THE TIME VALUE OF

MONEY

Department of Industrial Engineering

Simple Interest
 Capital
- refers to wealth in the form of money or property
that can be used to produce more wealth.
 Interest
- the amount of money paid for the use of
borrowed capital or the income produced by
money which has been loaned.
Simple Interest
 When the total interest earned or charged is
linearly proportional to the initial amount of
the loan (principal), the interest rate, and the
number of interest periods for which the
principal is committed, the interest and
interest rate are said to be simple.
Simple Interest
The total interest, I, earned or paid may be
computed using

𝑰=𝑷𝒊𝐧

where P =principal amount lent or borrowed

i = interest rate per interest period
n = number of interest periods
Simple Interest
The total amount F to be repaid is equal to the sum of
the principal (P) and the total interest (I):

𝑭 = 𝑷 + 𝑰 = 𝑷(𝟏 + 𝒊 𝒏)
Simple Interest
 Ordinary Simple Interest
 computed on the basis of one banker’s year,
which is:
= 12 months, each consisting of 30 days
= 360 days

 Exact Simple Interest

 computed on the basis of the exact number of
days, 365 for an ordinary year and 366 days for a
leap year
Simple Interest
If d is the number of days in the interest period, then

𝒅
𝑶𝒓𝒅𝒊𝒏𝒂𝒓𝒚 𝒔𝒊𝒎𝒑𝒍𝒆 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕 = 𝑷 𝒊
𝟑𝟔𝟎
𝒅
𝑬𝒙𝒂𝒄𝒕 𝒔𝒊𝒎𝒑𝒍𝒆 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕(𝒐𝒓𝒅𝒊𝒏𝒂𝒓𝒚 𝒚𝒆𝒂𝒓) = 𝑷 𝒊
𝟑𝟔𝟓

𝒅
𝑬𝒙𝒂𝒄𝒕 𝒔𝒊𝒎𝒑𝒍𝒆 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕(𝒍𝒆𝒂𝒑 𝒚𝒆𝒂𝒓) = 𝑷 𝒊
𝟑𝟔𝟔
Example
 Determine the ordinary simple interest on
P700 for 8 months and 15 days if the rate of
interest is 15%.

Number of days = (8) (30) + 15

= 255 days
I= Pni = P700 x (255/360) x 0.15
= P74.38
Example
 Determine the ordinary simple interest on
P1000 for 10 months and 10 days if the rate
of interest is 12%.

Number of days = (10) (30) + 10

= 310 days
I= Pni = P1000 x (310 /360) x 0.12
= P 103.33
Example
 Determine the Jan 10-31 = 21 (excluding Jan.10)
Feb = 29
exact simple Mar = 31
interest on P500 Apr = 30
for the period May = 31
from January 10 Jun = 30
Jul = 31
to October 28, Aug = 31
2016 at 16% Sep = 30
interest. Oct = 28 (including Oct.28)
292 days
 Exact simple interest = Pni
= P500 x (292/366) x 0.16
= P63.83
Example
 What will be the future worth of money after
14 months, if a sum of P10,000 is invested
today at a simple interest rate of 12% per
year?

F = P (1+ ni)
= P10,000 [ 1+ (14/12) (0.12)]
= P11,400
Cash-Flow Diagrams
 A cash-flow diagram is a graphical
representation of cash flows drawn on a
time scale.

 Receipt (positive cash flow or cash inflow)

 Disbursement (negative cash flow or cash
outflow)
 A loan of P100 at a simple interest of 10% will
become P150 after 5 years.

P150

0 1 2 3 4 5

P100
 A loan of P100 at a simple interest of 10% will
become P150 after 5 years.

P100

0 1 2 3 4 5

P150
  A mutual fund investment of P20,000 becomes
P35,000 after 10 years.
P35k

0 1 2 3 4 5 6 7 8 9 10

P20k
  A pension plan has an annual payment of P10,000 per
year for the next 10 years. After another 10 years, the plan
holder receives P50,000 every year for five years.
50k 50k 50k 50k 50k 50k

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

10k 10k 10k 10k 10k 10k 10k 10k 10k 10k
Compound Interest
 Whenever the interest charge for any interest
period is based on the remaining principal
amount plus any accumulated interest
charges up to the beginning of that period,
the interest is said to be compound.
 P

0 1 2 3 n-1 n
F

Principal at
Interest earned Amount at end
Period beginning of
during period of period
period

1 P Pi P + Pi = P (1+ i )

P (1+ i ) + P (1+ i ) i =
2 P (1+ i ) P (1+ i ) i
P (1+ i )²

P (1+ i )² + P (1+ i )²i =

3 P (1+ i )² P (1+ i )²i
P (1+ i )³
… … … …
n-1 n-1 n
n P (1+ i ) P (1+ i ) i P (1+ i )
Compound Interest

F=P(F/P, i%, n)
𝐹 = 𝑃 1+𝑖 𝑛

The quantity 1 + 𝑖 𝑛 is the “single payment

compound amount factor” and is designated by
F/P, i%, n.
Compound Interest

P=F(P/F, i%, n)
−𝑛
𝑃 =𝐹 1+𝑖
𝐹
𝑃= 𝑛
1+𝑖

The quantity 1 + 𝑖 −𝑛 is the “single payment

present worth factor” and is designated by P/F, i%,
n.
Example
 What will be the future worth of money after
15 years, if a sum of P10,000 is invested
today of 12% compounded annually?

