MAN 312

TIME VALUE OF MONEY

AND
GROWTH
Please download the TVM spreadsheet on Ikamva
G.Botes | 2021
 INTRODUCTION
Objective of financial manager is:
• to increase the value of the firm by investing in assets (fixed &
current) that will earn returns greater than the cost of capital
(shareholder’s interest and long-term loans)
• Timing of investment and earning of a return does not occur
instantaneously
• Usually time lapses before a return is earned
• When cash inflows and –outflows differ; time value of money comes
into play

Please download the TVM spreadsheet on Ikamva

 INTRODUCTION
Question: What is an asset?

• Property, plant and equipment

• Patents, Research and Development
• Knowledge, Reputation, Opportunities

From a business perspective, an asset is a sequence of cash flows.

 INTRODUCTION
Time lines show timing of cash flows.
0 1 2 3
i%

CF0 CF1 CF2 CF3

Tick marks at ends of periods.

Time 0 is today
Time 1 is the end of Period 1
 INTRODUCTION
• What is “time value of money”?

• An amount of money today is worth more than at some point in time in the
future; R1 today is worth more than R1 in 6 months’ time

• Opportunity cost – Invest R1 today and earn interest over investment period
(example 1 year). Should you not invest the R1 today, the opportunity cost
would be the interest that you could have received

• Time Value of Money not to be confused with decrease in purchasing power

due to inflation
 INTRODUCTION
Time line for $100 lump sum due at end of year 2

0 1 2 Year
i%

100

Finding future values (moving to the right of the time line) is called COMPOUNDING.
Finding present values (moving to the left of the time line) is called DISCOUNTING.
 FUTURE VALUE
Calculation of interest on a present amount to result in some future amount

Where
FV - Future Value
PV - Present Value
n - number of periods
i - annual rate of interest paid
 FUTURE VALUE
Annual compounding

Interest earned on principal amount becomes part of the principal at the end of the 1 st compounding
period.

R1000 R1100
=R1000(1+0,1) R1210
=R1000(1+0,1)(1+0,1)

0 1 2
 FUTURE VALUE
From the example on slide 7:
FVn = PV(1 + i)
FV2 = 1000(1+0,1)²
FV2 = 1000(1,1)(1,1)
FV2 = 1210
On financial calculator:
PV = 1000, N = 2, I = 10 , Compute FV
 FUTURE VALUE
Intra-year compounding :
annual interest rate, compounded semi-annually / quarterly / monthly / daily

FV – Future Value
n – amount of years
m – number of compounding periods per annum
i – annual interest rate
PV – Present Value
 CALCULATING i
• What is the implied interest rate of an investment?

• FVn = PV(1 + i)
• Determine “i”
• i = (FV / PV)1/n – 1

• Faster and efficient method – use financial calc or Excel

 CALCULATING n
• What are the number of periods of an investment?

𝑛=
log
𝐹𝑉
𝑃𝑉 ( )
log ⁡(1+𝑖)
• Faster and efficient method – use financial calc or Excel
 FUTURE VALUE
• Future Value of an Annuity

• Series of equal cashflows over a specified number of periods

• A)Ordinary annuity
• Payment made in arrears
• B)Annuity due
• Payment made upfront
 FUTURE VALUE
What is the FV of a 3-year ordinary annuity of R100 at 10%?

0 1 2 3
10%

100 100 100

110
121
FV = 331
 FUTURE VALUE

3 10 -100
INPUTS N I/YR PV PMT FV

331.00
OUTPUT
 FUTURE VALUE
Future Value of an Annuity Due

0 1 2 3 4 5 R1000
R1000 R1000 R1000 R1000
FV

FV

FV

FV

What is the FV if i = 16%? R7977.48 FV

 PRESENT VALUE
• R1 today is worth more (interest earned) in a year’s time
• Equally R1 in a year’s time is worth less than R1 today
• To know the present value of your future R1, you need to discount it at the
discount rate.
• i.e. discounting is inverse of compounding
• Discount rate = opportunity cost = cost of capital =
required return
0 1 2
I = 10%

PV = ? 100
 PRESENT VALUE
Finding the PV of an ordinary annuity is a similar process to that of the FV but in reverse.

