The Time Value

of Money
 The Time Value of Money
Means preference of having money now
than any future date.

If a Choice is given,between Tk10,000 now

or Tk 10,000 one year from now
Common sense tells us to take Tk 10,000
now than to take Tk 10,000 one year later
 Measurement of time value of
money
If you have got a choice of having money
now and money one year later.

Then you can have money now and put the

money in the bank and earn an interest.

Therefore rate of interest can be used to

express the time value of money
 Simple Interest
Simple interest rate is interest rate that is
paid only on the oiginal amount called
Pincipal.
Interest rate is a function of three Vaiables
the oiginal amount borrowed (lent)(,
interest rate per time peiod, and the number
of time peiods for which the oiginal amount
is borrowed (lent)
 Formula for calculating simple
rate of interest
S i = Po (r) (n)
where, S i = Simple interest
Po = Pincipal (oiginal amount
borrowed/lent)
r = rate of Interest per time period
n = Number of time periods for
which money is borrowed/lent
 Example
Deposit of Tk100 at 8% rate of interest for 10
years
Simple Interest Rate = Tk 100 x 0.08 x 10
= Tk 80

Future value FV = Original value + Int. earned

= Tk100 + Tk80 = Tk 180

FV = Po +Si = Po +Po (r) (n) = Po (1 + (r) (n))

 Illustration of Simple Interest Rate for Tk100 lent
out at 8% rate
Year Beginning Amount Int. earned during Ending Amount
(Tk) period (Tk) (Tk)
1 100 8 108
2 100 8 116
3 100 8 124
4
5 100 8 132
6
7
8
9
10 100 8 180

TOTAL 80
Proceeding in opposite direction,
we can know the present value
(PV) of a loan if future value is
FV and r is the rate of interest
and n is the number of years

PV = FV / (1 + ((r) (n))
 Compound Interest Rate
It means an interest charged on the interest,
besides interest on the principal amount.
In last example, Tk 80 was Si

In first year Si was Tk8, in second year also

Tk8 and so on for 10 years (Si= Tk8 x 10 =
Tk80, Here interest is not charged on
interest .)
 Compound Int. rate
In compounding, interest is charged on
interest.
Example : If Tk 100 is lent out for 5 years
at compound interest rate.
Future value at end of 1 years
FV1 = Po (1+ r)
Future value at end of 2 years
FV2 = FV1 (1+ r) = Po(1+ r) 2
 Compound Interest Rate
In general, Future value with compound
interest rate for n years is:

FVn = Po (1 +r) n
= Po x Interest Factor (at r rate of
interest for n years)
= Po x FVIF n,r
 Illustration of compound Interest Rate for Tk100 lent
out at 8% rate
Year Beginning Amount Int. earned during Ending Amount
(Tk) period (Tk) (Tk)
1 100 8 108
2 108 8.64 116.64
3 116.64 9.33 125.97
4 125.97 10.08 136.05
5 136.05 10.88 146.93
6 146.93 11.76 158.69
7 158.69 12.69 171.38
8 171.38 13.71 185.09
9 185.09 14.81 199.90
10 199.0 15.99 215.89
 Future Value Interest Factor (FVIF) of Tk1 at
1-15% at the end of n peiods
Period 1% 3% 5% 8% 10% 15%
(n)
1 1.010 1.030 1.050 1.080 1.100 1.150
2 1.020 1.061 1.102 1.166 1.210 1.322
3 1.031 1.093 1.158 1.260 1.331 1.321
4 1.041 1.126 1.216 1.360 1.464 1.749
5 1.051 1.159 1.276 1.469 1.611 2.011
6 1.062 1.194 1.340 1.587 1.722 2.313
7 1.072 1.230 1.407 1.714 1.949 2..660
8 1.083 1.267 1.477 1.851 2.144 3.059
9 1.094 1.305 1.551 1.999 2.358 3.518
10 1.105 1.344 1.629 2.159 2.594 4.046
25 1.282 2.094 3.386 6.848 10.855 32.919
50 1.645 4.383 11.467 46.902 117.391 1083.657
 The table is called Future Value Interest
Factor tables .

Table for example shows that Future value

Interest Factor at 8% interest rate for 9
years is nearly 2 (1.999)

This means that Tk 100 invested at 8%

interest for 9 years will double.

