement

Measurement
Annually = 1
Semi-annually = 2
Quarterly = 4
Monthly =12
Future Value of an Ordinary Annuity
Example #1

Suppose P1,000 is invested at the end of each year for 3 years and that 9%
interest is paid compounded annually. How much will be the account after 3
years?

Solution:
PMT = P1,000; n = 3 years; i = 9%

FV = P1,000 [(1 + 0.09)^3 – 1 / 0.09)

FV = P,1000 (0.2950 / 0.09)
FV = P1,000 (3.2781)
FV = P3,278.10
Future Value of an Ordinary Annuity
Example #2
Every 3 months for 5 years, Crizel deposits P2,000 in JUAN Financing
Company. If the money earns 8% interest compounded quarterly, how much
will be in the fund after 5 years?
Solution.
PMT = P2,000; t = 5 years; r = 8% ; m = 4; i = 0.08/4=0.02; n=5*4=20
IN USING CALCULATOR
- To find the Future Value (FV) of ordinary annuity

STEP 1: 1 + interest (in decimal)

STEP 2: Multiply the STEP 1 to itself
STEP 3: Press “equals” / “=” based on the total number of periods minus 1
STEP 4: Minus 1
STEP 5: Divide it with the interest (in decimal)
STEP 6: Multiply the STEP 5 to payment
Present Value of an Ordinary Annuity
o The sum of the present values of the periodic payments, each discounted to
the time of present value

Formula:

-n
1 – (1 + i )
PV PMT
Where:
PMT = periodic payment
i = interest per conversion period or payment period
n = total number of payment period
Present Value of an Ordinary Annuity
Example #1
What sum would have to be invested today at 8% compounded annually to
provide an ordinary annuity of P2,000 per year for 4 years?

Solution:
PMT = 2,000; i = 8% t=4
Present Value of an Ordinary Annuity
Example #2
Tere Enterprise wishes wishes to have P3,000 each month for 2 years. Her
account earns 9% compounded monthly. What must be the initial savings in
her account to have the annuity for 2 years?

Solution:
PMT = P3,000; i = 9%; t = 2; m=12; n=24; i= 0.09/12 = 0.0075
IN USING CALCULATOR
- To find the Present Value (PV) of ordinary annuity

STEP 1: 1 + rate (in decimal)

STEP 2: Press “divide” / “÷” twice
STEP 3: Press “equals” / “=” based on the total number of periods
STEP 4: Minus 1
STEP 5: Divide with rate (in decimal)
Future Value of an Annuity Due
o The sum of all the accumulated amounts of payments at the end of the
term.

Formula:

-n

Where:
PMT = periodic payment
i = interest per conversion period or payment period
n = total number of payment period
Future Value of an Annuity Due
Example #1

The monthly rent of a commercial space is P10,000 payable in

advance. At 12% compounded monthly, what is the future value of
the yearly rental?

Solution:
PMT = P10,000; r = 12%; m = 12; t = 1; n=12; i = 0.12/12= 0.01
Future Value of an Annuity Due
Example #2

Jom Corporation set aside P80,000 at the beginning of each quarter

to create a fund for future expansion. If the fund earns 8% interest
compounded quarterly, how much will the fund be after 6 years?

Solution:
PMT = P80,000; r = 8%; m = 4; t = 6; n=24; i = 0.8/4= 0.02
IN USING CALCULATOR
- To find the Future Value (FV) of annuity due

STEP 1: 1 + interest (in decimal)

STEP 2: Multiply the STEP 1 to itself
STEP 3: Press “equals” / “=” based on the total number of periods minus 1
STEP 4: Minus 1
STEP 5: Divide it with the interest (in decimal)
STEP 6: Multiply with the product of payment and STEP 1
Present Value of an Annuity Due
o The sum of all the present values of the payments at the time of the first
payment.

Formula:

-n

Where:
PMT = periodic payment
i = interest per conversion period or payment period
n = total number of payment period
Present Value of an Annuity Due
Example #1
A machine is bought for P12,000 down and P4,200 installment paid
at the beginning of each quarter for 3 years. If interest is charged at
10% compounded quarterly, what is the cash price of the machine?

Solution:
PMT = P4,200; r = 10%; m = 4; t = 3; n=12; i = 0.10/4= 0.025
Present Value of an Annuity Due
Example #2

The monthly rent of a commercial space is P10,000 payable in

advance. At 12% compounded monthly, what is the future value of
the yearly rental?

