MABALACAT CITY COLLEGE

Rizal St. Brgy. Dolores, Mabalacat City, Pampanga

CYCLE 1
1st Semester | A.Y. 2021-2022

October 4 - October 9,
2021

FINMAN
Financial Management 1

Ian Paulo N. Punsalan,

MM

Institute of Business Education

BSA 2-A

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 MABALACAT CITY COLLEGE
Institute of Business Education
Cycle 1, 1st Semester, Academic Year 2021-2022

FINMAN: FINANCIAL MANAGEMENT

1 MODULE 5: TIME VALUE OF
MONEY

1. LEARNING OBJECTIVES:
After this module, you should be able to:
1. Discuss the role of time value in finance, the use of computational tools, and the
basic patterns of cash flow.
2. Understand the concepts of future value and present value, their calculation for
single amounts, and the relationship between them.
3. Find the future value and the present value of both an ordinary annuity and an
annuity due, and find the present value of a perpetuity.
4. Calculate both the future value and the present value of a mixed stream of cash
flows.

II. TOPIC OUTLINE:

 Time Value in Finance
 Future and Present Values of Single Amount
 Future and Present Values of Ordinary Annuity
 Future and Present Values of Annuity Dues
 Present Value of a Perpetuity
 Future and Present Values of Mixed Streams

III. LESSON PROPER

THE ROLE OF TIME VALUE IN FINANCE

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 today is worth
more than a dollar in the future. 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. This module introduces you to those tools.

Future Value versus Present Value

Suppose a firm has an opportunity to spend P15,000 today on some investment that will
produce P17,000 spread out over the next five years as follows:
Year 1 P3,000
Year 2 P5,000
Year 3 P4,000
Year 4 P3,000
Year 5 P2,000

Is this a wise investment? It might seem that the obvious answer is yes because the firm
spends P15,000 and receives P17,000. 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 P17,000 inflows are enough to justify the initial
investment.

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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 in 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 P15,000 today? In other words, what is the future value of P15,000? The
other approach asks, What amount today is equivalent to P17,000 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?

Basic Patterns of Cash Flow

The cash flow—both inflows and outflows—of a firm can be described by its general
pattern. It can be defined as a single amount, an annuity, or a mixed stream.

 Single amount: A lump-sum amount either currently held or expected at some

future date. Examples include P1,000 today and P650 to be received at the end of
10 years.

 Annuity: A level periodic stream of cash flow. For our purposes, we’ll work
primarily with annual cash flows. Examples include either paying out or receiving
P800 at the end of each of the next 7 years. (the cash flow in annuity it
should be equal or the money involve is the same)

 Mixed stream: A stream of cash flow that is not an annuity; a stream of unequal
periodic cash flows that reflect no particular pattern. The previous example on the
investment of P15,000 that will produce P17,000 spread out over the next five
years is an example of mixed stream.

SINGLE AMOUNTS
A lump-sum amount either currently held or expected at some future date

Future Value of a Single Amount

Future value 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. Compound interest is interest that is earned on a given deposit and has
become part of the principal at the end of a specified period. Principal is the amount of
money on which interest is paid.

The general equation for the future value at the end of period n is:
𝐹𝑉𝑛 = 𝑃𝑉 × (1 + 𝑟)^n

We use the following notation for the various inputs:

 FVn —— future value at the end of period n
 PV—— initial principal, or present value
 r —— annual rate of interest paid
 n = number of periods (typically years) that the money is left on deposit

Example:Jane places P800 in a savings account paying 6% interest compounded annually.

She wants to know how much money will be in the account at the end of five years.
𝐹𝑉𝑛 = 𝑃800 × (1 + 0.06)5
𝐹𝑉𝑛 = 𝑃1,070.58

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 PV =FVn
(1 + r)n

PV = P1,700
(1 +
0.08)8

PV = P918.46


 𝐹𝑉𝑛 = 𝐶𝐹
×{ [(1 + r)n − 1]
r

𝐹𝑉𝑛 = 𝑃1,000 × {[(1 + 0.07)5 − 1]

}
0.07

𝐹𝑉𝑛 = 𝑃5,750.94
 𝐶𝐹 1
𝑃𝑉𝑛 = ( ) × [1 − ]
r (1 + 𝑟 )𝑛

𝑃700 1
𝑃𝑉𝑛 = ( ) × [1 − ]
0.08 (1 + 0.08)5

𝑃𝑉𝑛 = 𝑃2,794.90

[(1 + r)n − 1]
FVn = CF × { } × (1 + r)
r

[(1 + 0.07)5 − 1]
FVn = P1,000 × { } × (1 + 0.07)
0.07

FVn = P6,153.29
 𝐶𝐹 1
𝑃𝑉𝑛 = ( ) × [1 − ] × (1 + 𝑟)
𝑟 (1 + 𝑟 )𝑛

P700 1
FVn = ( ) × [1 − ] × (1 + 0.08)
0.08 (1 + 0.08)5
FVn = P3,018.49

CF
PV =
r

P200,000
PV =
0.10

PV = P2,000,000
Future Value of a Mixed Stream
Example: Shrell Industries, a cabinet manufacturer, expects to receive the following mixed
stream of cash flows over the next 5 years from one of its small customers.

