120 16 Chapter 17 TimeValueofMoney

5/17/2021
Chapter 17
Project Selection and Portfolio
Management, Time Value of Money
Project Management for Business,

Engineering, and Technology
Basic Concepts
Time-value of Money
1
5/17/2021
Time-value of Money
◼ All Projects involve a cash stream of some

sort
❑ It is usually a combination of both income and
expenses
❑ If the net is positive the project “made money”;
otherwise, it “lost money”
◼ One way to sort out project alternatives is
through engineering economy
The General Concepts

◼ Money, besides being a measure of value, is a
commodity, just like gold, wheat…
◼ It is can be bought, sold, borrowed, loaned,
saved, consumed, and stolen
◼ When money is borrowed the “rent” is called
interest.
❑ If you loan money you earn interest; If you borrow
money you pay interest
◼ Because the amount of interest is a function of
time, the value of an amount of money varies as
a function of time
2
5/17/2021
Interest
◼ Simple interest vs. compound interest:

❑ Simple interest is a certain % of the money loaned
◼ Time may, or may not, be a factor
❑ Compound interest is a relatively new invention
(1700’s?) and is essentially, interest on interest
Discounting
◼ When interest rates are greater than zero,
$$-amounts can only be summed at the
same point in time
◼ Usually, this means that all future $$
amounts are converted to a present value
before they are summed
◼ This is called “discounting” the cash flow
◼ Almost every commercial project is
evaluated and compared based upon some
“discounted cashflow” – stocks, bonds,
projects, real estate…
3
5/17/2021
Other Points …
◼ When interest rates are zero $$-amounts can

summed independent of time
◼ Money is more valuable now than it is some
time in the future – (See 2nd law)
◼ Unless specifically told otherwise, always
assume compound interest
Law 1: Show me the money
The Basic Formula
PV = FV/(1+i%)n
❑ PV or P is present value
❑ FV or F is some amount in the future
❑ i%= the interest rate per period (years, months,
weeks, …)
❑ n = the number of periods
4
5/17/2021
Example # 1 – Single Amount

◼ Question: What is the PV (the value now)
of $10,000 that you expect to receive 2
years from now, if current interest rates are
10% compounded annually?
◼ Answer: PV=$10,000/1.12 = $8,264
FV=$10,000
PV=$8,264
Cash Flow Diagram
Time = 0 Time = 2
1
(or now) Years (or 2-years from now)
Remember!
◼ The time the money is loaned or borrowed is
broken into even time intervals (or, periods) –
years, quarters, months, days.
◼ All cash-flow events occur at the ends of the
time intervals and the interest rate per period
is constant.
◼ Interest rates are generally expressed as
nominal annual (per year =12%) but must be
adjusted to fit the compounding period (per
month =1%, per quarter =3%).
A very common exam mistake
5
5/17/2021
$1,000 now is equivalent to $8,916 12-years in the

future at 20% interest
Period 20% $8,916 =F =P(1+%)n =$1,000(1.2)12
0 $1,000
1 $1,200
Present Money Grows
2 $1,440
3 $1,728
Future Value of $1,000

$10,000
4 $2,074 $8,000
5 $2,488 $6,000
6 $2,986 $4,000
7 $3,583 $2,000
8 $4,300 $0
9 $5,160 0 1 2 3 4 5 6 7 8 9 10 11 12
10 $6,192 Years
11 $7,430
12 $8,916
Law 2: Get the Money Up-Front!
Brute Force
$10,000 12-years in the future at 20% is equivalent

to $1,122 now
Period 20% $1,122 =P =F(1+%)-n =$10,000(1.2)-12
12 $10,000
11 $8,333
10 $6,944
Future Money Shrinks
9 $5,787
8 $4,823 $12,000
Present Value of
7 $4,019 $10,000
$10,000
6 $3,349 $8,000
$6,000
5 $2,791 $4,000
4 $2,326 $2,000
3 $1,938 $0
2 $1,615 12 11 10 9 8 7 6 5 4 3 2 1 0
1 $1,346 Years
0 $1,122
Brute Force Law 3: Take the Money and Run!
6
5/17/2021
Summarizing with Q&A
Net Present Value
7
5/17/2021
Net Present Value

◼ One way to evaluate projects, stocks,
bonds, etc. is by discounted cash flow
◼ Amounts of money scattered at various
points in time can only be summed at the
same point in time – usually now
◼ The relationship: PV=FV/(1+i%)n
is used to “move” money from one point in
time to another
◼ Other evaluation methods: B/C and IRR
Some Commonly Used Terms

◼ P, PV, and NPV – all mean Present
Value or the value of the money Now
◼ F and FV stand for future value
◼ A, AE, and PMT all stand for the

periodic amount in a uniform series
or “annual equivalent” or equal
installment payment, etc.
8
5/17/2021
Derivation of F=P(1+i)n
Years Start Interest End

First P iP P(1+i)
Second P(1+i) iP(1+i) P(1+i)2
Third P(1+i)2 iP(1+i)2 P(1+i)3
n-th P(1+I)n-1 iP(1+I)n-1 P(1+i)n
QED, F=P(1+i)n OR P=F(1+i)-n
Derivation of F=A*(F/A,i,n)
=
(1) F=A(1+i)n-1+…A(1+i)2+ A(1+i)1+A

Multiply by (1+i)
(2) F+Fi = A(1+i)n+A(1+i)n-1…A(1+i)2+A(1+i)1

Subtracting (1) from (2), you get. Fi=A(1+i)n-A
F=A[((1+i)n-1)/i], and
P=A[((1+i)n-1)/i(1+i)n]
9
5/17/2021
Single Value Problem

The relationships between equivalent
amounts of money ($5,000 now) at different
points in time are shown below.
P F
A
1. P= $5,000, i=12% 0 5
2. F= $5,000(1.12)5 = $8,811.71
3. A= $8,811.71*.12/(1.125-1) = $1,387.05
4. P= $1,387.05*(1.125-1)/(.12*1.125) = $5,000
10
5/17/2021
Class Exercise
NPV
Exercise
◼ You borrow $10,000 at 12% per year for 5-years

to purchase a car. What are your monthly
payments?
P=A[((1+i)n-1)/i(1+i)n]
11
5/17/2021
12

120 16 Chapter 17 TimeValueofMoney

Uploaded by

Copyright:

Available Formats

120 16 Chapter 17 TimeValueofMoney

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

120 16 Chapter 17 TimeValueofMoney

Uploaded by

Copyright:

Available Formats

5/17/2021

Project Management for Business,

◼ All Projects involve a cash stream of some

The General Concepts

◼ Simple interest vs. compound interest:

◼ When interest rates are zero $$-amounts can

The Basic Formula

Example # 1 – Single Amount

$1,000 now is equivalent to $8,916 12-years in the

Future Value of $1,000

$10,000 12-years in the future at 20% is equivalent

Brute Force Law 3: Take the Money and Run!

Summarizing with Q&A

Net Present Value

Net Present Value

Some Commonly Used Terms

◼ F and FV stand for future value

◼ A, AE, and PMT all stand for the

Years Start Interest End

QED, F=P(1+i)n OR P=F(1+i)-n

(1) F=A(1+i)n-1+…A(1+i)2+ A(1+i)1+A

(2) F+Fi = A(1+i)n+A(1+i)n-1…A(1+i)2+A(1+i)1

Single Value Problem

Summarizing with Q&A

◼ You borrow $10,000 at 12% per year for 5-years

Summarizing with Q&A

You might also like