Solution:
PMT = P10,000; r = 12%; m = 12; t = 1; n=12; i = 0.12/12= 0.01
IN USING CALCULATOR
- To find the Present Value (PV) of annuity due

STEP 1: 1 + rate (in decimal)

STEP 2: Press “divide” / “÷” twice
STEP 3: Press “equals” / “=” based on the total number of periods
STEP 4: Minus 1
STEP 5: Divide with rate (in decimal)
STEP 6: Multiply to STEP 1
Perpetuity
o An annuity whose payment begins on a fixed date and continues forever

-n

Where:
PMT = periodic payment
i = interest per conversion period or payment period
d = total deferred time
Present Value of Perpetuity
Example #1
The Ohwaysis Company Inc. is expected to pay P12.50 every quarter
indefinitely on a share of its preferred stocks. If money is worth 9.2%
compounded quarterly, how much should a shareholder be willing
to pay for a share of stock?

Solution:
PMT = P12.50; r = 9.2%; m = 4; i = 0.023
Perpetuity Due
Example #2
What is the present value of P4,500 perpetuity payable at the
beginning of each month if money is worth 12% compounded
monthly?

Solution:
PMT = P4,500; r = 12%; i = 0.12/12= 0.01
Deffered Perpetuity
Example #3
What is the present value of P2,400 perpetuity payable at the end of
each 6 months if the first payment begins at the end of 8 years,
money is worth 8% compounded semi-annually?

Solution:
PMT = P2,400; r = 8%; i = 0.08/2= 0.04; d = 8 x 2 – 1 = 15
Effective Annual Interest Rate (EAR)
o The rate of interest actually earned on an investment or paid on a loan as a result
of compounding the interest over a given period of time.
o Usually higher than the nominal rate and is used to compare different financial
products that calculate annual interest with different compounding periods
o Increasing the number of compounding periods makes the effective annual
interest rate increase as time goes by.

Formula:
Nominal interest rate n
[1+ No. of compounding periods ] -1
Effective Annual Interest Rate (EAR)
Example
Union Bank offers a nominal interest rate of 12% on its certificate of deposit to Mr.
Obama, a bank client. The client initially invested P1,000 and agreed to have the interest
compounded monthly for one full year.
Solution.
NIR = 12% or 0.12; t = 1year; m = 12; n=1*12=12

EAR =

EAR = [1 + 0.12/12] ^12 -1

EAR = [1.01] ^12 -1
EAR = 1.1268 – 1
EAR = 0.1268 or 12.68%
Amortization
o Sequence of equal periodic payments due at equal interval of time.
o Usually associated in the payment of debt which includes both Principal and
Interest
o Amortization is also the Payment “PMT”

Formulas:
Amortization (Ordinary Annuity)
Example #1
Mr. Ron borrows P300,000 from MQ Savings Bank for the renovation of
his office. The bank charges 6% interest compounded quarterly. He
repays the loan by regular payments at the end of every 3 months. If the
loan is to be paid in 4 years, how much is his quarterly payments?

Solution:
PVoa = P300,000; r = 6%; t=4; m=4; i=0.06/4=0.015 n=16
Amortization (Annuity Due)
Example #2
A mortgage of P500,000 is to be paid by monthly payments over a
period of 3 years. If the rate interest is 1% per month, how much is the
monthly payment if made at the beginning of each month?

Solution:
PVad = P500,000; r = 1%; t=3; m=12; n = 3 x 12 = 36
Amortization (Deferred Annuity)
Example #3
Ms. Cristy purchased a new car for P800,000 and made a 40% down
payment. The rest will be paid in a monthly installment for 3 years, the first
of will start at the end of 1 year. If money is worth 6% compounded
monthly, how much is the monthly installment?

Solution:
PVda=P800,000; r=6%; t=3; m=12; i=0.06/12=0.005; n=36; d=1x12–1=11
Amortization Schedule
o A table showing precisely how a loan will be repaid. It gives the required payment on each
payment date and a breakdown of the payment, showing how much is interest and how much is
repayment of principal. Furthermore, it shows the remaining liabilities or the outstanding principal
after each payment period.

Period Periodic Payment on Repayment on Outstanding Principal

Payment Interest Principal

Where:
Interest Payment = Outstanding Principal x Interest % per period
Repayment on Principal = Periodic Payment – Interest Payment
Outstanding Principal = Outstanding Principal – Repayment
Amortization Schedule
Example
Mr. Angelo bought a handy cam worth P36,999. The MIA Photo Shop
charges interest on installment payment at 10% compounded quarterly.
If the handy cam is to be paid in 2 years:
a) What must be the size of the quarterly payments?
b) Construct an amortization schedule.

Solution:
PVoa = P36,999; r = 10%; t=2; m=4; n = 2 x 4 = 8; i=0.10/4=0.025
THANK YOU!