Class 5

Time Value of Money
Presented by
Kanon Kumar Sen
Future Value
FV=PV(1+r)n
Here, FV= Future value
PV= Present value
R= Interest Rate
n= Number of period
Spread Sheet Calculation
Determine FV
Suppose you currently have $2,000 and plan to
purchase a 3-year certificate of deposit (CD) that
pays 4% interest, compounded annually. How much will
you have when the CD matures? How would your answer
change if the interest rate were 5%, or 6%, or 20%?
($2,249.73)
Present Value
FV=PV(1+r)n
=> PV= FV/(1+r)n
Determine PV
• Suppose a risk-free bond promises to pay
$2,249.73 in 3 years. If the going risk-free
interest rate is 4%, how much is the bond
worth today? How much is the bond worth if it
matures in 5 rather than 3 years? If the
risk-free interest rate is 6% rather than 4%,
how much is the 5-year bond worth today?
• $2000
• $1849.11
• $1681.13
Finding the Interest Rate
• Suppose you can buy a U.S. Treasury bond
that makes no payments until the bond
matures 10 years from now, at which time it
will pay you $1,000.5 What interest rate
would you earn if you bought this bond for
$585.43?
• (5.5%)
• What rate would you earn if you could buy
the bond for $550?
• (6.16%)
Finding the Interest Rate
• =RATE(N,PMT,PV,FV).
• For this example, the interest rate is found as =RATE(10,0,−100,150) =
0.0414 = 4.14%.
Finding the Number of Years, N
=NPER(I,PMT,PV,FV)
=NPER(I,PMT,PV,FV). Inserting data, we have
=NPER(0.045,0,−500000,1000000) = 15.7473.
• How long would it take $1,000 to double if
it were invested in a bank that pays 6% per
year? How long would it take if the rate
were 10%?
• 11.9 years
• 7.27 years
PV of Perpetuity
The previous sections examined the relationship

between the present value and future value of a
single payment at a fixed point in time.
However, some securities promise to make
payments forever.
PV of Perpetuity
• What is the present value of a perpetuity that
pays 1,000 per year, beginning 1 year from now,
if the appropriate interest rate is 5%?
• What would the value be if the perpetuity began
its payments immediately?
• 20,000
• 21,000
Annuity
• If the payments are equal and are made at fixed intervals, then we
have an annuity.
Ordinary annuity, which is also called a deferred annuity
Annuity due
Future Value of an Ordinary Annuity
Spreadsheet Calculation
Future Value of an Annuity Due
PV of Ordinary Annuity
PV of Ordinary Annuity
PV of Annuity Due
What is the PVA of an ordinary annuity with 10
payments of $100 if the appropriate interest rate is
10%?
($614.46)
What would the PVA be if the interest rate were 4%?
$811.09
What if the interest rate were 0%? ($1,000.00) What
would the PVAs be if we were dealing with annuities
due?
$675.90
$843.53
$1,000.00
Finding Annuity Payment:
To find out Annuity payment,
We need
1. Future value or present value
2. Interest rate
3. Number of periods
For example- FVOA= PMT* ((1+i)^n -1)/i
PVOA= PMT*((1/i)-(1/(1+i)^n)
Excel Application
= PMT(I, N, PV, FV, Type)
You just inherited $100,000 and invested it at 7%
per year. How large a withdrawal could you make at
the end of each of the next 10 years and end up
with zero?
$14,237.75
How would your answer change if you made
withdrawals at the beginning of each year?
$13,306.31
Finding the Interest Rate, I
=RATE (N, PMT, PV, FV, Type)
Your uncle named you as the beneficiary of his life
insurance policy. The insurance company gives you a
choice of $100,000 today or a 12-year annuity of
$12,000 at the end of each year. What rate of return
is the insurance company offering?
6.11%
Finding the number of period, N
If you have $100,000 that is invested at
7%and you wanted to withdraw $10,000 at the
end of each year, how long will your funds
last? (17.8 years) How long would they last
if you earned 0%?
10 years
How long would they last if you earned the
7% but limited your withdrawals to $7,000
per year?
forever
• You just inherited an annuity that will pay you
$10,000 per year for 10 years, and you receive the
first payment today. A professional investor offers
to give you $60,000 for the annuity. If you sell it
to him, what rate of return will he earn on the
investment?
• (13.70%)
• If you think a “fair” rate of return would be 6%,
how much should you ask for the annuity?
• ($78,016.92)

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Time Value of Money

The previous sections examined the relationship

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