Term Paper on

Time Value of Money

Prepared by: MD. RUHUL- AMIN

Session: 2014-15

Dept. of AIS

Comilla University

Introduction

The time value of money refers to the observation that it is better to receive money sooner than
later. Money that you have in hand today can be invested to earn a positive rate of return,
producing more money tomorrow. For that reason, a dollar in hand today is worth more than a
dollar to be received in the futureif you had the dollar now you could invest it, earn interest,
and end up with more than one dollar in the future. The process of going forward, from present
values (PVs) to future values (FVs), is called compounding. In business, managers constantly
face trade-offs in situations where actions that require outflows of cash today may produce
inflows of cash later. Because the cash that comes in the future is worth less than the cash that
firms spend up front, managers need a set of tools to help them compare cash inflows and
outflows that occur at different times.

Definition of Time Value of Money

When we talk about the time value of money, we recognize that people refer to receive a given
amount of money now rather than at some time in the future. The time value of money is one of
the most important concepts in finance. Most financial decisions involve situations in which
1
someone pays money at one point in time & receives money at some later time. Money paid or
received at two different points in time are different, and this different is recognized & accounted
for by time value of money.
According to Scholars View:
(i) Time value is based on the belief that a dollar today is worth more than a dollar that
will be received at some future date. - L.J. Gitman.
(ii) Time value of money means that the value of unit of money is different in different
time periods. - Khan & Jain.
The time value of money can be also referred to as time preference for money.

Time Line
A horizontal line on which time zero appears at the left most end and future periods are marked
from left to right; can be used to depict investment cash flows.
According to Prasanna Chandra-A time line is the timing and the amount of each cash flow in a
cash flow stream.
So, one of the most important steps in a time value analysis is to set up a time line to help you
visualize whats happening in the particular problem.

To illustrate, consider the following diagram, where PV represents $100 that is in a bank
account today and FV is the value that will be in the account at some future time (3 years from
now in this example):

The intervals from 0 to 1, 1 to 2, and 2 to 3 are time periods such as years or months. Time 0 is
today, and it is the beginning of Period 1; Time 1 is one period from today, and it is both the end
of Period 1 and the beginning of Period 2; and so on.
In our example, the periods are years, but they could also be quarters or months or even days.
Note again that each tick mark corresponds to both the end of one period and the beginning of
the next one. Thus, if the periods are years, the tick mark at Time 2 represents both the end of
Year 2 and the beginning of Year 3. Cash flows are shown directly below the tick marks, and the

2
relevant interest rate is shown just above the time line. Unknown cash flows, which you are
trying to find, are indicated by question marks. Here the interest rate is 5%; a single cash
outflow, $100, is invested at Time 0; and the Time-3 value is unknown and must be found. In
this example, cash flows occur only at Times 0 and 3, with no flows at Times 1 or 2. We will, of
course, deal with situations where multiple cash flows occur. Note also that in our example the
interest rate is constant for all 3 years. The interest rate is generally held constant, but if it varies
then in the diagram we show different rates for the different periods.
Time lines are especially important when you are first learning time value concepts, but even
experts use them to analyze complex problems.

Future Value Vs Present Value

Suppose a firm has an opportunity to spend $15,000 today on some investment that will produce
$17,000 spread out over the next five years as follows:
Year 1 $3,000
Year 2 $5,000
Year 3 $4,000
Year 4 $3,000
Year 5 $2,000
Is this a wise investment? It might seem that the obvious answer is yes because the firm spends
$15,000 and receives $17,000. Remember, though, that the value of the dollars the firm receives
in the future is less than the value of the dollars that they spend today. Therefore, it is not clear
whether the $17,000 inflows are enough to justify the initial investment. Time-value-of-money
analysis helps managers answer questions like these. The basic idea is that managers need a way
to compare cash today versus cash inn the future. There are two ways of doing this. One way is
to ask the question, What amount of money in the future is equivalent to $15,000 today? In other
words, what is the future value of $15,000? The other approach asks, What amount today is
equivalent to $17,000 paid out over the next 5 years as outlined above? In other words, what is
the present value of the stream of cash flows coming in the next 5 years?
A time line depicts the cash flows associated with a given investment. It is a horizontal line on
which time zero appears at the leftmost end and future periods are marked from left to right. A

3
time line illustrating our hypothetical investment problem appears in Figure 5.1. The cash flows
occurring at time zero (today) and

Figure-1.1: Time line depicting an investments cash flows.

