Chapter 2 - Time Value of Money

Chapter 2 –Time value of money
Prepared by Mr Z Hoza CA(SA)

Learning outcomes
At the end of the chapter, you should be able :
• Understand the role of time value of money in fiancé and understand the concept of compound interest .
• Use formulae ,tables , financial calculators and spreadsheets to determine
-The future value of a single amount invested today
-The future value of an annuity
-The present value of a single future amount
-The present value of an annuity
-The present value of a perpetuity
-The present value of a growing perpetuity
-The present value of a cashflow growing at a constant rate over period of time
-The present value of uneven cash flow stream
• Define and calculate an annual effective rate
• Distinguish between nominal and real interest rates
• Apply time value of money principles to real world problems and valuation of bonds
• Establish factors that determine the term structure of interest rates .
What is a future value ?,what is Present value
?
FV: The amount of cash which will have accrued by a given date
resulting from earlier lump-sum or periodic investments. is the value in Rands
that an investment or series of investments will grow over a stated time period
at a specified interest rate.
PV: The value of an investment at the beginning of a period, sometimes

referred to as the principal sum.
r or i: The interest rate, expressed as a decimal fraction.
Pmt: The periodic investments or instalments made
n: The number of periods for which the investment is to receive interest.
future Value single lump sum
• An amount of R100 is invested for a one-year rate of 12% p.a. What
is the future value of the investment?
• FV = PV (1 + r)n
• = R100 (1.12)^1
• = R112`
Future value of lumpsum multiple periods
and non-annual compounding
An investor deposits R100 into an account which offers 12% p.a.
interest compounded monthly. What is the value of the investment at
the end of 10 years?
• Answer:
• FV = PV (1 + r/m)mn
• = R100 (1 + 0.12/12)12x10
• = R100 x 3.300
• = R 330
Present value single lumpsum
An investor wishes to invest a sum of money which will accumulate to
R310.58 in 10 years time. How much must be invested today, if a rate
of 12% p.a. is obtained?
PV = FV / (1+r)n
= 310.58 / (1.12)10
= 310.58 / 3.1058
= R100
Future value of annuity –ordinary
Investment opportunities are also available that require a series of
payments of a fixed amount for a specific number of periods ,these are
known as annuities .where installments(series of payments ) are made
at the end of the period be it monthly ,year or quaterly etc-this is
known as ordinary annuity ,we apply this unless otherwise stated .
Formular ordinary annuity
Using table B FVA=PMTXFVIFA

Future value of annuity –Due
Investment opportunities are also available that require a series of
payments of a fixed(equal) amount for a specific number of periods
,these are known as annuities .where installments(series of payments )
are made at the beginning of the period be it monthly ,year or quaterly
etc-this is known as annuity due .
Formula :
Use table B (add 1 period then subract on the factor )

FVA=PMTx(FVIFA -1)
Present value of ordinary annuity
Formula
Use table D PVA=PMT*PVIFA

Present Value of the annuity Due
Formula +1
USE Table D add 1 on the present value factor

PVAdue=PMTxPVIFA +1
Differed annuity
A deferred annuity –is an annuity which begins at some time in future
,this would occur if an investor wanted to invest a sum of money now
,but wanted the annuity to commence only at some future date
,example of deferred annuity is a pension plan .
Use table D
PVA=(PMT)*(PVIFAend year –PVIFAyear before start of annuity )
Perpetuities –Present value
There are cases of annuities which provides cash flows for an infinite
period ,such cash flows are called perpetuities .
PVA=PMT/r
Growing perpetuity
If a cash flow is growing at a constant rate ,this is called a growing
perpetuity ,this concept is very useful when valuing a company .
Cashflow growing at a constant rate over
period of time
Uneven streams of cash flows
Companies will often be required to evaluate investment projects
which result in uneven streams of future cashflows. What do we do to
calculate the present value in such cases?the annuity tables cannot be
used.Each cash flow must be separated and discounted separately
using table C or or PV formula of lumpsum .
Annual effective rate
The effective annual rate of interest is the annual rate that if compounded
once a year would give us the same result as the interest per period
compounded a number of times per year .This interest rate is calculated as
follows :
Rn =nominal rate ,m=times annually

It is useful to be able to convert a quoted or nominal interest rate into
effective interest rate for many reasons ,particularly in order to compare
investments with different compounding periods
Example Effective interest rate
Convert 12.% p.a compounded monthly to Annual effective rate
• Type 12(number of period0
• x, y
• 12
• 2nd function Eff
• Answer = 12,68%
This means 12% compounded monthly per year is equivalent to
12,68% interest compounded annualy .
Apply time value of money principles to real
world problems and valuation of bonds
The effects of inflation reduce the value of money over time ,whilst investing in a
bank account may offer an interest rate of 4,8% per year ,we need to consider the
impact that the inflation will have on the purchasing power of money .if the
expected inflation is 3% per year then you are not really making 4,8% .
Establish factors that determine the term
structure of interest rates
What is repo rate ?
The interest rate which represent the return required by the lender is
generally influenced by three main variables :
-The time value of money
-The risk of the capital not being repaid
-Inflation
Financial calculator
N=Number of period
I/YR =Interest rate as a percentage
(enter a number ,so if the rate is 10% ,enter 10 not 0,10)
PV=Present Value
PMT =annuity payment (enter zero when dealing with lumpsum only )
FV=Future Value
END
Thank you ..

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Chapter 2 –Time value of money

Prepared by Mr Z Hoza CA(SA)

PV: The value of an investment at the beginning of a period, sometimes

Formular ordinary annuity

Using table B FVA=PMTXFVIFA

Use table B (add 1 period then subract on the factor )

Use table D PVA=PMT*PVIFA

USE Table D add 1 on the present value factor

Rn =nominal rate ,m=times annually

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