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Lecture notes about time value of money
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This document provides an overview on the time value of money
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5003FIN – Lecture 2Time Value of Money
Basic idea is £1 received today is worth more than £1 received in the future
Important element is decision
It allows interest to be earned on the money
It allows for inflation that can reduce the value of money in the future
It allows for uncertainty (risk) associated with future cash flows, lowering the value of money
in the future
The connecting piece or link between present and future is the interest or discount rate
Four types of Time Value of Money
Simple Present value – Discounted
Present Value of Annuity
Simple Future Value – Compounding
Future Value of Annuity
Key Terminology
Future Value (FV) – amount an investment is worth after one or more periods
Present Value (PV) – what that future cash flow is worth today
Compounding – the process of calculating present values of cash flows
Discounting – the process of calculating present values of cash flows
Main Elements in Time Value of Money calculation
1. Cash Flow
2. Period
3. Interest Rate / Required rate of returns
4. Single Cash Flow or Series of Cash Flow
Future Value and Compounding
How much would you have at the end of one year if you deposit £700 in a bank account that pays
10% interest each year?
After 1 year:
FV1 = PV + Interest1 = PV + PV (r)
= PV(1 + r)
= £700(1.10)
= £770.00
After 2 years:
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