TOPIC 5

TIME VALUE OF MONEY

Axiom 2:
The Time Value of Money - A Dollar Received
Today Is Worth More Than a Dollar Received in
the Future

Compound Interest : FV=PV(1+i)n

e.g. If we place RM1000 in a Saving Account
earning 5% per annum compounded annually,
how much will our account equal to in 10 years?
Mathematical
FV=PV(1+i)n
FV = RM1000(1+ 0.05)10 = RM1628.89
Compounding Table
FV=RM1000(5%, 10 yrs) = RM1000(1.629) = RM1629

How many years will it take for an initial

investment of RM300 to grow to RM774 if it is
invested at 9% p.a compounded annually?
FV =PV(1+i)n
RM774=RM300(1+0.09)n
2.58 = (1+0.09)n
Refer to Table at 9% and Factor of 2.58 we will get
n=11 yrs.

At what rate (i) must RM100 be compounded

annually for it to grow to RM179.10 in 10 years?
FV=PV(I+i)n
RM179.10=RM100(1+i)10
1.791 = (1+i)10
Looking through the table n=10 and factor of 1.791,
we will arrive at i=6%

Non-annual Compound Periods

Until now, we have assume that interest is
compounded annually ( once at the end of the
year). Some financial institutions compound
interest on a semiannual basis ( twice a year) or
quarterly ( 4 times a year) or some even on a
daily basis (365 times a year).
Following the same formula some adjustments is
made:

FV= PV (1 + i)n
FV = PV (1+ i/m ) mn
m = the number of times compounding occur
during the year.
i = interest rate per annum

If we place RM100 in a Saving Account that earn

12% but compounded quarterly, what will our
saving account be at the end of five (50) year?
FV = PV (1 = i/m)mn
FV = RM100 (1+12/4)4 . 5
= RM100(1.03)20
= RM100(1.806)
= RM180.60

Present Value (lump sum)

FV= PV (1+I)n
PV = FV
or
(1+i)n

FV

1
(1+i)n

What is the value of RM500 to be received 10

years from today if our discount rate is 6%?
PV = FV
(1+i)n

RM500
=
(1+6%)10

= RM500 (0.558)
= RM279

RM500
1.791

present value factor

ANNUITIES
An annuities is a series of equal RM payments for
a specified number of period e.g. RM1000 every
year for next 10 years, or RM 100 every month for
the next 5 years.

Annuities (cont.)
Ordinary Annuity - payment occur at the END of
each period
Annuity Due - payment occur at the beginning of
each period

Compound Annuities
- depositing or investing an equal sum of money at
the end of each period for a certain numbers of
years and allowing it to grow.
E.g. to provide for college education by depositing
RM500 at the end of the year ( I.e. ordinary
annuities) for the next 5 years where it will earn
6%. How much will we have at the end of fifth
year?

Using Formula
FV = PMT (FVIFA i, n )
FVIFA i, n = Future Value Interest Factor
Annuity with i interest and n periods

FV = PMT (FVIFA i,n)

= RM500 (FVIFA 6%, 5 years)
= RM500 ( 5.637)
= RM2818.50

RM2818.50 = PMT (FVIFA i,n)

= PMT(FVIFA 6%, 5 years)
PMT
PMT

= PMT ( 5.637)
= RM2818.50/5.637
= RM500

FV
RM2818.50

= PMT (FVIFA i,n)

= RM500 (FVIFA i, 5 yrs)

(FVIFA i, 5 yrs) =RM2818.50/RM500

(FVIFA i, 5yrs)

= 5.637

Referring to FVIFA Table a factor of 5.637 equates

Year 5 with Interest of 6%

FV
RM2818.50

= PMT (FVIFA i,n)

= RM500 (FVIFA 6%, n yrs)

(FVIFA 6%, n yrs) = RM2818.50/RM500

(FVIFA 6%, n yrs) = 5.637
Referring to the FVIFA Table 5.637 equates 6% with
period equal to 5 years.

Present Value Annuity

PV = PMT (PVIFA i, n)
e.g What is the PV of a 10 year RM1000 annuity
discounted back to the present at 5%?

Present Value Annuity

PV = PMT (PVIFA i, n)
PV = RM1000 (PVIFA 5%, 10 yrs)
PV = RM1000 (7.722)
PV = RM7722
thus if you deposit RM7722 now you can withdraw
RM1000 every year for the next 10 years.

Present Value Annuity

PV = PMT (PVIFA i, n)
PV = RM1000 (PVIFA 5%, 10 yrs)
By manipulation of the equation, you can find either
PV, PMT, Interest and period.

Ordinary Annuity Vs. Annuity Due

Ordinary Annuity refer to payment occurs at the end of the
period
Annuity due refer to payment occur at the beginning of the
period.

FV = PMT (FVIFA i,n) - ordinary annuity

FV = PMT (FVIFA i,n)(1+i) - annuity due

PV = PMT (PVIFA i,n) - ordinary annuity

PV = PMT (PVIFA i, n)(1+i) - annuity due.

UNEVEN CASH STREAM

YEAR CASH FLOW
1
RM500
2
RM200
3 - RM400
4
RM500
5
RM500

YEAR CASH FLOW

6
RM500
7
RM500
8
RM500
9
RM500
10
RM500

Check Your Understanding

What is the PV of an investment involving RM200
received at the end of years 1 through 5, a RM300
cash outflow at the end of year 6, and RM500
received at the end of years 7 through 10, given a
5% discount rate?
The answer should be RM1964.66

PERPETUITIES

What is the PV of a RM500 perpetuity discounted

back to the present at 8%.
PV = PP/i = RM500/8%
= RM6250

Making Interest Rate Comparable

Conversion of Nominal/Quoted Rate into Effective
Annual Rate/Annual Percentage Yield
Effective Annual Yield = (1+i/m)m-1
where: I = nominal rate
m = number of compounding period
within a year

Example: 12% loan compounded monthly

EAR = (1+0.12/12)12-1 = 12.80%
: 12% compounded semiannual
EAR = (1+0.12/2)2-1 = 12.36%

Summary of Time Value of Money

Equations
1. Future Value of Single Payment:
FVn=PV(FVIFi,n)
2. Future Value Single Payment with nonannual
compounding :
FVn = PV(1+ i/m)mn

3. Present Value of Single Payment:

PV = FVn(PVIF i,n)
4. Future Value Annuity:
FVn = PMT (FVITA i,n)
5. Present Value Annuity:
PV = PMT (PVIFA i,n)

Present Value of a Perpetuity

PV = PP/i

END OF CHAPTER