Universidad de Zamboanga

Sunken Garden, City Campus,

Zamboanga City

Master in Business Administration

School of Graduate Studies

TIME VALUE OF MONEY

In Partial Fulfillment of the Requirements of

MBA-103-Financial Management
5:00PM-8:00PM-Thursday-Graduate Room-2nd Semester SY 2022-2023

Submitted by:
HANNAH ROSS E. BAEL

BENNET MANDIADI

January 31, 2023

 I. Table of Content 2

II. Introduction 3

III. Scope of the Topic Report 3

IV. Limitation of the Topic Report 4

V. Topic Report Proper 5

VI. Illustrative Problem 14

VII. Solution to the Illustrative Problem 14

VIII. Observation 15

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 II. Introduction

The primary goal of financial management is that to maximize the value of the firm’s

share. This necessarily involves the study of the time value of money. This is because

the benefits that a firm expects to receive from an investment are usually spread out

over a period of time. Such benefits need to be translated into their present value so

as to facilitate their comparison with the initial investment and thereby to ascertain

whether the investment has really added something to corporate wealth.

Financial managers may need to evaluate and assess new project proposals or do

“buy or lease” decisions. These decisions entail capital outlays on the part of the entity.

It is pivotal that they use mathematical tools of the TVMA (Time Value of Money

Analysis) as the primary steps in making decisions involving capital outlay.

III. Scope of the Topic Report

General learning objectives related to this lesson involves the following;

1. Explain the concept of time value of money in general,

2. To show how the future value of cash flows is computed,

3. To show how the present value of future cash flows is computed,

4. Apply the different mathematical models in analyzing the time value of money,

5. Know and explain the use and implications of the time value of money to

financial management and company as a whole, and

6. Interpret the results in computing the time value amounts.

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 III. Limitation of the Topic Report

The concept of time value of money deals with the fact that an amount of money

received in the future is not as valuable as the same amount of money received in

the present. This is because:

1. The future is uncertain;

2. Individuals prefer current to future consumption;

3. The opportunity exists to invest the amount received in the present at a

specific rate of interest;

4. Inflationary trends are a common feature reducing the value of money in

the future.

All this means that future benefits should include some compensation for waiting. In

other words, the future benefits should be equal to the sum of the present benefits

and an amount equivalent to the compensation for waiting.

One disadvantage is that it can be challenging to accurately arrive at a discount rate

that represents the investment's true risk premium. Another disadvantage is that a

company may select a cost of capital that is either too high or too low, thus leading

the company to miss a profitable opportunity or make an investment that is not

worthwhile. There is also the underlying risk associated with every investment made

by the company. In a world of uncertainty, the return may not be realized. Risk can

be thought of as the possibility that the actual return might deviate from the expected

return.

Time value of money analysis (TVMA) is often called discounted cash flow analysis

(DCFA). It is a skill that a financial manager must contain for it involves decisions

that could make an impact on the growth of the company. Some of these involves

evaluating new project proposals which would entail cash inflow as well as cash

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outflow; assessing whether or not the company would need to acquire or merely

lease an equipment it may need for operation; managing and valuing cash funds like

sinking funds and bond redemption bonds, pension funds, and employee benefits;

managing and valuing receivables and long-term obligations like bond payable

where funding a bond is concern. In these situations, determination of the present

value or future values of the cash inflows and outflows is crucial.

V. Topic Report Proper

1. COMPUTATION OF FUTURE VALUE

a) Future Value of a Single Amount (FV of P1.0)

The future value of an amount at the end of Period 1 (A1) will be equal to the product

of the original value (P) and the rate of interest plus 1. This can be expressed in the

form of an equation as follows:

A₁ = P (1 + r)

Here the subscript denotes the end of the specific period. To sight an example,

considering an amount of P100,000.00 is to be invested at a rate of return expected

to be 5%. A₁ = P (1 + r)

A₁ = 100,000 (1 + 0.05) = 105,000.00

Similarly the future value of the amount P at specific rate of interest r at the end of

Period 2 will be: A₂ = {P(1 + r)} (1 + r)

Continuing on the basis of the above example, A after a 2-year period will be:

A₂ = {100,000(1+0.05)}(1+0.05) = 110,250.00

Again, the future value of an amount of money at the end of period n will be:

Aᵑ = P(1 + r)ᵑ

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The future value of 100,000.00, 5 years from now at 5% rate of interest will be:

Aᵑ = 100,000(1 +0.05)⁵ = 127, 628.16

The same can also be computed using the long method, as illustrated below:

December 31, 2021 P100000 x 1.05 P105,000.00

December 31, 2022 (P100000 x 1.05)(1.05) P110,250.00

December 31, 2023 (P100000 x 1.05)³ P115,762.50

December 31, 2024 (P100000 x 1.05)⁴ P121,550.63

December 31, 2025 (P100000 x 1.05)⁵ P127,628.16

Normally, it is difficult to raise (1 + r) to the nth power. In order to overcome this

difficulty, one uses numerical tables. The present value is multiplied by the

compound factor (CF) given in the table in order to arrive at the future value (P ×

CFr,ᵑ). For example, the investment could last up to 10 years at a rate of 5 percent is

illustrated ive the tabulation below.

