Time Value of Money

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Puzzle

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 Why Its Really Happen?

Opportunity Cost:

The rate of return you could earn on an

alternative investment of similar
risk.

It is denoted by “i” or “r”

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What Makes Balance Between
Present Value & Future Value?

Present Interest Future

Rate Value
Value

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 Some Important terminology

i. Present Value Vs Future Value.

ii. Time Line.
iii. Compounding Vs Discounting.

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i. Present Value Vs Future Value
Present Value:
The value today of a future cash flow or
series of cash flows.

Future Value:
The amount to which a cash flow or series
of cash flows will grow over a given period
of time when compounded at a given rate.

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 ii. Time Line

It is a graphical representation used to

show the timing of cash flows.

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 iii. Compounding Vs Discounting
Compounding:
The arithmetic process of determining the
final value of a cash flow or series of cash
flows when compound interest is applied.

Discounting is the reverse of compounding.

Discounting:
The process of finding the present value of a
cash flow or a series of cash flows.

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 Interest Rate

Simple Vs Compound

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 Simple Vs Compound

Simple Interest:
Occurs when interest is not earned on
interest.

Compound Interest:
Occurs when interest is earned on prior
periods’ interest.
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Effect of Compounding Interest Rate

Effective annual rate,

EAR = EFF% = (1 + iNom/m)m  1

For Example:
Nominal Interest rate is 10% with
semiannual compounding. What will be the
EAR?

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Different Types of Cash Flows & Calculations

Type-1: Lump Sums.

Type-2: Even Cash Flows ( ordinary

annuity & annuity due)

Type-3: Uneven Cash Flows

Type-4: Perpetuity Cash Flows

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 Type-1: Lump Sums
For annual compounding use the formula to
find the future value of a single payment (lump
sum):

FVn = PV(1 + i)n.

When compounding occurs more frequently

than once a year, use this formula:

FVn = PV(1 + iNom/m)mn.

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 Type-1: Lump Sums

Example:
X invest 100 taka @ 10% interest rate,
what will be Future Value after 5 years, if
compounded annually & if Compounded
Semiannually?

Back to
Conditions
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 Type-2: Even Cash Flows ( ordinary
annuity & annuity due)

Defining FVAn as the Future Value of

Annuity of an ordinary annuity of n years,
and PMT as the periodic payment, we can
write
 (1  i )  1 n
FVA n  PMT  
 i 

For annuity due, you have to multiply (1+i)

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 Type-2: Even Cash Flows ( ordinary
annuity & annuity due)

Example: X makes a plan to deposit 100

taka each year for 5 years. What will be the
Future Value after 5 Years, If payment is
make at the end of the year & if at the
beginning of the year? Given: Interest rate is
10%. (for both, compounded annually &
semiannually)

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 Type-2: Even Cash Flows ( ordinary
annuity & annuity due)
• Defining PVAn as the Present Value of
Annuity of an ordinary annuity of n years,
and PMT as the periodic payment, we can
write
 1  (1  i )  n 
PVA n  PMT 
 

 i 

• For annuity due, you have to multiply (1+i)

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 Type-2: Even Cash Flows ( ordinary
annuity & annuity due)

Example: How much money X has to deposit

now to receive 100 taka each year for 5
years. If payment is make at the end of the
year & if at the beginning of the year? Given:
Interest rate is 10%. (for both, compounded
annually & semiannually)

Back to
Conditions
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 Type-3: Uneven Cash Flows

Example:
What is the present value & Future value
if x will get 100 taka, 200 taka, 300 taka
respectively for next 3 years & interest
rate is 10%?

Back to
Conditions

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Condition-4: Perpetuity Cash Flows

PV of a Perpetuity = PMT/I

Example:
If a security gives 25 taka for infinity time
period, what will be the present value?
Given, interest rate for this security is
2.5%.
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 Loan Amortization

A loan that is repaid in equal payments

over its life.

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 Loan Amortization
A homeowner borrows Tk 100,000 on a
mortgage loan, and the loan is to be repaid
in five equal payments at the end of each
of the next 5 years. Lender charges 6% on
the balance at the beginning of each year.
Prepare a loan amortization schedule.

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Year Beginning Payment Interest Repayment Ending Balance
1 Amount
100,000.00 23,739.64 6,000.00 of Principal
17,739.64 82,260.36

Any Query?

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Class Summary

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