Md.

Al Amin
Lecturer
Department of Marketing
Jagannath University

Time Value of Money 1

* Which would you rather have ?
*$100 today - or
*$100 one year from today
*Sooner is better !

Time Value of Money 2

 The value of money varies in terms of
time.
According to this concept, a dollar
received today is worth more than a dollar
expected to be received in the future.
This is because of the fact that the sooner
a dollar is received, the quicker it can be
invested to earn a positive return.
Time Value of Money 3
Four underlying reasons:
1. Consumption: People like to consume today
rather than consuming in future.
2. Uncertainty: Future is always uncertain. For this
uncertainty people need some compensation.
3. Investment Opportunity: If one gets the money
now, he can invest the amount and after a certain
period can get a return on the invested capital
4. Inflation: The purchasing power of money
decreases with the passes of time because of the
inflation.
Time Value of Money 4
 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 interest rate.

 Therefore, the future value is dependent on three

things : i) present value; (ii) period and (iii) rate of
interest.
 As for example, if present value equals to Tk. 100,
period is 1 year and rate of interest is 10 percent;
then future value will be Tk. 110.
Time Value of Money 5
 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 interest rate.

 Therefore, the future value is dependent on three

things : i) present value; (ii) period and (iii) rate of
interest.
 As for example, if present value equals to Tk. 100,
period is 1 year and rate of interest is 10 percent;
then future value will be Tk. 110.
Time Value of Money 6
 * Time 0 is today; Time 1 is one period from today

Interest rate
Time 0 1 2 3 4 5
5%
Cash Flows
-100 105
Outflow Inflow

Time Value of Money 7

 The
following two techniques are generally used in time value
money : (i) compounding and (ii) discounting.
 Compounding: The process of going from today’s values
which are termed as present values (PV), to future values
(FV) is called compounding.
 Thatis, the process of determining the value of a cash flow
sometime in the future, by applying compound interest rate is
known as compounding.

* Discounting Technique: Discounting refers to the process of

determining the present value of a cash flow or a series of cash
flows. It is the reverse of compounding.

Time Value of Money 8

 Compound Interest Rate: The interest rate that is
applied on the principle amount as well as the
interest earned that is reinvested.
 whilesimple interest refers to the interest earned
only on the original principal amount invested.

*Suppose your principal amount is Tk. 1000 and the

rate of interest is 10% and the period is 3 years. In
the example, compound interest comes to Tk. 331
(100+110+121); whereas, simple interest comes to
Tk. 300 (100+100+100) only at the end of 3 years.
Time Value of Money 9
*Suppose your principal amount is Tk. 1000 and the
rate of interest is 10% and the period is 3 years.
*In the example, compound interest comes to Tk.
331 (100+110+121);
*whereas, simple interest comes to Tk. 300
(100+100+100) only at the end of 3 years.

Time Value of Money 10

When Simple FV1  PV  PV.i.n
interest rate is
applied
When Compound
interest rate is
applied
FVn  PV(1  i) n

Time Value of Money 11

 There are three different formulas for calculating future
value under three different cases.
Case: 1. Under a single lump sum Payment
Case: 2. Under multiple payments with uneven cash flows.
Case: 3. Under annuity payments.

Ordinary Due

Time Value of Money 12

Prob: If you deposit $12,000 in a savings account that will earn
at an interest rate of 8 percent compounded annually. How
much you expect to have in your deposit account after 8
years from now?

Time Value of Money 13

* In case of annual (single) compounding :

* FVn = PV (1+i)n

Where, FVn = Future value at period n

PV = Present value
i= Rate of interest
n = Time period

Time Value of Money 14

* In case of Multiple Compounding:

i
FVn = Pv (1 + ------)mn
m

Time Value of Money 15

* Problem – 1
* Find out the future values (FV) in the following situations :
* a) At the end of 3 years, how much is an initial deposit of
Taka 1,000 worth, assuming a annually compounded interest
rate of (i) 10% and (ii) 100%.

* b) At the end of 10 years, how much is an initial investment

of Taka 1,000 worth, assuming an interest rate of 10%
compounded : (i) annually; (ii) semiannually; (iii) quarterly,
(iv)monthly ?

Time Value of Money 16

FVn = PV(1+i)n
Where, FVn = Future value at n period;
PV = Present value
i = Interest rate and
n = Time period
= 1,000(1 + .10)3
= 1,000(1.10)3
= 1,000 x 1.331
= Tk. 1,331

Again, 1,000(1 + 1)3

= 1,000 x 8
= 8,000.
Time Value of Money 17
 I . Annually
i ) FVn  PV (1  i ) n
 1000(1  0.10)10
 1,000  2.594
 Tk .2,594
i mn
* (ii) semiannually ii ) FVn  PV (1  )
m
10 210
 1000(1  )
2
 1000(1  0.05) 20
 1000  2.6533
 Tk .2,653
Time Value of Money 18
Prob: XYZ Inc. has identified in investment
project with the following cash flows. If the
cash flows grows at 8 percent compounded
annually, what is the future value of these cash
flows at the end of 4 years?
Year Cash Flow
1 $2500
2 $3300
3 $1750
4 $3750
Time Value of Money 19
 * At end of the year:
FV=PV1(1+r) n-1+ PV2 (1+r) n-2……

* At beginning of the year:

FV=PV1(1+r) n-0+ PV2 (1+r) n-1……

Time Value of Money 20

Opportunity cost
* the rate of return on the best available alternative investment of
equal risk
If you can have $100 today or $127.63 at the end of
five years, your choice will depend on your opportunity
cost
*The Present Value is the value today of a future
cash flow or series of cash flows
*The process of finding the present value is
discounting, and is the reverse of compounding
*Opportunity cost becomes a factor in discounting

Time Value of Money 21

 0 5% 1 2 3 4 5

PV = ? 127.63

*Start with future value:

*FVn = PV(1 + i)n FVn
PV 
(1  i) n

Time Value of Money 22

 There are three different formulas for
calculating Present value under three different
cases.
Case: 1. Under a single lump sum Payment
Case: 2. Under multiple payments with uneven
cash flows.
Case: 3. Under annuity payments.

