Learning Module

Would you prefer to

have $1 million now or
$1 million 10 years
from now?

Of course, we would
all prefer the money
now!
This illustrates that
there is an inherent

A dollar received today is worth more

than a dollar received tomorrow

This is because a dollar received today can

be invested to earn interest
The amount of interest earned depends on
the rate of return that can be earned on
the investment

Time value of money quantifies the

value of a dollar through time
3

Time Value of Money, or TVM, is a concept

that is used in all aspects of finance
including:

Bond valuation
Stock valuation
Accept/reject decisions for project management
Financial analysis of firms
And many others!

Common formulas that are used in TVM

calculations:*
Present value of a lump sum:
PV = CFt / (1+r)t OR PV = FVt / (1+r)t
Future value of a lump sum:
FVt = CF0 * (1+r)t OR FVt = PV * (1+r)t

Present value of a cash flow stream:

n

PV = [CFt / (1+r)t]
t=0

Future value of a cash flow stream:

n

FV = [CFt * (1+r)n-t]
t=0

Present value of an annuity:

PVA = PMT * {[1-(1+r)-t]/r}

Future value of an annuity:

FVAt = PMT * {[(1+r)t 1]/r}

* List adapted from the Prentice Hall Website

where

r = rate of return
t = time period
n = number of time periods
PMT = payment
CF = Cash flow (the subscripts t and 0 mean at
time t and at time zero, respectively)
PV = present value (PVA = present value of an
annuity)
FV = future value (FVA = future value of an
annuity)

There are many types of TVM calculations

The basic types will be covered in this review
module and include:

Present value of a lump sum

Future value of a lump sum
Present and future value of cash flow streams
Present and future value of annuities

Keep in mind that these forms can, should,

and will be used in combination to solve
more complex TVM problems
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The following are simple rules that you should always use
no matter what type of TVM problem you are trying to
solve:
1.
Stop and think: Make sure you understand what the
problem is asking. You will get the wrong answer if you
are answering the wrong question.
2.
Draw a representative timeline and label the cash
flows and time periods appropriately.
3.
Write out the complete formula using symbols first and
then substitute the actual numbers to solve.
4.
Check your answers using a calculator.
While these may seem like trivial and time consuming
tasks, they will significantly increase your understanding
of the material and your accuracy rate.
9

Present value calculations determine

what the value of a cash flow received in
the future would be worth today (time 0)
The process of finding a present value is
called discounting (hint: it gets
smaller)
The interest rate used to discount cash
flows is generally called the discount
rate
10

1.

How much would $100 received five years from now be

worth today if the current interest rate is 10%?
Draw a timeline

i = 10%

?
0

$100
3

The arrow represents the flow of money and the

numbers under the timeline represent the time period.
Note that time period zero is today.
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Write out the formula using symbols:

PV = CFt / (1+r)t
2.

Insert the appropriate numbers:

PV = 100 / (1 + .1)5
3.

Solve the formula:

PV = $62.09
5.
Check using a financial calculator:
FV = $100
n=5
PMT = 0
i = 10%
PV = ?
4.

12

You can think of future value as the

opposite of present value
Future value determines the amount
that a sum of money invested today
will grow to in a given period of time
The process of finding a future value is
called compounding (hint: it gets
larger)

13

1.

How much money will you have in 5 years if you invest

$100 today at a 10% rate of return?
Draw a timeline

i = 10%

$100
0

?
4

Write out the formula using symbols:

FVt = CF0 * (1+r)t
2.

14

Substitute the numbers into the formula:

FV = $100 * (1+.1)5
4.
Solve for the future value:
FV = $161.05
5.
Check answer using a financial calculator:
i = 10%
n=5
PV = $100
PMT = $0
FV = ?
3.

15

In both of the examples, note that if you were

to perform the opposite operation on the
answers (i.e., find the future value of $62.09 or
the present value of $161.05) you will end up
with your original investment of $100.
This illustrates how present value and future
value concepts are intertwined. In fact, they
are the same equation . . .

Take PV = FVt / (1+r)t and solve for FVt. You will get
FVt = PV * (1+r)t.

As you get more comfortable with the formulas

and calculations, you may be able to do the
calculations on your calculator alone. Be sure
you understand WHAT you are entering into
each register and WHY.
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A cash flow stream is a finite set of payments

that an investor will receive or invest over
time.
The PV of the cash flow stream is equal to
the sum of the present value of each of the
individual cash flows in the stream.
The PV of a cash flow stream can also be
found by taking the FV of the cash flow
stream and discounting the lump sum at the
appropriate discount rate for the appropriate
number of periods.