Figure-1.2: Time line showing compounding to find future value and discounting to find
present value.
at the end of each subsequent year are above the line; the negative values represent cash outflows
($15,000 invested today at time zero), and the positive values represent cash inflows ($3,000
inflow in 1 year, $5,000 inflow in 2 years, and so on). To make the right investment decision,
managers need to compare the cash flows depicted in Figure 1.1 at a single point in time.
Typically, that point is either the end or the beginning of the investments life. The future value
technique uses compounding to find the future value of each cash flow at the end of the
investments life and then sums these values to find the investments future value. This approach
is depicted above the time line in Figure 1.2. The figure shows that the future value of each cash

4
flow is measured at the end of the investments 5-year life. Alternatively, the present value
technique uses discounting to find the present value of each cash flow at time zero and then sums
these values to find the investments value today. Application of this approach is depicted below
the time line in Figure 1.2. In practice, when making investment decisions, managers usually
adopt the present value approach.

Future Value
The most basic future value and present value concepts and computations concern single
amounts, either present or future amounts. We begin by considering problems that involve
finding the future value of cash that is on hand immediately. Then we will use the underlying
concepts to solve problems that determine the value today of cash that will be received or paid in
the future.
Definition
The value at some future time of a present amount of money, or series of payments, evaluated at
a given interest rate.
In the other way, it is the value at a given future date of an amount placed on deposit today and
earning interest at a specified rate. Found by applying compound interest over a specified period
of time.
According to Scholars view:
(i) Future value is cash you will receive at a given future date. - L.J. Gitman.
(ii)Future value is the value at some future time of present amount of money. - Van
Horne.
Future value is also called terminal value or compounded value.

Simple Interest:
Simple interest is interest that is paid (earned) on only the original amount, or principal,
borrowed (lent). The dollar amount of simple interest is a function of three variables: the original
amount borrowed (lent), or principal; the interest rate per time period; and the number of time
periods for which the principal is borrowed (lent).
The formula for calculating simple interest is:

5
 SI = P0 (i)(n) [Formula: 01]
Where,
SI = simple interest in dollars,
P0 = principal, or original amount borrowed (lent) at time period 0,
i = interest rate per time period and
n = number of time periods.
Example: Assume that you deposit $100 in a savings account paying 8 percent simple interest
and keep it there for 10 years. At the end of 10 years, the amount of interest accumulated is
determined as follows:
$80 = $100+[$100(0.08)(10)]
=$180

Compound Interest:
Compound interest is the interest paid (earned) on any previous interest earned, as well as on the
principal borrowed (lent).
The notion of compound interest is crucial to understanding the mathematics of finance. The
term itself merely implies that interest paid (earned) on a loan (an investment) is periodically
added to the principal. As a result, interest is earned on interest as well as the initial principal. It
is this interest-on-interest, or compounding, affect that accounts for the dramatic difference
between simple and compound interest. As we will see, the concept of compound interest can be
used to solve a wide variety of problems in finance.
The future value of a present amount is found by applying compound interest over a specified
period of time.
The formula of future value for calculating compound interest is:

FVn = P0 (1 + i)n [Formula: 02]

