FEU HIGH SCHOOL

S.Y. 2022 - 2023

BUSINESS FINANCE
MODULE 6: TIME VALUE OF MONEY
Module Overview:

This module will introduce you to the concept of the time value of money, explaining why money today is worth more
than money in the future. You will learn about the different factors that influence the time value of money and
understand how to calculate present and future values.

Topic Objectives:
At the end of this module learners will be able to:
• Understand the concept of the time value of money and its importance in financial decision-making.
• Calculate the future and present value of an investment using different formulas and techniques.
• Evaluate the impact of compounding and annuities on the time value of money and understand how to calculate
the effective annual rate of interest.
• Apply the concepts of the time value of money to real-world financial situations used in business and personal
transactions.

Introduction:

The time value of money is a fundamental concept in finance that refers to the idea that money has a different value at
different points in time. Specifically, money available today is worth more than the same amount of money available in
the future, due to the potential for earning interest or returns on investment.

Understanding the time value of money is essential for making informed financial decisions, such as investing,
borrowing, and budgeting. By considering the time value of money, individuals and businesses can evaluate the
potential benefits and costs of financial transactions over time, and make decisions that are in their best interest.

Some of the key factors that affect the time value of money include the interest rate, inflation, and the length of time
involved. For example, a higher interest rate generally increases the present value of future cash flows, while inflation
decreases the purchasing power of money over time.

Overall, understanding the time value of money is essential for anyone who wants to make smart financial decisions and
achieve their long-term financial goals.

Understanding Time Value of Money:

The time value of money is a financial concept that refers to the idea that the value of money today is worth more
than the same amount of money in the future due to the potential for earning interest or returns. This concept is based
on the assumption that money today can be invested to earn a return, which will increase its value over time. The time
value of money is essential for making informed financial decisions, including investments, loans, and savings, as it helps
individuals and businesses compare the value of money today versus money in the future.

Why do we need to know about time value of money?

Understanding the time value of money is crucial for making informed financial decisions. Here are reasons why we
need to understand the time value of money:

1. Investment Decisions: Investors need to consider the time value of money when evaluating investment
opportunities. By understanding the potential future value of an investment and the expected return, investors
can determine whether the investment is worth making.

2. Loan Decisions: Borrowers need to consider the time value of money when taking out a loan. The borrower
needs to consider the interest rate and the length of the loan term to determine the total amount of interest
that will be paid over the life of the loan.
 3. Retirement Planning: Understanding the time value of money is essential for retirement planning. By
considering the present value and future value of money, investors can determine how much they need to save
to achieve their retirement goals.

4. Inflation: The time value of money takes into account inflation, which is the increase in the price of goods and
services over time. By understanding inflation, individuals can make better financial decisions to ensure their
money retains its value over time.

5. Business Decisions: Businesses also need to consider the time value of money when making financial decisions.
By understanding the present and future value of money, businesses can determine whether to invest in a
project or make a strategic acquisition.

The Present Value of Money

The present value of money refers to the value of a sum of money at the present time, which is equal to the amount of
money that would have to be invested now at a given interest rate to equal the sum of money at a future point in time.
It is based on the principle that money available now is worth more than the same amount of money in the future due
to the time value of money.

The present value of money is important in finance and investing, as it allows individuals and businesses to evaluate the
profitability of investments, loans, and other financial transactions over time. By calculating the present value of a future
cash flow, investors can determine whether an investment is likely to generate a feasible return or not.

The formula for calculating the present value of money is:

𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)

Present Value (PV) =
(1 + 𝑖)𝑛
Where:
PV = Present value
FV = Future value
i = nominal rate (%) / frequency of conversion
Frequency of Conversion:
• Annual =1
• Semi-Annual = 2
• Quarterly =4
• Monthly = 12
n = Number of periods (time x frequency of conversion)

For example, if you expect to have a future return of Php 1,000 due in 3 years and a nominal rate of 5% compounded
annually, the present value of would be:

𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑉)

Present Value (PV) =
(1 + 𝑖)𝑛
Where i is:
1,000 0.05
Present Value (PV) = = 0.05
(1 + 0.05)3 1

Present Value (PV) = Php 863.84

This means that the present value of Php 1,000 due in 3 years at a rate of 5% compounded annually is Php 863.84 today.

Additional Problem:

John Michael wants to earned at least 45,000 in a time deposit for 5 years, the bank offered him two options, the first
option is to compound monthly and the second option to compound quarterly, both at 5% interest. Which option would
require a smaller deposit?
The Future Value of Money

The future value of money refers to the value of an amount of money at a future point in time, based on a certain
interest rate or rate of return. Essentially, it is the amount that an investment or savings account will be worth in the
future, after accounting for the effects of interest or compounding.

The future value of money can be calculated using a formula that takes into account the present value of the money, the
interest rate, and the time period involved. The formula is:

Future Value (FV) = Present Value (1 + 𝑖)𝑛

Where:
PV = Present value
FV = Future value
i = nominal rate (%) / frequency of conversion
Frequency of Conversion:
• Annual =1
• Semi-Annual = 2
• Quarterly =4
• Monthly = 12
n = Number of periods (time x frequency of conversion)

For example, if you deposit Php 1,000 into a savings account that earns an annual interest rate of 5% compounded
annually and you plan to leave it there for 5 years, the future value of your money would be:

Future Value (FV) = Present Value (1 + 𝑖)𝑛

Where i is:
Future Value (FV) = 1,000 (1 + 0.05)5 0.05
= 0.05
1
Future Value (FV) = Php 1,276.28

This means that after 5 years, your initial investment of Php 1,000 would be worth Php 1,276.28, assuming that the
interest rate stays the same and that the interest is compounded annually.

Additional Problem:

You decided to deposit your monthly savings on a time deposit account amounting to Php 9,000. ABC Bank offers 12
percent per year compounded monthly, while King Bank offers 12 percent but will only compound annually. How much
will your investment be worth in 10 years at each bank?

References:
• [Link]
solutions/
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Prepared by:
Mr. Albert Gaddiel Cobico
SPP – Business Finance