17

1.

Joe made an investment that will pay $100 the first year,
$300 the second year, $500 the third year and $1000 the
fourth year. If the interest rate is ten percent, what is the
present value of this cash flow stream?
Draw a timeline:

0
?
?
?
?

$100

$300

$500

$1000

4
i = 10%
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2.

Write out the formula using symbols:

n

PV = [CFt / (1+r)t]
t=0

OR
PV = [CF1/(1+r)1]+[CF2/(1+r)2]+[CF3/(1+r)3]+[CF4/(1+r)4]
Substitute the appropriate numbers:
PV = [100/(1+.1)1]+[$300/(1+.1)2]+[500/(1+.1)3]+[1000/(1.1)4]
3.

19

Solve for the present value:

PV = $90.91 + $247.93 + $375.66 + $683.01
PV = $1397.51
4.

Check using a calculator:

5.

Make sure to use the appropriate rate of return, number of

periods, and future value for each of the calculations. To
illustrate, for the first cash flow, you should enter FV=100, n=1,
i=10, PMT=0, PV=?. Note that you will have to do four separate
calculations.

20

The future value of a cash flow stream is

equal to the sum of the future values of the
individual cash flows.
The FV of a cash flow stream can also be
found by taking the PV of that same stream
and finding the FV of that lump sum using
the appropriate rate of return for the
appropriate number of periods.

21

1.

Assume Joe has the same cash flow stream from his
investment but wants to know what it will be worth at the
end of the fourth year
Draw a timeline:

0
i = 10%

$100

$300

$500

$1000

4
$1000
?
?
?
22

2.

Write out the formula using symbols

n

FV = [CFt * (1+r)n-t]
t=0

OR
FV = [CF1*(1+r)n-1]+[CF2*(1+r)n-2]+[CF3*(1+r)n-3]+[CF4*(1+r)n4]
Substitute the appropriate numbers:
FV = [$100*(1+.1)4-1]+[$300*(1+.1)4-2]+[$500*(1+.1)4-3] +
[$1000*(1+.1)4-4]
3.

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Solve for the Future Value:

FV = $133.10 + $363.00 + $550.00 + $1000
FV = $2046.10
4.

Check using the calculator:

5.

Make sure to use the appropriate interest rate, time period and
present value for each of the four cash flows. To illustrate, for
the first cash flow, you should enter PV=100, n=3, i=10, PMT=0,
FV=?. Note that you will have to do four separate calculations.

24

An annuity is a cash flow stream in which the

cash flows are all equal and occur at regular
intervals.
Note that annuities can be a fixed amount,
an amount that grows at a constant rate over
time, or an amount that grows at various
rates of growth over time. We will focus on
fixed amounts.

25

1.

Assume that Sally owns an investment that will

pay her $100 each year for 20 years. The current
interest rate is 15%. What is the PV of this annuity?
Draw a timeline
$100 $100

$100 $100 $100

0 1

3 . 19 20

?
i = 15%
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2.

Write out the formula using symbols:

PVA = PMT * {[1-(1+r)-t]/r}

3.

Substitute appropriate numbers:

PVA = $100 * {[1-(1+.15)-20]/.15}

4.

Solve for the PV

PVA = $100 * 6.2593

PVA = $625.93

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Check answer using a calculator

5.

Make sure that the calculator is set to one period per year
PMT = $100
n= 20
i = 15%
PV = ?
Note that you do not need to enter anything for future
value (or FV=0)

28

1.

Assume that Sally owns an investment that will

pay her $100 each year for 20 years. The current
interest rate is 15%. What is the FV of this annuity?
Draw a timeline

$100 $100

$100 $100 $100

0 1

3 . 19 20
?
i = 15%

29

Write out the formula using symbols:

FVAt = PMT * {[(1+r)t 1]/r}
3. Substitute the appropriate numbers:
FVA20 = $100 * {[(1+.15)20 1]/.15
2.

Solve for the FV:

FVA20 = $100 * 102.4436
FVA20 = $10,244.36
4.

30

Check using calculator:

5.

Make sure that the calculator is set to one period per year
PMT = $100
n = 20
i = 15%
FV = ?

31