Where,
FVn = future value at the end of period n,
P0 = initial principal, or present value,
i = annual rate of interest paid and
n = number of periods (typically years) that the money is left on deposit.
6
Or,
FVn= P0 (FVIFi,n)
Where, we let FVIFi,n (i.e., the future value interest factor at i% for n periods) equal (1+ i)n.
Example: In 1790 John Jacob Astor bought approximately an acre of land on the east side of
Manhattan Island for $58. Astor, who was considered a shrewd investor, made many such
purchases. How much would his descendants have in 2009, if instead of buying the land, Astor
had invested the $58 at 5 percent compound annual interest?
Answer: We can find the FVIF of #1 in 50 years 11.467 and the FVIF of $1 in 19 years
2.527. So what, you might ask. Being a little creative, we can express our problem as follows:1
FV219 = P0 (1 + i)219
= P0 (1 + i)50 (1 + i)50 (1 + i)50 (1 + i)50 (1 + i)19
= $58 11.467 11.467 11.467 11.467 2.527
= $58 43,692.26 = $2,534,151.08
Similarly, we can determine the future levels of other variables that are subject to compound
growth. This principle will prove especially important when we consider certain valuationmodels
for common stock.

Multi-Period Compounding:

Semiannually/Half-yearly 6 Monthly Interval M = 2

Q u a r t e r l y 3 Monthly Interval M = 4
B i m o n t h l y 2 Monthly Interval M = 6
M o n t h l y 1 Monthly Interval M = 1 2
W e a k l y 1 Day Interval M = 5 2
D a i l y Ever yda y Int erva l M = 3 6 5

The formula of future value for calculating Multi-Period Compounding is:

FV = PV (1+i/m)nm [Formula: 03]
Where,

7
 FV = future value
PV = present value
i = annual rate of interest paid.
n = number of year
m = Multi-period compounding of a year.

A Graphical View of Future Value

Remember that we measure future value at the end of the given period. Figure 1.1 illustrates how
the future value depends on the interest rate and the number of periods that money is invested.
The figure shows that (1) the higher the interest rate, the higher the future value is , and (2) the
longer the period of time, the higher the future value. Note that for an interest rate of 0 percent,
the future value always equals the present value ($1.00). But for any interest rate greater than
zero, the future value is greater than the present value of $1.00.

8
Figure: Future Value Relationship (Interest rates, time periods, and future value of one dollar.)

Present Value
We all realize that a dollar today is worth more than a dollar to be received one, two, or three
years from now. Calculating the present value of future cash flows allows us to place all cash
flows on a current footing so that comparisons can be made in terms of todays dollars.
It is often useful to determine the value today of a future amount of money. For example, how
much would I have to deposit today into an account paying 7 percent annual interest to
accumulate $3,000 at the end of 5 years?
Definition
Present value is the current dollar value of a future amountthe amount of money that would
have to be invested today at a given interest rate over a specified period to equal the future
amount. Like future value, the present value depends largely on the interest rate and the point in
time at which the amount is to be received. This section explores the present value of a single
amount.
Scholars View:
(i) Present value is just like cash in hand today. - L.J. Gitman.
(ii) Present value is the current value of a future amount of money. - Van
Horne.
To calculated present value, it is necessary to understand discounted rate and discounting.
Present value is also called discounted value.

Discount Rate and Discounting

Discount rate is the interest rate used to convert future values to present value. The compound
interest rate used for discounting cash flows is called the discounted rate. The required rate of
return and expected rate of return are also called the discounted rate of return.
The process of of determining present value of a future payment (or receipt) or a series of future
payment (or receipt) is known as discounting. The process of finding present values is often
referred to as discounting cash flows. Finding the present value (or discounting) is simply the
reverse of compounding.

9
 PV = FVn/ (1 + r)n [Formula:04]
Where,
PV = present value
FV = future value
i = annual rate of interest paid.
n = number of year.
Or,
PV0 = FVn(PVIFi,n)
Where,
A present value table containing PVIFs for a wide range of interest rates and time periods
relieves us of making the calculations every time we have a present value problem to solve.