Ordinary Due

Time Value of Money 23

Prob: Suppose your father will receive Tk. 650,000 from his
provident fund after 10 years from now. If an opportunity
cost of 8 percent annually is applied, then what is the present
value of his future payments?

FVn
i ) PV 
(1  i ) n

Time Value of Money 24

In case multiple interest payment in a year like semiannually,
quarterly, monthly and daily.)

FVn
ii ) PV 
i mn
(1  )
m

Time Value of Money 25

* Problem - 3
* Determine the Present Values (PVs) in the following cases :
* a) Taka 1,000 at the end of 5 years is worth how much today,
assuming a discount rate of : (i) 10
* percent and (ii) 100 percent;
* b) What is the aggregate PVs of the following receipts,
assuming a discount rate of 15 percent :
* i) Taka 1,000 at the end of 1 year;
* ii) Taka 1,500 at the end of 2 years;
* iii) Taka 1,800 at the end of 3 years;

Time Value of Money 26

Problem - 4
Find the present values of the following amount due :
a) Taka 6,600 due in 10 years at a 6 percent discount rate,
calculating annually;
b) Taka 9,000 due in 8 years at a 12 percent discount rate,
calculated semiannually;
c) Taka12,000 due in 6 years at a 18 percent discount rate,
calculated quarterly and
d) Taka 15,000 due in 3 years at a 12 percent discount rate,
calculated monthly.
e) Taka 18,000 due in 5 years at a 15 percent discount rate,
calculated continuously.
Time Value of Money 27
Prob: Suppose you have identified an
investment project with the following
cash flows. If the discount rate is 8
percent, what is the present value of
these cash flows?
Year Cash Flow
1 $2500
2 $3300
3 $1750
4 $3750
Time Value of Money 28
 FV 1 FV 2 FV 3
i ) PV    ....
(1  i )1
(1  i ) 2
(1  i ) 3

FV 1 FV 2 FV 3
) PV  FVo    ..
Time Value of Money (1  i )1
29 (1  i ) 2
(1  i ) 3
 Now the question is which works out highest
interest amount?

r
i ) EIR  (1  )m  1
m
(i) A company offers 12% rate of interest on
deposits. What is the effective rate of interest if
the compounding is done on
(a) Half-yearly
(b) Quarterly
© Monthly
(ii) As an alternative, the following rates of
interest are offered for choice. Which basis
gives the highest rate of interest that is to be
accepted?
Basis of Compounding Interest Rate:
Yearly 12%
Half-yearly 11.75%
Quarterly 11.50%
Monthly 11.25%
 An Annuity represents a series of equal
payments (or receipts) occurring over a
specified number of equidistant periods.

*Ordinary Annuity:
Annuity Payments or receipts
occur at the end of each period.
*Annuity Due:
Due Payments or receipts occur
at the beginning of each period.
* Student Loan Payments
* Car Loan Payments
* Insurance Premiums
* Mortgage Payments
* Retirement Savings
(Ordinary Annuity)
End of End of End of
Period 1 Period 2 Period 3

0 1 2 3

$100 $100 $100

Today
Equal Cash Flows
Each 1 Period Apart
 (Annuity Due)
Beginning of Beginning of Beginning of
Period 1 Period 2 Period 3

0 1 2 3

$100 $100 $100

Today Equal Cash Flows
Each 1 Period Apart
 If you deposit Taka 100 at the end of each of three years in a
Savings A/C that pays 5% interest per year; how much will you
have at the end of 3 years ?

(1  i )  1 n
FVAn  PMT [ ]
i

Time Value of Money 37

 * Find out the Future Values of the following ordinary annuities
:
* Taka 4,000 per year for 10 years at 12 percent;
* Taka 2,000 per year for 5 years at 10 percent;

Time Value of Money 38

 * Find out the future value of the following annuities due -
* (a) Tk. 3,000 per year for 8 years at 8%;
* (b) Tk. 5,000 per year for 10 years at 12% and

 (1  i ) n  1 
FVA ( DUE )  PMT    (1  i )
 i  

Time Value of Money 39

* Find out the present values of the following ordinary
annuities :
* a) Taka 2,500 for 10 years at 12 percent;
* b) Taka 4,500 for 12 years at 10 percent and
* c) Taka 6,000 for 8 years at 0 percent.

 1 
1  (1  i ) n 
PVAn  PMT  
 i 
 
* Find the present value of the following annuities; if the PMT
occur at the beginning of the year i.e. annuities due :
* a) Taka 7,500 for 9 years at 14 percent;
* b) Taka 10,000 for 5 years at 9 percent and

 1  
1  (1  i ) n  
PVAn ( DUE )  PMT    (1  i )
 i  
  