F= P(1+i)^n
= 10000 (1.12)^15
= P54,735.66
Example
 How much should you pay your friendly
lender for a P5000 loan after ten years at
10% compounded annually?

 F=5000(1.1)^10
 P12,968.71
Seatwork
1. How much should you deposit in the bank
today at 2% compounded annually if you want
your money to grow to P1Million after 40
years?
2. If you want to retire with P10Million after 42
years of hard work, how much should you
invest today (one time investment) at 12%
compounded annually?
Nominal Rate of Interest

The nominal rate of interest specifies the rate of

interest and a number of interest periods in one
year.
𝑟
𝑖=
𝑚
Where: i = rate of interest per interest period
r = nominal interest rate
m = number of compounding periods per
year
Effective Rate of Interest

Effective rate of interest is the actual or exact rate

of interest on the principal during one year.

𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑟𝑎𝑡𝑒 = 1 + 𝑖 𝑚
−1
Example
 Find the nominal rate which if converted
quarterly could be used instead of 12%
compounded monthly. What is the
corresponding effective rate?
Example
1. Find the amount at the end of two years and 11
months if P1000 is invested at 8% compounded
quarterly for the first two years and using simple
interest for the next 11 months.

2. A P2000 loan was originally made at 8% simple

interest for 4 years. At the end of this period the
loan was extended for 4 years, without the interest
being paid, but the new interest rate was made
10% compounded semi-annually. How much
should the borrower pay at the end of 8 years?
Example
 A P2000 loan was originally made at 8%
simple interest for 4 years. At the end of this
period the loan was extended for 3 years,
without the interest being paid, but the new
interest rate was made 10% compounded
semi-annually. How much should the
borrower pay at the end of 7 years?
Example
 What payment amount 15 years from now is
equivalent to a payment of Php 3,500 five
years from now, if interest is 11% and is
compounded [a] semi-annually and [b]
monthly?
Example
 If you have to invest, which is better: 12%
compounded semi-annually or 12%
compounded monthly?
Discount

 Interest deducted in advance

 Difference on what is worth in the future and

its present worth

 Discount = Future Worth – Present Worth

Discount

The rate of discount is the discount on one unit of

principal per unit of time.

If d is the rate of discount, then

𝑑 = 1 − (𝑃/𝐹, 𝑖%, 1)
𝑑 = 1 − (1 + 𝑖)−1
1
𝑑 =1−
1+𝑖
Discount
𝑖
𝑑=
1+𝑖

𝑑
𝑖=
1−𝑑
Example

 Mr. J. Dela Cruz borrowed money from a

bank. He received from the bank P1,342 and
promise to pay P1,500 at the end of 9
months. Determine the following:
 Rate of discount (Banker’s discount)

 Rate of interest

 Rate of interest for one year

Inflation
 Inflation is the increase in the prices of goods
and services from one year to another, thus
decreasing the purchasing power of money.
Inflation

𝐹𝐶 = 𝑃𝐶 1 + 𝑓 𝑛

Where: PC = present cost of a commodity

FC = future cost of the same commodity
f = annual inflation rate
n = number of years
Example
 A certain product presently costs P500. if
inflation rate is at the rate of 6% per year,
what will be the cost of this product in 4
years?
 An economy is experiencing inflation at an annual
rate of 8%. If this continues, what, will P1000be
worth two years from now, in terms of today's
pesos?
Inflation

In an inflationary economy, the buying power of

money decreases as costs increase. Thus,
𝑃
𝐹=
1+𝑓 𝑛

where F is the future worth, measured in today’s

pesos, of a present amount P.
Inflation

If interest is being compounded at the same time

that inflation is occurring, the future worth will be

𝑛
𝑃 1+𝑖 𝑛 1+𝑖
𝐹= 𝑛
=𝑃
1+𝑓 1+𝑓
Example
 In year zero, you invest P10,000 in a 15%
security for 5 years. During that time, the
average annual inflation is 6%. How much, in
terms of year zero pesos will be in the
account at maturity?
Seatwork
 Fifteen years ago, P1,000 was deposited in a
bank account, and today it is worth P2,370.
the bank pays interest semi annually. What
was the interest rate paid in this account?
Seatwork
 A man borrowed P20,000 from a local
commercial bank which has a simple interest
of 16% but the interest is to be deducted
from the loan at the time the money was
borrowed and the loan is payable at the end
of one year. How much is the actual rate of
interest?
Seatwork
 What payment “X” 10 years from now is
equivalent to a payment of Php 10 000 six
years from now, if interest is 15%
compounded [a] annually, and [b] monthly?
Seatwork
 You wish to have Php 1 500 000 ten years
from now. What amount should you invest
now if it will earn interest of 8% compounded
annually during the first 5 years and 12%
compounded quarterly during the next 5
years?