Subject: Fiscal Management WF

Professor: Dr. Emerita R. Alias

Prepared by:Cherie C. Duran
Topic: Time Value Analysis
Date: June 26, 2020
Objectives:
• Understanding the concept involving the Time Value of Money
• Present Value of 1.0 with single amount and several amounts using long and Short
method.
• Future value of P1.0 with Single amount using mathematical model and interest tables.
• Future Value of P1.0 with several amounts using different methods.

I. Understanding the concept involving the Time Value of Money

Read the Story:
Consider the case of Lola Clara. When she was 24 years old, her Papa gave her PHP50,000. She
was very happy and was immediately planning on spending the money. However, before she
could spend the money, her Mama taught her the importance of saving. Not wanting to
disappoint her Mama, she invested her money in a bank time deposit with an interest rate of 5%
at that time. Lola Clara became a very successful career woman but she somehow forgot that she
placed PHP50,000 in the bank. She suddenly remembered and was shocked at what had
happened to her money after 50 years.
It is now valued at 50,000 x (1.05)50 = 573,369.99.
 Concept of Time Value of Money Fundamentals

The concept of the time value of money asserts that the value of a dollar today is worth more
than the value of a dollar in the future. This is typically because a peso today can be used now to
earn more money in the future. There is also, typically, the possibility of future inflation, which
decreases the value of a dollar over time and could lead to a reduction in economic buying
power.

Businesses consider the time value of money before making an investment decision. They need
to know what the future value is of their investment compared to today’s present value and what
potential earnings they could see because of delayed payment. These considerations include
present and future values.

 The time value of money analysis helps managers and investors compare cash flows
today versus cash flow in the future.

• The time value of money is one of the most fundamental concepts in finance; it is based
on the notion that receiving a sum of money in the future is less valuable than receiving
that sum of today.

• This is because a sum received today can be invested and earn interest.

There are reasons to justify this…

 High purchasing power– A sum of money can be exchanged for more goods and
services today than after 5-10 years.

For instance 20 years ago, P100 had a huge value than today.

 Risks involved– There’s a risk involved in getting money back that you already have
today.

Say you lend the money to a person for one year and the person goes bankrupt or runs
away, you may lose your money.

Key components of the time value of money

• 1. Rate (i)– It is a discount rate or an interest rate which is used in compounding or

discounting a sum of money.

• 2. Periods (T) – It is a total number of periods in the overall time frame which can be
weekly, monthly, cashquarterly, semi-annually, annually and so on.

• 3. Present value (PV)– the amount you have to invest today if you want to have a certain
amount of cash flow in the future.
 • 4. Future value (FV)–the amount to which an investment will grow after earning
interest. It implies a sum of money to be received at a future date which is obtained by
compounding the present cash flow.

Differentiate simple and compounded interest.

• Simple Interest – the charging interest rate r based on a principal P over T number of
years. Interest = P x r x T

Principal = PHP500,000 Rate = 8% Time = 5 years

Thus, Interest = 500,000 x .08 x 5 = PHP200,000

• Compound Interest - the interest in the first compounding period is added on the
principal, which will then be the basis for the interest to be computed for the next period.
So in our earlier example, the interest to be earned on the first year is equal to 500,000 x .
08 = 40,000. The 40,000 interest will be added to the 500,000 principal which will then
be the basis for interest computation for the second year 540,000 x .08 = 43,200, and so
on.

The formula below shows the summary of the effects of adding on the interest, where m
is the compounding frequency.

Interest = ( P x (1 + ) (T x m) ) - P

Principal = PHP500,000

Rate = 8%

Time = 5 years

Compounding frequency = annually

Thus, Interest = 500,000 x (1 + (0.08/1))(5x1) – 500,000 = PHP234,664.04

Differentiate future value and present value.

• Future Value - the amount to which an investment will grow after earning interest. In our
previous examples, it is the principal plus total interest earned over a stated period. So the future
value of an investment of PHP500,000.00 yielding an interest of 8% for a 5-year period
compounded annually is PHP734,664.04.