Multi-Period Discounting
Often the discount rates are discounted more than once in a year. The process of calculating the
present value of a payment (or receipt), when applying the concept of discounted more than
once a year is known as multi-period discounting. The value for different discounting is same of
multi-period compounding.

PV0=FVn /(1 + i/m)n [Formula:05]

Where,
PV = present value
FV = future value
i = annual rate of interest paid.
n = number of year and
m = Multi-period Discounting of a year.

A Graphical View of Present Value

Remember that present value calculations assume that the future values are measured at the end
of the given period. The relationships among the factors in a present value calculation are
illustrated in Figure 1.2. The figure clearly shows that, everything else being equal, (1) the higher

10
the discount rate, the lower the present value, and (2) the longer the period of time, the lower the
present value. Also note that given a discount rate of 0 percent, the present value always equals
the future value ($1.00). But for any discount rate greater than zero, the present value is less than
the future value of $1.00.

Figure: Present Value Relationship (Discount rates, time periods, and present value of one
dollar.)

Annuity
An annuity is a stream of equal periodic cash flows over a specified time period. These cash
flows can be inflows of returns earned on investments or outflows of funds invested to earn
future return.
Definition
An annuity is a series of equal payments or receipts occurring over a specified number of
periods. In an ordinary annuity, payments or receipts occur at the end of each period; in an
annuity due, payments or receipts occur at the beginning of each period.

11
Scholars View:
(i) An annuity is a series of equal payments made at fixed intervals for a specified
number of periods.- Brigham & Ehrhadrit.
An annuity, by definition, requires that:
(a) Equal amount
(b) Same interval
(c) Series of payment.
In practical field, when indicate: every year, each year, per year, yearly, annually, semi-
annually, half yearly, quarterly, monthly, weakly, daily, installment, equal payment or receipts
are the symbol of annuity.

Types of Annuity
There are two basic types of annuities. One is ordinary annuity and the other is annuity due.
Other types of annuity is perpetuity. So annuity has the following types:

Ordinary Annuity

Ordinary Annuity is an annuity for which the cash flow occurs at the end of each period.

(i) An ordinary annuity for which the cash flow occurs at the end of each period. - L.J.
Gitman.

(ii)An annuity is a series of equal payments or receipts occurring over a specified number of
periods. - Van Horne.

Annuity Due

Annuity due is an annuity for which the cash flow occurs at the beginning of each period.

(i) Annuity due is an annuity for which the cash flow occurs at the beginning of each
period. -L.J. Gitman.
(ii) An annuity due is the payment or receipt occurs at the beginning of each period. -
Van Horne.
12
Perpetuity

Most annuities call for payments to be made over some finite period of time. However, some
annuities go on indefinitely, these are called perpetuity.

(i) An annuity that goes for ever is called perpetuity. - Khan & Jain.
(ii) Perpetuity is an annuity that occurs indefinitely.- IM Pandey.

So, perpetuity is simply an annuity whose promised payments extend out forever.

Future Value of an Annuity

In computing the future value of an annuity, it is necessary to know:

1. The rate of interest,
2. The number of compound period,
3. The amount of periodic receipts or payments,
Future Value of an OrdinaryAnnuity
If the payments occur at the end of each period, the annuity is ordinary annuity.
One way to find the future value of an ordinary annuity is to calculate the future value of each of
the individual cash flows and then add up those figures. Fortunately, there are several shortcuts
to get to the answer. You can calculate the future value of an ordinary annuity that pays an
annual cash flow equal to CF by using Equation 06:

FVn = CF*{[(1 + r)n 1]/r} [Equation: 06]

As before, in this equation r represents the interest rate, and n represents the number of payments
in the annuity (or equivalently, the number of years over which the annuity is spread). The
calculations required to find the future value ofan ordinary annuity are illustrated in the
following example.
Example: Fran Abrams wishes to determine how much money she will have at the end of 5
years if she chooses annuity A, the ordinary annuity. She will deposit $1,000 annually, at the end