Aᵑ = P100,000.00 x 1.6289 = P162,890.00

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 b) Future Value of a Series of Payments

When a single amount is not involved; rather a series of receipts occurs over a

specific period of time, the total future value of these receipts can be found out by

adding up the individual future values at the same future time.

The future value of a series of three annual receipts of P50,000, P30,000 and

P20,000 respectively at the end of the third year at 5% rate of interest will be:

A₃ = 50,000 (1.05)² + 30,000 (1.05) + 20,000 = P106,625.00

c) Future Value in Case of Annuities

In the preceding sub-section, the size of receipts in different years was not uniform.

But there are cases when the size of receipts over time is equal or uniform.

Uniformity of cash flows represents a case of annuity. Annuity may be of two types:

1. Regular annuity where the cash flows, equal in size, occur at the end of each

time period;

2. Annuity due where the uniform cash flows occur at the beginning of each

period.

Irrespective of whether the cash flow occurs at the beginning or at the end of each

period, P is equal and so it becomes a common factor. It can be re-written in cases

of regular annuity as follows:

Here too, the difficulty of raising (1 + r ) to the nth power does arise if the value of n

is large. In such cases, the amount of annuity is multiplied by the annuity compound

factor (ACF). This can be expressed in the form of an equation as follows:

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To sight an example, consier the future value of an equal annual investment of

P100,000 at the end of a 10-year period at 10% rate of interest will be:

P100,000 {(1.10)¹⁰-1}/ 0.10 = P1,593,700.00

It can also be computed using the Short Method by determining the equivalent

compound factor in the table, as illustrated below:

P100,000 (15.1937) = P1,519,370.00

The same can be achieve if we solve the given problem using the Long Method by

providing the corresponding compound factor at the end of each year time period.

See illustration below:

In case of an annuity due where cash flows occur at the beginning of a particular

period, the amount is invested for the year. As a result, in this case, it can be re-

written as follows:

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A person saves Php10,000 every year for 18 years so that he will get a lumpsum

amount thereafter to do a business. He expects that his savings should earn 8%

interest. Find the size of the lumpsum amount.

Solution:

Php10,000 x {(1.08¹⁸ – 1)/0.08}

=Php10,000 x 37.4502 = Php374,502.00

d) Frequency of Compounding

Normally, the interest rate is given in per annum terms and compounding is also

done on an annual basis. But there are cases when compounding is done on a half-

yearly or quarterly basis. In specific cases, it is even done monthly. If the frequency

of compounding increases, which means that it is done more than once a year, the

future value of the receipt will be greater. This is because the annual percentage

yield (APY) is greater than the annual percentage rate (APR). The greater the

frequency of compounding, the greater is the APY and the larger the future value of

the receipt. APY is the effective annual rate of interest. It is computed by

compounding the periodic rate for the compounding frequency. This can be

expressed in form of equation as follows:

Where:

m = the number of compounding periods per year

Illustration:

If the annual interest rate is 12% and compounding is done on a monthly basis, the

APY will be:

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 = {1 + (0.12/12)}¹² – 1 = 12.68%

If the annual interest rate is 12% and compounding is done on a quarterly basis, the

APY will be:

= {1 + (0.12/4)}⁴ – 1 = 12.55%

If the annual interest rate is 12% and compounding is done on a semi-annual basis,

the APY will be:

= {1 + (0.12/2)}² – 1 = 12.36%

2. COMPUTATION OF PRESENT VALUE OF CASH FLOWS

a) Present Value of a Single Amount (PV of P1.0)

The formula for determining the future value (A1) of an amount of money (P) is given

in the illustration below. Given the future value of an amount (A1) the formula for

arriving at its present value (P) can be derived and written as follows:

And the equation to arrive at P for the period n will be:

Illustration:

The present value of Php100,000 to be received after 5 years at 10% rate of

discount will be:

Php100,000/(1.10)⁵ = Php62,092.13

Alternatively, Php100,000 can be multiplied by the present value factor (PVFr,n)

which is 0.621 in his case to arrive the present value:

Php100,000 x 0.621 = Php62,100.00

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A slight difference is to be noted due to the rounding of decimals in the compounding

factor used in the illustration.

b) Present Value of a Series of Future Values

When a series of receipts occurs over a specific period of time, the present value of

all the future values can be found out by adding up the present value of individual

future values. If A1, A2, A3 and so on are the receipts during different years, their

present value will be:

P = A₁/(1 + r) + A₂/₁/(1 + r)² + … + Aᵑ₁/(1 + r)ᵑ

Summing up the above equation, we get:

Where:

A₃ = 50,000/(1.05) + 30,000/(1.05)² + 20,000(1.05)³ = Php92,106.68

c) Present Value in Case of Annuity

In case of an annuity, the value of A is uniform and so the present value (P) of an

annuity can be written in the form of an equation as follows:

Or:

Alternatively, one can go for a tabular solution. In this process, the value of annuity is

multiplied by the annuity discount factor.

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To illustrate:

The present value of an investment yielding Php100,000 annually for 20 years at a

discount rate of 8% will be:

Php100,000 [{1 – (1/1 + 0.08)²⁰}/0.08 ] = Php981,814.74

Alternatively,

Php100,000 (9.81815) = Php981,815.00

If it is a case of annuity due which means that cash flows occur at the beginning of

each period, the result will be multiplied by (1 + r) and on the basis of above

example, the present value will be:

Php981,815 x 1.08 = Php1,060,360.20

d) Special Cases of Annuity

Perpetuity: There are some special cases of annuity. The first is perpetuity where

annuity is infinite. In other words, a perpetuity assures the investor/owner of the

funds, periodic cash flows over an infinite period of time (at least in theory). It is

normally found in case of preference shares. Since n approaches infinity, the term

{1/(1 + r)}ᵑ approaches zero.

Example:

If a company offers an annual dividend of Php20 per share and the risk of

investment

justifies a rate of return of 14%, the present value of perpetuity annuity will be:

Php20/0.14 = Php142.86

Deferred Annuity: The other special case of annuity is deferred annuity. It is regular

annuity with the exception that the cash begins to flow only after the deferral period.

If in a six-year annuity the deferral period is 2 years, cash flows will begin at the end

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of the third year. In this case, the present value of the cash flow during the deferral

period will be subtracted from the present value of the cash flow for the entire period.

Example:

If the annual cash flow is Php500, the total period of annuity is 6 years and the

deferral

period is 2 years, the present value at a rate of discount of 10% will be:

=500 (ADF10%, 6+2 yrs – ADF10%, 2yrs)

= 500 (5.3349 – 1.73554)

= Php1799.70

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 VI. Illustrative Problem

Simoun and Clara want to have enough money to travel around the world when they
retire. They just turned 30 and will retire when they turn 60. They earn a total of
9,000 after taxes each month. Their monthly expenditures include 3,000 in mortgage
payments, 850 in car payments, and 1,450 in other expenses. They approached a
fund manager and decided to invest the rest of their income at the end of each year.
They expect to earn a 10 percent expected annual rate of return for each of the next
30 years. When they retire, they will sell their cottage for an expected price of
50,000.
A. Determine how much they will have when they retire.
B. How much can Simoun and Clara withdraw annually at the beginning of the year
for travelling after they retire if they expect to live until they are 90?

VII. Solution to the Illustrative Problem

A. 1st Calculate their yearly income available for investment
Monthly income available
P9,000 – P3,000 – P850 –P1,450 = 3,700
Yearly available = (3,700)(12) = P44,400
2nd Calculate the FV of their investment when they retire:

(1 + 0.10)30 - 1
FV30 = 44,400 = P7,303,535.00
0.10

3rd Calculate the amount they will have when they retire:
P7,303,535 + P50,000 = P7,353,535
B. This is an annuity due problem.
PV=7,353,535, k=10%, n=30
1
7,303,535 = PMT 1- (1 + 0.10)30
0.10
So, PMT=709,143

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 VIII. Observation
Time value of money helps understand when trying to decide between two or more
financial options. The outcome varies depending on the need. Most people prefer to
have the money now due to the daily necessity that needs to be fulfilled right away.
The value of money changes over time and there are several factors that can affect
it. The general rise in prices of goods and services, inflation as they call, has a
negative impact on the future value of money. That's because when prices rise, your
money only goes so far. Even a slight increase in prices means that your purchasing
power drops.

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