BBUS6020 Ch5

Chapter 5
Introduction to Valuation: The Time Value of Money
5.1 Future Value and Compounding

5.2 Present Value and Discounting
5.3 More on Present and Future Values
5.4 Summary and Conclusions
© Dr. Alex Ng, Thompson Rivers University

Introduction to Time Value of Money
• Fundamental concept
• Important applications for financial decision making
• I.e. bank deposits, taking out a loan, buying a bond, investing in

a stock, saving for RRSP’s
• Financial managers must determine value of cash flows today that

are expected in the future i.e. capital budgeting
• A dollar today is wroth more than a dollar promised in the future,

why?
• Today’s dollar could have earned interest
• Today’s dollar would grow more than a dollar

Introduction to Time Value of Money
PV of $1 for Different Periods and Rates
Present
value
of $1 ($)
1.00 r = 0%
.90
.80
.70
r = 5%
.60
.50
.40 r = 10%
.30 r = 15%
.20 r = 20%
.10
Time
1 2 3 4 5 6 7 8 9 10 (years)
Questions and Examples Related to Time Value
• Future value of money can be thought as later money
• Present value of money can be thought as earlier money
• Think of exchange rate to convert CDN$ to US$
• Using interest rates to convert between earlier money (PV) to

later money (FV)
• Try drawing a time line:
PV FV
• Understanding time value allows you to relate/solve such questions:
• If I have $1,000 in savings and interest is 5%, how much will I have in 5 years?
• If you need $20,000 in 5 years to pay tuition, you can earn 8% on your money,
how much do you need today?
Calculator Keys
• Texas Instruments BA‐II Plus
– FV = future value
– PV = present value
– I/Y = period interest rate
• P/Y must equal 1 for the I/Y to be the period rate
• Interest is entered as a percent, not a decimal
– N = number of periods
– Remember to clear the registers (CLR TVM) after
each problem
– Other calculators are similar in format
5‐6
Future Value for a Lump Sum
• Notice that
1. $110 = $100 x (1 + 0.10)
2. $121 = $110 x (1 + 0.10) = $100 x 1.1 x 1.1 = $100 x 1.12
3. $133.10 = $121 x (1 + 0.10) = $100 x 1.1 x 1.1 x 1.1
= $100 x __________
• Future value, FVt, of $1 invested today at r% for t periods is:
FVt = $1 x (1 + r)t
• (1 + r)t is the future value interest factor
• When t = 1, simple interest. When t > 1, compound interest effect

Future Value for a Lump Sum Cont’d
Q.Deposit $5,000 today in hopes to purchase
a car in 6 years. You deposit in an account
paying 12%. How much will you
have in 6 years? How much is
simple interest? How much is
compound interest?
A.Multiply the $5,000 by the future value interest factor

$5,000 x (1 + r)t = $5,000 x __________
= $5,000 x 1.9738227
= $9,869.1135
At 12%, simple interest is 0.12 x $5,000 = $_____ per year. After 6

years, this is 6 x $600 = $______; the difference between
compound and simple interest is thus $_______ - $3,600 =
$_____
Exercise on Doing Future Values
Calculate future value of each of the following cash flows:
Today’s $ Interest Rate Time in Years Future Value
$60,000 12% 1
$273,000 10% 3
$1,500 4% 7
Future Value for a Lump Sum Cont’d
• Basic vocabulary:
1. The expression (1 + r)t is called the future value interest

factor or _________________________
2. The r is usually called the ________________________
3. The approach is often called _______________________

Present Value of a Lump Sum
Q.Suppose you need $20,000 in three years to pay

your college tuition. If you can earn 8% on your
money, how much do you need today?
A.Here we know the future value is $20,000, the rate (8%), and the
number of periods (3). What is the unknown present value amount
(called the present value)? From before:
FVt = PV x (1 + r)t
$20,000 = PV x _________
Rearranging:
PV = $20,000 / (1.08)3
= $_____________
In general, the present value, PV, of a $1 to be received in t periods

when the rate r is:
PV = $ 1 / (1 + r)t
Exercise on Doing Present Values or Discounting
Calculate present value for each of the following cash flows:
Future Cash Flow Interest Rate Time in Years Present Value of