13
of each of the next 5 years, into a savings account paying 7% annual interest. This situation is
depicted on the following time line:

As the figure shows, at the end of year 5, Fran will have $5,750.74 in her account. Note that
because the deposits are made at the end of the year the first deposit will earn interest for 4 years,
the second for 3 years, and so on. Plugging the relevant values into formula-06 we have

FV5 = $1,000 *{[(1 + 0.07)5 1]/0.07}

= $5,750.74
Calculator Use: Using the calculator inputs shown at the left, you can confirm that the future
value of the ordinary annuity equals $5,750.74.

Future Value of an Annuity Due

Because each payment occurs one period earlier with an annuity due, the payments will all earn
interest for one additional period. Therefore, the FV of an annuity due will be greater than that of
a similar ordinary annuity.
FVADn = R(FVIFAi,n)(1 + i ) [Formula:07]
Example: Time lines for calculating the future (compound) value of an annuity due [periodic
receipt = R = $1,000; i = 8%; and n = 3 years].

14
 Present Value of an Annuity

In computing the present value of an annuity, it is necessary to know:

1. The discount rate,
2. The number of discount period,
3. The amount of the periodic receipts or payments.

Present Value of an Ordinary Annuity

The method for finding the present value of an ordinary annuity is similar to the method just
discussed. One approach would be to calculate the present value of each cash flow in the annuity
and then add up those present values.
PVADn = (1 + i )(R)(PVIFAi,n) [Formula:08]

Example: Time lines for calculating the present (discounted) value of an (ordinary) annuity
[periodic receipt = R = $1,000; i = 8%; and n = 3 years].

15
Present Value of an Annuity Due
If payments are made at the beginning of each period, the annuity is an annuity due.
PVADn = R(PVIFAi,n1) + R [Formula:09]
= R (PVIFAi, n1 + 1)
Example: Time lines for calculating the present (discounted) value of an annuity due [periodic
receipt = R = $1,000; I = 8%; and n = 3 years].

Perpetuity

Perpetuity is an ordinary annuity whose payments or receipts continue forever.

PVA = R/I [Formula: 10]

16
 Mixed Streams

Many time values of money problems that we face involve neither a single cash flow nor a single
annuity. Instead, we may encounter a mixed (or uneven) pattern of cash flows.

Present Value

The Present Value of a Cash Flow Stream is equal to the sum of the Present Values of the
individual cash flows. To see this, consider an investment which promises to pay $100 one year
from now and $200 two years from now. If an investor were given a choice of this investment or
two alternative investments, one promising to pay $100 one year from now and the other
promising to pay $200 two years from now, clearly, he would be indifferent between the two
choices. (Assuming that the investments were all of equal risk, i.e., the discount rate is the same.)
This is because the cash flows that the investor would receive at each point in time in the future
are the same under either alternative. Thus, if the discount rate is 10%, the Present Value of the
investment can be found as follows:

Present Value of the Investment

PV = $100/ (1 + 0.10) + $200/ (1 + 0.10)2

PV = $90.91 + $165.29 = $256.20

The following equation can be used to find the Present Value of a Cash Flow Stream.

[Formula: 11]

Where,

PV = the Present Value of the Cash Flow Stream,

CF t = the cash flow which occurs at the end of year t,
r = the discount rate,
t = the year, which ranges from zero to n, and

17
 n = the last year in which a cash flow occurs.

Example: Find the Present Value of the following cash flow stream given that the interest rate is
10%.

Future Value

The Future Value of a Cash Flow Stream is equal to the sum of the Future Values of the
individual cash flows. For example, consider an investment which promises to pay $100 one year
from now and $200 two years from now. Given that the discount rate is 10%, the Future Value at
the end of year 2 of the investment can be found as follows:

Future Value of the Investment

FV 2 = $100(1 + 0.10) + $200

FV 2 = $110.00 + $200.00 = $310.00

As of year 2, the $100 received at the end of year 1 would have earned interest for one year
while the $200 received at the end of year 2 would not yet have earned any interest. Thus, the
Future Value at the end of year 2, i.e., immediately after the $200 cash flow was received, is
$310.00.

The following equation can be used to find the Future Value of a Cash Flow Stream at the end of
year t.

[Formula: 12]
18
Where,

FV t = the Future Value of the Cash Flow Stream at the end of year t,
CF t = the cash flow which occurs at the end of year t,
r = the discount rate,
t = the year, which ranges from zero to n, and
n = the last year in which a cash flow occurs.

Example: Find the Future Value at the end of year 4 of the following cash flow stream given
that the interest rate is 10%.

19
 Exercises

Problem-01: The following are exercises in present values:

A. $100 at the end of three years is worth how much today, assuming a discount rate of (I) 100
percent? (ii) 10 percent? (iii) 0 percent?
b. What is the aggregate present value of $500 received at the end of each of the next three years,
assuming a discount rate of (i) 4 percent? (ii) 25 percent?
c. $100 is received at the end of one year, $500 at the end of two years, and $1,000 at the end of
three years. What is the aggregate present value of these receipts, assuming a discount rate of (i)
4 percent? (ii) 25 percent?
d. $1,000 is to be received at the end of one year, $500 at the end of two years, and $100 at the
end of three years. What is the aggregate present value of these receipts assuming a discount rate
of (i) 4 percent? (ii) 25 percent?

Solution:
a. P0 = FVn[1/(1 + i)n]
(i) $100[1/(2)3] = $100(0.125) = $12.50
(ii) $100[1/(1.10)3] = $100(0.751) = $75.10
(iii) $100[1/(1.0)3] = $100(1) = $100
b. PVAn = R[(1 [1/(1 + i)n])/i]
(i) $500[(1 [1/(1 + .04)3])/0.04] = $500(2.775) = $1,387.50
(ii) $500[(1 [1/(1 + 0.25)3])/0.25 = $500(1.952) = $ 976.00
c. P0 = FVn[1/(1 + i)n]
(i) $100[1/(1.04)1] = $100(0.962) = $ 96.20
500[1/(1.04)2] = 500(0.925) = 462.50
1,000[1/(1.04)3] = 1,000(0.889) = 889.00
$1,447.70
(ii) $100[1/(1.25)1] = $100(0.800) = $ 80.00
500[1/(1.25)2] = 500(0.640) = 320.00
1,000[1/(1.25)3] = 1,000(0.512) = 512.00
$ 912.00

20
d. (i) $1,000[1/(1.04)1] = $1,000(0.962) = $ 962.00
500[1/(1.04)2] = 500(0.925) = 462.50
100[1/(1.04)3] = 100(0.889) = 88.90
$1,513.40
(ii) $1,000[1/(1.25)1] = $1,000(0.800) = $ 800.00
500[1/(1.25)2] = 500(0.640) = 320.00
100[1/(1.25)3] = 100(0.512) = 51.20
$1,171.20

Problem-02: The following are exercises in future (terminal) values:

a. At the end of three years, how much is an initial deposit of $100 worth, assuming a compound
annual interest rate of (i) 100 percent? (ii) 10 percent? (iii) 0 percent?
b. At the end of five years, how much is an initial $500 deposit followed by five year-end,
annual $100 payments worth, assuming a compound annual interest rate of (i) 10 percent? (ii) 5
percent? (iii) 0 percent?
c. At the end of six years, how much is an initial $500 deposit followed by five year-end, annual
$100 payments worth, assuming a compound annual interest rate of (i) 10 percent? (ii) 5 percent?
(iii) 0 percent?
d. At the end of three years, how much is an initial $100 deposit worth, assuming a quarterly
compounded annual interest rate of (i) 100 percent? (ii) 10 percent?
e. At the end of 10 years, how much is a $100 initial deposit worth, assuming an annual interest
rate of 10 percent compounded (i) annually? (ii) Semiannually? (iii) Quarterly? (iv)
Continuously?
Solution:
a. FVn = P0(1 + i)n
(i) FV3 = $100(2.0)3 = $100(8) = $800
(ii) FV3 = $100(1.10)3 = $100(1.331) = $133.10
(iii) FV3 = $100(1.0)3 = $100(1) = $100
b. FVn = P0(1 + i)n; FVAn = R[([1 + i]n 1)/i]
(i) FV5 = $500(1.10)5 = $500(1.611) = $ 805.50

21
 FVA5 = $100[([1.10]5 1)/(0.10)]
= $100(6.105) = 610.50
$1,416.00
(ii) FV5 = $500(1.05)5 = $500(1.276) = $ 638.00
FVA5 = $100[([1.05]5 1)/(0.05)]
= $100(5.526) = 552.60
$1,190.60
(iii) FV5 = $500(1.0)5 = $500(1) = $ 500.00
FVA5 = $100(5)* = 500.00
$1,000.00
*[Note: We had to invoke lHospitals rule in the special case where i = 0; in short,
FVIFAn = n when i = 0.]
c. FVn = P0(1 + i)n; FVADn = R[([1 + i]n 1)/i][1 + i]
(i) FV6 = $500 (1.10)6 = $500(1.772) = $ 886.00
FVAD5 = $100 [([1.10]5 1)/(.10)] [1.10]
= $100(6.105)(1.10) = 671.55
$1,557.55
(ii) FV6 = $500(1.05)6 = $500(1.340) = $ 670.00
FVAD5 = $100[([1.05]5 1)/(0.05)] [1.05]
= $100(5.526)(1.05) = 580.23
$1,250.23
(iii) FV6 = $500(1.0)6 = $500(1) = $ 500.00
FVAD5 = $100(5) = 500.00
$1,000.00
d. FVn = PV0(1 + [i/m])mn
(i) FV3 = $100(1 + [1/4])12 = $100(14.552) = $1,455.20
(ii) FV3 = $100(1 + [0.10/4])12 = $100(1.345) = $ 134.50

e. FVn = PV0(1 + [i/m])mn; FVn = PV0(e)in

(i) $100(1 + [0.10/1])10 = $100(2.594) = $259.40

(ii) $100(1 + [0.10/2])20 = $100(2.653) = $265.30

22
 (iii) $100(1 + [0.10/4])40 = $100(2.685) = $268.50

(iv) $100(2.71828)1 = $271.83

Problem-03: You have been offered a note with four years to maturity, which will pay $3,000 at
the end of each of the four years. The price of the note to you is $10,200. What is the implicit
compound annual interest rate you will receive (to the nearest whole percent)?

Solution: $10,000 = $3,000(PVIFAx%,4)(PVIFAx%,4) = $10,200/$3,000 = 3.4 Going to the

PVIFA table at the back of the book and looking across the row for n = 4, we find that the
discount factor for 6 percent is 3.465, while for 7 percent it is 3.387. Therefore, the note has an
implied interest rate of almost 7 percent.

Problem-03: Suppose you were to receive $1,000 at the end of 10 years. If your opportunity rate
is 10 percent, what is the present value of this amount if interest is compounded (a) annually? (b)
Quarterly? (c) Continuously?
Solution:

Amount Present Value Interest Factor Present Value

$1,000 1/(1 + .10)10 = 0.386 $386
1,000 1/(1 + .025)40 = 0.372 372
1,000 1/e(.10)(10) = 0.368 368

23
 References

1. Business Finance by Kamruzzamana

2. Managerial Finance by Gitman
3. Wikipedia
4. Financial Management by Van Horne

24