Similarly If Tk 100 is invested at 15% for 5

years will ...
 Graphical representation of
Future values
Future Value in Tk 15%
10%
300

250

200

150
5%
Tk100
5 10 Years
 Finding Present Value
The geneic formula can be used to find the Present
Value of some future payment.
Previously, we knew that:
FVn = Po (1+ r) n
Readjusting, we find that Po = FVn/ (1+r) n
Or Po = FVn [1/(1+r) n]
We note that [1/(1+r) n]is simply the reciprocal of
future value interest factor (FVIF) for n peiods.
 The reciprocal has its own name THE
PRESENT VALUE INTEREST FACTOR
(PVIF r,n)
Therefore rewiting Po =FVn (PVIF r,n)
 Example of finding Present
Values
For example, we may be interested in
knowing present value of Tk1000 at 8% i
10 years from now.
Present Value Interest Factor (PVIF) of Tk1 at
1-15% at the end of n peiods
Period 1% 3% 5% 8% 10% 15%
(n)
1 0.990 0.909 0.870
2 0.980 0.826 0.756
3 0.971 0.751 0.658
4 0.961 0.683 0.572
5 0.951 0.621 0.497
6 0..942 0.564 0.432
7 0.933 0.513 0.376
8 0.923 0.467 0.327
9 0.914 0.424 0.284
10 0.905 0.386 0.247
25
50
 PRESENT VALUE
The greater the interest
Tk100
rate lower the present
value

5%

10%
0 years No. of years 10 years
 Knowing interest Rate
Suppose we know future and present values
and we do not know r.
How to find rate of interest?
We know that FV = Po(FVIF)
Therefore FVIF =FV/Po ( a known value)
From the Future Value Interest Factor table,
we can find corresponding interest rate for 8
years. Example at what rate 1 ml Taka will
become 1.5 ml Taka if invested for 8 years
For Exactly Finding of Rate of Interest ( r ) and Number
of years
For finding r
We know that , FV =Po(1+r)n
Therefore (1+r) n = FV/Po
or (1+r) =(FV/Po) 1/n
or r =[(FV/Po) 1/n]-1
For finding n
log (1+r) n = log (FV/Po)
or n log (1+ r) = log (FV/Po)
or n = log (FV/Po) / log (1+ r)
 ANNUITY
Annuity is a seies of equal payments or receipts
occuring over a specified number of peiods.

Suppose you receive Tk1000 every year for 3

years. And we assume Tk1000 drawn every year
on savings account earning 8% annually.

How much money you will earn in 3 years.

 Cont.Annuity
If FVAn is future value of the annuity after n years,
then:
FVAn = R (1+r) n -1+ R(1+r) n-2+ R(1+r) 0
= R [(FVIFr,n-1) + (FVIFri,n-2)+ (FVIFr,0)]

We find that FVAn is simply equal to periodic fixed receipts times the
sum of future value interest factors at r% rate of interest for periods
n-1 to 0.

We also note that FVIFr,0 = 1

Fv = Po (1 +r) 0, anything to power zero is 1
Therefore Annuity (3 year) = add ( FVIF 2 + FVIF1 +1.00)
The underlined amount is usually given in a table shown in next slide.
 FVIFA n,i table.

Peiod (n) 1% 3% 5% 8% 10% 15%

1 1.010 1.000 1.000

2 2.010 2.050 2.150
3 3.030 3.153 3.473
4 4.060 4.310 4.993
5 5.101 5.526 6.742
6 6.152 6.802 8.754
7 7.214 8.142 11.067
8 8.286 9.549 13.727
9 9.369 11.027 16.786
10 10.462 12.578 20.304
 Finding present value of an annuity
1. Suppose you receive Tk1000 for each of the
following 3 years and you invest the money in
15% rate of interest, what is the present value of
the money received in 3 years?

2. PVA n,I = R /(1+ r) + R /(1+r) 2+

R /(1+r) 3 + R /(1+r) n
= R(PVIF r,1+PVIFr,2
++PVIFr,n)
1. Present Value (3 year ) = PVIF 3yr +PVIF 2 yr +
PVIF I year
Finding present value of an Annuity:
The ight hand of previous slide called PVIFA s presented in a
table below
Peiod 1% 3% 5% 8% 10% 15%
1 0.990 0.909
2 1.970 1.736
3 2.941 2.487
4 3.902 3.170
5 4.853 3.791
6 5.795 4.355
7 6.728 4.868
8 7.652 5.335
9 8.566 5.759
10 9.471 6.145
 Perpetuity
Perpetuity is an annuity whose payments or receipts
continue for ever e.g., infinity.
We know that PVA n,r =1 / (1 +r) n
by mathematical derivation
=( 1 [1 / (1 +r) n] ) / r

= R [1 (1/ (1 + r) n )]/ r
Now as n tends to infinity, the underlined portion of
above equation becomes zero
Therefore PVA n,r = R(1 0)/r
Or PVA n,r = r
 Home assignment no.2/2
deliverable within 2 weeks
1. Suppose you invest Tk25,000 today and receive Tk 75,000 in 10
years. What is the interest rate received by you?

2. How long it will take for Tk20,000 to grow to Tk 38,000 at a i of

3%?

3. Suppose you receive Tk4500 for 5 years and you invest these
yearly earnings in bonds giving 15% rate of interest. How much
money you will receive at the end of 5 years?

4. Suppose you receive Tk 11,000 for each of the following 9 years

and you invest the money in 15% rate of interest, what is the
present value of the money received?
5. Suppose a perpetuity of Tk 100,000 gives a fixed annual payment
of Tk2000 for infinity. What is the interest rate?
The End