End of the Cash flow

Year P11,500
1 P14,000
2 P12,900
3 P16,000
4 P18,000
5

If the firm expects to earn at least 8% on its investments, how much will it accumulate
by the end of year 5 if it immediately invests these cash flows when they are
received?

This situation is depicted on the following time line.

15,645.d2
7,d35.97
15,046.56
J 7,280.00
18,000.00
83,608.15 Fufure Yolue

11,500 1d,000 12,900 16,000 8,000

0 2 3 d 5
End of Yeer

Present Value of a Mixed Stream

Example: Frey Company, a shoe manufacturer, has been offered an opportunity to receive
the
following mixed stream of cash flows over the next 5 years.

End of the Cash flow

Year P400
1 P800
2 P500
3 P400
4 P300
5

If the firm must earn at least 9% on its investments, what is the most it should pay for this
opportunity?

This situation is depicted on the following time line.

End of Yeor
0 2 3

aOO 800 SOO aOO 300

366.97
673.3a
386.09
283.37

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PRACTICE PROBLEMS: Try to solve the following practice problems on the time value
of money.

1. You have P1,500 to invest today at 7% interest compounded annually.

a. Find how much you will have accumulated at the end of 3 years.
b. Find how much you will have accumulated at the end of 6 years.
c. Find how much you will have accumulated at the end of 9 years.

2. What is the present value of P6,000 to be received at the end of 6 years if the
discount rate is 12%?

3. What single investment made today, earning 14% annual interest, will be worth
P26,000 at the end of 5 years?

4. For each case in the accompanying table, answer the questions that follow.
Amount of Interest Deposit period
Case Annuity Rate (years)
A P2,500 8% 10
B P500 12% 6
C P30,000 20% 3
a. Calculate the future value of the annuity assuming that it is an ordinary annuity.
b. Calculate the future value of the annuity assuming that is an annuity due.

5. For each case in the accompanying table, answer the questions that follow.
Amount of Interest Deposit period
Case Annuity Rate (years)
A P12,000 7% 3
B P55,000 12% 15
C P700 20% 9
a. Calculate the present value of the annuity assuming that it is an ordinary annuity.
b. Calculate the present value of the annuity assuming that is an annuity due.

6. An insurance agent is trying to sell you an immediate-retirement annuity, which for a

single amount paid today will provide you with P600,000 at the end of each year for
the next 25 years. You currently earn 9% on low-risk investments comparable to the
retirement annuity. Ignoring taxes, what is the most you would pay for this annuity?

Consider the two cases below. Determine the future value of the cash flow stream if
deposits are made into an account paying annual interest of 12%. The deposits are
made:
a. At the end of each year.
b. At the beginning of each year.
Year B
1 P900 P30,000
2 P1,000 P25,000
3 P1,200 P20,000
4 P10,000
5 P5,000

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 8. Consider the two cases below. Determine the present value of the cash flow stream if
deposits are made into an account paying annual interest of 12%. The deposits are
made:
c. At the end of each year.
d. At the beginning of each year.
Year B
1 P800 P35,000
2 P1,200 P40,000
3 P1,400 P10,000
4 P8,000
5 P3,000

IV. REFERENCES

Brigham, E.F. & Houston, J.F. (2009). Fundamentals of Financial Management. Mason,
Ohio: South- Western Cengage Learning.

Gitman, LJ., & Zutter, T.J. (2012). Principles of Managerial Finance. Boston, Massachusetts:
Pearson Education, Inc.

V. DISCLAIMER

OFFICIAL MCC MODULE DISCLAIMER

It is not the intention of the author/s nor the publisher of this module to have monetary gain
in using the textual information, imageries, and other references used in its production. This
module is only for the exclusive use of a bona fide student of Mabalacat City College.

In addition, this module or no part of it thereof may be reproduced, stored in a retrieval

system, or transmitted, in any form or by any means, electronic, mechanical,
photocopying, and/or otherwise, without the prior permission of Mabalacat City
College.

Prepared by:

IAN PAULO N. PUNSALAN, MM

Instructor

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