Scribd
Upload
82 views

Chapter Four

The document discusses the time value of money concept. It states that the value of money decreases over time, so receiving money now is preferable to receiving it in the future. It also describes two common time value of money techniques: compounding, which calculates future values, and discounting, which calculates present values. Various time value of money formulas are provided to calculate future value, present value, interest rates, and number of periods. Several examples demonstrate how to apply these formulas to financial problems.

Uploaded by

Rawan Yasser
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
82 views

Chapter Four

The document discusses the time value of money concept. It states that the value of money decreases over time, so receiving money now is preferable to receiving it in the future. It also describes two common time value of money techniques: compounding, which calculates future values, and discounting, which calculates present values. Various time value of money formulas are provided to calculate future value, present value, interest rates, and number of periods. Several examples demonstrate how to apply these formulas to financial problems.

Uploaded by

Rawan Yasser
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 14

TIME VALUE OF MONEY

o Time value of money means that the value of money is different in different time periods.
o The value of money received today is more than the value of the same amount received at
some other time in future.
o The difference in the value of money today and tomorrow is referred as time value of
money

o Therefore, given a choice of receiving a sum of money today or in the future, a rational
person will always choose to receive the money now as it has more value today than in the
future.
TECHNIQUES TIME VALUE OF MONEY

The two most common methods of adjusting cash flows for a time value of money :

Compounding the process of calculating the future values of cash flows.

Discounting the process of calculating the present values of a cash flows.


FUTURE VALUE & PRESENT VALUE

  Future value =

  Present value =

 
PV : present value : Future value factor
FV : Future Value : present value factor
r: interest rate or Discount rate
t: period number

 
r=  
t = ln(FV / PV ) ln (1+ r )
Interest are two types :

Simple Interest Compounded interest


Interest on Principle only Interest on principle and interest previously
Interest on Principle only Interest
earned on principle and interest previously
earned
Ex: Ex:
Ex:
What is the simple interest and the total Suppose you have a $100,000 today and you
What
amountisreceived
the simple interest
of  8,000 and the
for 4 years total deposit it with a financial institution, which
at 12%?
amount received of  8,000 for 4 years at 12%? pays 8% compound interest for a period of
Answer : 5-years. how much deposit would you grow ?
Answer :
Interest per year :
Interest per year
8,000 * 12% : / Year
= $960 Answer :
8,000 * 12% = $960 / Year
Total interest: Future value =
Total
$ 960 interest:
* 4 years = $ 3,840 FV = = $ 146,932.8
$ 960 value
Total * 4 years = $ 3,840
received at end of 4 years :
Total
8,000 value
+ 3,840received at end of 4 years :
= $ 11,840
8,000 + 3,840 = $ 11,840
 When interest is payable semi-annually ( half yearly )
You have to adjust
R/2
T*2
 Compounded quarterly ( each three months )
R/4
T*4
 Compounded monthly
R / 12 interest per month
T *12

 Compounded weekly
R / 52 interest per week
T *52

 Compounded daily
R / 365 interest per day
T *365
Example 12 : (From End Of Chapter 4 Questions)
-Your coin collection contains fifty 1952 silver dollars. If your grandparents
purchased them for their face value when they were new, how much will your
collection be worth when you retire in 2058, assuming they appreciate at a 6.1
percent annual rate?

  SOLUTION

Givens :
PV= $ 50
t = 2058 – 1952 = 106 years
R= 6.1 %

To find the FV, we use:


 
FV = PV(1 + r )t

FV = $50(1+ 6.1% )106


FV = $26,595.04
Example 18 : (From End Of Chapter 4 Questions)

Calculating Future Values. You have just made your first $5,000 contribution to
your individual retirement account. Assuming you earn a 10.1% rate of return and
make no additional contributions, what will your account be worth when you retire in
45 years? What if you wait 10 years before contributing? (Does this suggest an
investment strategy?

  SOLUTION  
Givens
PV = $5,000
To find the FV, we use: r= 10.1%
  = 45 years
FV = PV(1 + r)t 45- 10 = 35 years
FV = $5,000(1+ 10.1%)45
FV = $379,663.95
 
If you wait 10 years, the value of your deposit at your retirement will be:
 
FV = $5,000(1+ 10.1%)35
FV = $145,052.8
 
Better start early!
Example 20 : (From End Of Chapter 4 Questions)

You expect to receive $25,000 at graduation in two years. You plan on investing it at 9 %
until you have $150,000. Required: How long will you wait from now?

  SOLUTION

0 1 2 ?? Year  Givens

$25,000 $150,000 $ FV = $150,000


PV= $ 25,000
r= 9%
  answer this question, we can use either the FV or the PV formula.
To
= ???
Both will give the same answer since they are the inverse of each other.
We will use the FV formula, that is:
 
FV = PV(1 + r )t
$150,000 = $25,000(1+ 9%)t
t = ln($150,000 / $25,000) ln (1+ 9%)  
t = ln(FV / PV ) ln (1+ r )
t = 20.79 years
 
From now, you’ll wait 2 + 20.79 = 22.79 years
Another Method

Firstly, we can get the PV of the 25,000 at year zero

0 1 2 ??

PV =??? $25,000 $150,000

 Present value = = = $ 21,042

 
t = ln(FV / PV ) ln (1+ r )

 
t = ln($150,000 / $21,042) ln (1+ 9%)
t = 22.79 years
Example 21 : (From End Of Chapter 4 Questions)

You have $7,000 to deposit.


Regency Bank offers 12 % per year compounded monthly (1 % per month), while
King Bank offers 12% but will only compound annually. How much will your investment be
worth in 20 years at each bank?

  SOLUTION  
Givens
PV= $ 7,000
To find the FV of a lump sum, we use:
  Regency Bank
FV = PV(1 + r)t
  r= 1% monthly
In Regency Bank, you will have: =20 * 12 = 240 month
 
FV = $7,000(1+ 1%) 20*12=240 King Bank
FV = $76,247.88 r= 12% annually
 
And in King Bank, you will have: =20 years
 
FV = $7,000(1+ 12%)20
FV = $67,524.05
Example 22 : (From End Of Chapter 4 Questions)

An investment offers to triple your money in 24 months (don't believe it). What rate per
three months are you being offered?

  SOLUTION

  find the length of time for money to double, triple, etc., the present value and future
To
value are irrelevant as long as the future value is twice the present value for doubling,
three times as large for tripling, etc. We also need to be careful about the number of
periods. Since the length of the compounding is three months and we have 24 months,
there are eight compounding periods. To answer this question, we can use either the FV or
the PV formula. Both will give the same answer since they are the inverse of each other.
We will use the FV formula, that is:
 
Solving for r, we get:
 
r = (FV / PV)1 / t – 1

r = (3 / 1 )1/8 – 1

r = 0.1472 or 14.72%
Example 23 : (From End Of Chapter 4 Questions)

Calculating the Number of Periods. You can earn .43 percent per month at your bank. If
you deposit $1,800, how long must you wait until your account has grown to $3,100?

  SOLUTION

 
t = ln(FV / PV ) ln (1+ r )

 
t = ln($3,100 / $1,800) ln (1+ 0.43%)
t = 126.7 months
Example 24 : (From End Of Chapter 4 Questions)

You need $75,000 in 10 years. If you can earn 0.57% per month, how much would you
have to invest today?

  SOLUTION

To find the PV of a lump sum, we use:


 
PV = FV / (1 + r)t
PV = $75,000 / (1+ 0.57% )120

PV = $37,918
https://forms.gle/RTYJ4jkct27SVVs57

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy