Introduction

All dollars are not created equal refers to the time

value of money.
The time value of money concept recognizes that
(i) money received at some point in the future is not
as valuable as money received today. A dollar
received today can be invested to earn interest and
thus will grow to a larger amount.
(ii)money paid at some point in the future is not as
valuable as money paid today.On the other hand,
money paid out at a later date is more desirable
than paying it now.
There is an opportunity cost to waiting for money.
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 Introduction
Time value of money techniques facilitate planning
for future events.
Individuals desire to invest for many financial goals
such as retirement, childrens education, etc.
The expenditures associated with these goals will
occur in the future and will be impacted by
inflation.
The amount invested will be impacted by the state
of the economy, income, investment choices, etc.
Using time value of money techniques, we will be
able to estimate our future funds needs.
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 Chapter Objectives
1. To gain a general understanding that monies received or
paid out at different times have different values and that
these values can change dramatically depending on
interest rate levels and when they are received or paid
2. To understand the process of compounding and to be
able to compute a future value of a single payment or
annuity
3. To understand the process of discounting and to be
able to compute the present value of a single payment
or annuity

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 Chapter Objectives
1. To be able to find approximate values for unknown
interest rates or unknown holding periods when the
values for other financial variables are known
2. To recognize the importance of planning in the effort
to achieve future goals
3. To be able to compute a required annual savings
amount to meet future goals
4. To be able to construct a savings plan designed to
show how savings will grow over time and be used to
meet future goals

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 Topic Outline

Compounding (Finding Future Values)

Discounting (Finding Present Values)

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 Compounding (Finding Future Values)
Compounding refers to the process of
accumulating value over time. Investing money to
earn interest will facilitate the growth of our
investment.
A single amount (or payment) can accumulate
value over time.
A series of equal payments (annuity) can
accumulate value over time.
The amount an investment grows to is called the
future value. It includes both the amount invested as
well as the interest earned.
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Suppose you invest $1,000 today, hold the investment
for 3 years, and earn 8% each year. How much will
you accumulate at the end of 3 years (the future
value)?
 Compounding Example:
Suppose you invest $1,000 today, hold the investment for
3 years, and earn 8% each year. How much will you
accumulate at the end of 3 years (the future value)?
__________________________________________
Year Beginning-of- Interest End-of-Year
Year Amount Earned Amount
1 $1,000 $80 $1,080
2 1,080 86.40 1,166.40
3 1,166.40 93.31 Answer :

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 Future Value Calculations
Future value calculations can be done with any of the following:
A financial calculator
The financial functions in Excel
Financial calculators on the Internet
Use of financial formulas and a calculator
Use of financial tables
To facilitate calculations, tables have been created that assume
an initial investment of $1. These tables then specify various
time periods and interest rates. Detailed tables appear in the
appendix of many financial textbooks.

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Future Value Table Sample - Assumes
an Initial Investment of $1

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 Future Value Example: Use FV Table
The previous future value table can be used to find the
FV of any amount.
Simply multiply the investment by the number from the
table.

Example 1: What is the future value of $500 invested at

6% for 10 years?

Example 2: What is the future value of $4,000 invested

at 8% for 30 years?

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 The Rule of 72
A technique that is quite popular in estimating the time
that it takes for an investment to double is called the
rule of 72.
If we know the interest rate for an investment, we can
use the rule of 72 to estimate how long it will take for
the money to double.
Doubling Time (DT) = 72/interest rate

Example: if the interest rate percent is 12, how long

will it take to double in value?

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 What is an Annuity?
An annuity is simply a series of equal payments.
Examples of annuities can be found everywhere: rent
payments, mortgage payments, car payments, etc.
From an investment perspective, bonds will often
involve interest payments that are annuities.
There are two types of annuities:
An ordinary annuity (OA) assumes the payments occur at the
end of the period. Most future-value-of-$1-annuity tables
show ordinary annuities.
An annuity due (AD) assumes the payments occur at the
beginning of the period.

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 Example: FV of an Ordinary Annuity
Assume an investment of $3,500 is made at the end of
each of the next 3 years and earns 6%. What is the
future value of this investment at the end of year 3?
__________________________________________
First investment of $3,500 earns interest for 2 years.
(Remember that an ordinary annuity assumes payments
are made at the end of the year.)
Second investment of $3,500 earns interest for 1 year.
Third investment of $3,500 earns no interest.

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 Example: FV of an Ordinary Annuity
The following is a timeline showing the investments at each point in time.
We want to find the future value at year 3.