Future $
$10,000 10% 1
$153,000 13% 3
$1,000,000 9% 10
Present Value of a Lump Sum Cont’d
• Basic vocabulary:
1. The expression 1/(1 + r)t is called the present value interest

factor or, more often , the _________________________
2. The r is usually called the ________________________
3. The approach is often called _______________________

BC SME
Carbon Engineering
https://www.youtube.com/watch?v=GkEAA7V
nyhE
Summary of Time Value Calculations
I. Symbols:
PV = Present value, what future cash flows are worth today
FVt = Future value, what cash flows are worth in the future
r = Interest rate, rate of return, or discount rate per period
t = Number of periods
C = cash amount
II.Future value of C dollars invested at r percent per period for t periods:
FVt = C x (1 + r)t
The term (1 + r)t is called the future value interest rate factor and
often abbreviated FVIFr,t or FVIF(r,t)
Summary of Time Value Calculations
III. Present value of C dollars to be received in t periods at r percent per

period:
PV = C/(1 + r)t
The term 1/(1 + r)t is called the present value interest rate factor and
often abbreviated PVIFr,t or PVIF(r,t)
IV. The basic present equation giving the relationship between present
and future value is:
PV = FVt / (1 + r)t
More Time Value – Calculating Interest and Periods
• Recall: the basic equation of PV and FV
PV = FVt / (1 + r)t
• To calculate r, the interest rate:
r = t root of [FV/PV] – 1
i.e. What interest rate makes a PV of $100 to become a FV of

$150 in 6 years?
R = tFV/PV - 1
= 6150/100 - 1
= 1.07-1
= .07 or 7%
More Time Value – Calculating Interest and Periods Cont’d
• To calculate # of periods, t
t = [ In(FV/PV)]
In (1+ r)
i.e. Solve for the unknown time period for the following:
Present Value Future Value Interest Time (yrs)
100 350 12%
4100 8,512 5%
Today, We learned….
Chapter 5
Introduction to Valuation: The Time Value of Money
5.1 Future Value and Compounding

5.2 Present Value and Discounting
5.3 More on Present and Future Values
5.4 Summary and Conclusions

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Chapter 5

Introduction to Valuation: The Time Value of Money

5.1 Future Value and Compounding

© Dr. Alex Ng, Thompson Rivers University

• Important applications for financial decision making

• I.e. bank deposits, taking out a loan, buying a bond, investing in

• Financial managers must determine value of cash flows today that

• A dollar today is wroth more than a dollar promised in the future,

• Today’s dollar could have earned interest

• Today’s dollar would grow more than a dollar

• Future value of money can be thought as later money

• Present value of money can be thought as earlier money

• Think of exchange rate to convert CDN$ to US$

• Using interest rates to convert between earlier money (PV) to

• Try drawing a time line:

• Understanding time value allows you to relate/solve such questions:

1. $110 = $100 x (1 + 0.10)

2. $121 = $110 x (1 + 0.10) = $100 x 1.1 x 1.1 = $100 x 1.12

3. $133.10 = $121 x (1 + 0.10) = $100 x 1.1 x 1.1 x 1.1

• Future value, FVt, of $1 invested today at r% for t periods is:

• (1 + r)t is the future value interest factor

• When t = 1, simple interest. When t > 1, compound interest effect

A.Multiply the $5,000 by the future value interest factor

At 12%, simple interest is 0.12 x $5,000 = $_____ per year. After 6

Calculate future value of each of the following cash flows:

Today’s $ Interest Rate Time in Years Future Value

1. The expression (1 + r)t is called the future value interest

2. The r is usually called the ________________________

3. The approach is often called _______________________

Q.Suppose you need $20,000 in three years to pay

In general, the present value, PV, of a $1 to be received in t periods

Calculate present value for each of the following cash flows:

Future Cash Flow Interest Rate Time in Years Present Value of

1. The expression 1/(1 + r)t is called the present value interest

2. The r is usually called the ________________________

3. The approach is often called _______________________

II.Future value of C dollars invested at r percent per period for t periods:

III. Present value of C dollars to be received in t periods at r percent per

• To calculate r, the interest rate:

i.e. What interest rate makes a PV of $100 to become a FV of

Present Value Future Value Interest Time (yrs)

100 350 12%

5.1 Future Value and Compounding

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