0 1 2 3
10%

100 100 100

90.91
82.64
75.13
248.69 = PV
 PRESENT VALUE

3 10 100
INPUTS N I/YR PV PMT FV

-248.69
OUTPUT
 PRESENT VALUE
Cashflows each period may be different. This is called an UNVEVEN or
IRREGULAR CASHFLOW.
0 1 2 3
10%

100 150 200

PV
PV
PV
 PERPETUITY

• Perpetuity refers to an infinite amount of time. In finance,

perpetuity is a constant stream of identical cash flows with no
end. 
• An annuity is a stream of cash flows. A perpetuity is a type of
annuity that lasts forever, into perpetuity. The stream of cash
flows continues for an infinite amount of time.
 TYPES OF INTEREST RATES
• When we move beyond annual compounding, we must deal with the
following types of interest rates:

• Nominal annual rates

• Periodic rates
• Effective annual rates
 TYPES OF INTEREST RATES

• Nominal annual interest rate is the rate quoted by banks, brokers, and other
financial institutions.
• Not used in calculations or shown on time lines.
• Periods per year (m) must be given
Examples:
• 8%; Quarterly
• 8%, Daily interest (365 days)
 TYPES OF INTEREST RATES

• The periodic rate is used in calculations, shown on time lines.

• where m is number of compounding periods per year.

• E.G m = 4 for quarterly, 12 for monthly, and 360 or 365 for daily
compounding.
• Examples:
• 8% quarterly: iPer = 8%/4 = 2%.
• 8% daily (365): iPer = 8%/365 = 0.021918%.
 TYPES OF INTEREST RATES
• The EAR is the annual rate which causes PV to grow to the same FV as under multi-period
compounding
• Example: Invest R1 for one year at 12%, semiannual:
FV = PV(1 + iNom/m)m
FV = 1 (1.06)2 = 1.1236.
EFF% = 12.36%, because R1 invested for one year at 12% semiannual
compounding would grow to the same value as R1 invested for one year at
12.36% annual compounding.

• An investment with monthly payments is different from one with quarterly

payments. Must put on EFF% basis to compare rates of return. Use EFF% only
for comparisons.
• Banks say “interest paid daily.” Same as compounded daily.
 AMORTISATION
• An extremely important application of compound interest involves loans that are
paid off in installments over time.
• Included are automobile loans, home mortgage loans, student loans, and many
business loans.
• A loan that is to be repaid in equal amounts on a monthly, quarterly, or annual
basis is called an amortized loan.

• See the example the spreadsheet.

 GROWING ANNUITY
• What happens if Cash Flows are not constant but instead growing at some rate?
This is a GROWING ANNUITY.
• The Present Value of a Growing Ordinary Annuity is as follows

0 1 2 3

CF0 CF1 * CF2 *

 GROWING ANNUITY
The Present Value of a Growing Ordinary Annuity is as follows

( )
𝑛
1 1+𝑔
𝑃 𝑉 𝐺 𝐴 =𝐶 ∗ ∗(1 − )
𝑟 −𝑔 1+𝑟

Where:

C = initial cash flow

g = growth rate
r = discount rate
n = number of periods
 GROWING ANNUITY
Solving for the initial Cash Flow
𝑃 𝑉 𝐺𝐴
𝐶=

[ ( )
]
𝑛
1 +𝑔
1−
1+ 𝑟
Where:
𝑟 −𝑔

C = initial cash flow

g = growth rate
r = discount rate
n = number of periods
 GROWING ANNUITY
Future Value of a Growing Annuity
𝑛 𝑛
( 1+𝑟 ) − ( 1+𝑔 )
𝐹 𝑉 𝐺 𝐴 =𝐶 ∗
𝑟 −𝑔
Where:

C = initial cash flow

g = growth rate
r = discount rate
n = number of periods
 GROWING ANNUITY
Solving the initial cash flow

𝐹 𝑉 𝐺𝐴
𝐶=

Where:
[ ( 1 + 𝑟 )𝑛 − ( 1 + 𝑔 )𝑛
𝑟 −𝑔 ]
C = initial cash flow
g = growth rate
r = discount rate
n = number of periods
 GROWING PERPETUITY
Present Value of a Growing Perpetuity

• r must be greater than g. Why?

• If r=g, then denominator = 0. Cannot divide by 0
• If g>r, then denominator is negative, which would lead to a negative perpetuity.

𝐶
𝑃 𝑉 𝐺𝑟𝑜𝑤𝑖𝑛𝑔 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 =
𝑟−𝑔