Now 1 2 3

$3,500 $3,500 $3,50

0
- First payment: $3,500 (1.06) (1.06) = $3,932.60
- Second payment: $3,500 (1.06) = $3,710
- Third payment: $3,500 (1.00) = $3,500
- Total value (FV): $3,932.60 + $3,710 + $3,500 = _______

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Future Value Table Sample - Assumes
Equal Periodic Investments of $1

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 Example: FV of an Annuity Due
Assume an investment of $3,500 is made at the
Begining of each of the next 3 years and earns 6%.
What is the future value of this investment at the end of
year 3?
__________________________________________
First investment of $3,500 earns interest for 3 years.
Second investment of $3,500 earns interest for 2 years.
Third investment of $3,500 earns interest for 1 year.

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 Example: FV of an Ordinary Annuity
The following is a timeline showing the investments at each point in time.
We want to find the future value at year 3.

Now 1 2 3

$3,500 $3,500 $3,500

- First payment: $3,500 (1.06) (1.06) x (1.06) = $4,168.56

- Second payment: $3,500 (1.06) x (1.06) = $3,932.60
- Third payment: $3,500 (1.06) = $3,710
- Total value (FV): $4,168.56+$3,932.60 + $3,710 = __________

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 Discounting (Finding Present Values)
In compounding, we find future values given an
investment amount. In discounting, we find present
value and this is useful in setting financial goals

In discounting, we find the present value of:

A single payment
An annuity (ordinary and due)

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Present Value Table Sample - Assumes a
Future Value of $1

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Present Value Graph

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 Example: Finding Present Values Single
Payment
The easiest method is to use the PV tables.

Example: What is the present value of $1,500 to be

received at the end of 10 years assuming an 8% discount
rate?

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Present Value Table Sample - Assumes
Equal Periodic Investments of $1

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 Example: Finding Present Values of an
Annuity
Once again, we will use the PV table.
Example: 1) What is the present value of $500 to be
received at the end of each of the next 20 years,
assuming a 10% interest rate (ordinary annuity)?

Example 2) If payments were made at the beginning of

the period (annuity due):

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 More Applications of Future and
Present Values
For all the problems we solved, we assumed an
interest rate and a number of periods.
It is possible to find either the interest rate or the
number of periods if both the present and future
values are known.
If we express the relationships between PV and
FV:
FV = PV x FVIF n, i

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 More Applications of Future and
Present Values (Example)
If we want $100,000 in 30 years but we only have
$10,000 to invest now, what interest rate would we
need to earn to make this goal possible?

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 Conclusion
The time value of money has several practical
applications:
Used to determine future amounts
Used to determine present amounts
Applies to interest rates, inflation rates, investment
rates, compounding of money, etc.
Compound interest is the 8th wonder of the world.
(Albert Einstein)

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Tutorial : Time Value of Money
1) If you deposit RM10,000 in a bank account that pays 10% interest
annually, how much would be in your account after 5 years?

2) What is the present value of a security that will pay RM5,000 in 20 years
if securities of equal risk pays 7% annually?

3)How much would you need to invest now to earn $2,000 after 4 years at a
compound interest rate of 8% a year?

4) What is the present value of $5,000 receivables at the end of year 3 at a

cost of capital of 7% per annum?
5) You just put $1,000 in a bank account which pays 6 percent nominal
annual interest. How much will you have in your account after 3 years?

6) What is the value of RM10,000 deposited into a bank at a 5% simple

interest at the end of five years?

7) Catherine decided to buy a photocopy machine that is projected to yield

cash savings of RM2,000 per year over a 20 years period. Using a 15%
discount rate, calculate the present value of the savings. (Assume that
the cash savings occur at the end of the year).
8) Anthony borrows RM35,000 from the bank at 12% compounded
annually to purchase a new machine. The loan is to be repaid in equal
annual installments at the end of each year over the next five years. How
much will each annual payment be?

9) Jenifer is planning ahead for her sons education. Her son will start his
tertiary education in 20 years time. How much must she set aside now to
have RM100,000 when her son starts schooling. Assume that the interest
rate is 8% compounded annually.

10) If you have deposited RM500 at the end of each year in a bank account
that pays 20% interest rate. How much will you have in your account
after 10 years?
11) Janet is planning for her retirement. She is 30 years old today and would
like to have $800,000 when she turns 55. She estimates that she will be
able to earn a 9% rate of return on her retirement investment over time;
she wants to set aside a constant amount of money every year (at the
end of the year) to help achieve her objective. How much money must
she invest at the end of each of the next 25 years to realize her goal of
$800,000 at the end of that time?

12) Mathew wishes to have RM200,000 in his account 20 years from now.
If he can earn an interest of 10% on his investment, how much must
Mathew deposit today?

13) If the average new home costs RM125,000 today, how much will it cost
in 10 years if the price increase by 5% each year?