• Present Value - the amount you have to invest today if you want to have a certain amount of
cash flow in the future.

These definitions can better be illustrated in a timeline.

0 1 2 3 4 5

Initial Investment T-0 Value of Investment at T-5

(PV) : Php 500,000 (FV) :Php 734,664.04

Figure 1: Growth of Value over 5-year period

Differentiate the basic patterns of cash flow.

• Single Amount (Lump Sum) - a single cash outflow is made and the total receipts will be at a
single future date.
• Annuity - periodic stream of equal cash flow at equal time intervals (annually, monthly, etc.).
For example, payment for a certain item shall be for 12 equal monthly instalments of PHP1,000.
• Mixed Stream - unequal periodic cash flows that reflect no particular pattern. For example,
payments made by a customer are in 3 unequal instalments.
TIME AMOUNT
Year 1 1500
Year 2 3000
Year 3 2,500

Table 1: Sample of Mixed Stream

II. Present Value of 1.0 with single amount and several amounts using long and
Short method.
How much must be invested today to produce a certain amount in the future?
Since future value is calculated by multiplying the present investment by 1 + interest rate
compounded by the number of periods, we shall just reverse the process.
Visualizing the Present Value (PV) Amount
We now know three of the four components we need:
(1) the future value amount (1,000),
(2) the length of time (2 years), and
(3) the interest rate (10%).

Formula: PV = FV (1 + r)T
PV = 1000 / (1 + .01)^2
PV = 980.00
Present Value - answers the question: How much must be invested today to produce a
certain amount in the future. Since future value is calculated by multiplying the present
investment by 1 + interest rate compounded by the number of periods, we shall just reverse
the process. This method is called discounting.
Formula: PV = FV / (1 + r)T
llustration:
You need P25,000.00 to buy a laptop when you enter into college 2 years from now. How
much must you invest now if the interest rate is at 6% per annum?
PV = 25,000/(1.062) = PHP22,249.91
You need to invest PHP22,249.91 to have PHP25,000.00 by the end of 2 years.
 Illustrate how to calculate future value and present value of mixed streams of cash flows.
Future Value: Suppose that you choose to put your savings annually in MRI bank at 8% per
annum. For today, you put PHP1,200, on the second year PHP1,400, and PHP1,000 for the third
year. How much will you have available at the end of three years?

Factor Multiplied by the amount Future Value

Deposited

(1.08) 3 = 1.2597 1,200 1,296

(1.08)2 = 1.1664 1,400 1,632.96

(1.08)1 = 1.08 1,000 1,259.712

Total FV P 4,189.00

Table 2: Sample Computation to Identify Future Value

0 1 2 3
-1200 -1400 -1,100 4,189.00
Figure 2: Timing of Cash Flows
(Present Value) Suppose that you can buy a phone for PHP8,000 down payment with 4,000
for each of the next two years or pay PHP15,500 cash today. Given an interest rate of 8%,
which is a cheaper alternative?
Present Value
P 8,000 8,000
4,000/ ( 1.08) 1 3703.70
4,000/ ( 1.08) 2 3429.36
Total PV P 15, 133.06

-8,000 -4,000 -4,000

PV= 15, 133.06

Note: To use the table provided, look for the rate of interest at the uppermost row and the
number of periods on the left most column. The intersection will be the factor to be multiplied to
the cash flow.
REFERENCES:
Teaching Guide for Senior High School BUSINESS FINANCE pp.240-248
The Commission on Higher Education in collaboration with the Philippine Normal University

https://opentextbc.ca/principlesofaccountingv2openstax/chapter/explain-the-time-value-of-money-
and-calculate-present-and-future-values-of-lump-sums-and-annuities/

https://www.accountingcoach.com/present-value-of-a-single-amount/explanation
https://slideplayer.com/slide/8648343/