Measuring and recording of liabilities are based on the concept of Time Value of Money Time Value of Money TVM Compound Interest Compound vs Simple interest Simple Compound P x r x t Earns interest on the principal value invested Earn interest on principal and all interest previously earned Compounding the frequency with which interest is added to the principal Four Basic Time Value of Money Cases Future Value of Lump Sum Present Value of Lump Sum Future Value of an Annuity Present Value of an Annuity Use Table Factors Number of Periods n Interest rate i When interest is compounded other than annually Interest of compounds per year N x of compounds per year Future Value of a Lump Sum We know sum today want to know what it will be worth at some certain time in future Future Value Present Value x Future Value Factor Future Value factors Calculated by 1 i n Present Value of Lump Sum today We know what the amount is worth in the future but we want to know how much it is worth Present Value Future Value x Present Value Factor Figuring out how much a future amount is worth TODAY is called Discounting Present Value Factors Calculated by 1 1 i n LUMP SUM KEY POINT Future Value and Present Value of a Lump Sum are reciprocal opposites of each other Can be used interchangeably to solve problems FV PV x FV Factor Annuity Series of equal payments receiving or paying with each payment having the same time interval between them Ordinary Annuity payments occurring at the end of each period Annuity Due payments occurring at the beginning of each period Future Value of an Annuity Ordinary How much is a dollar received at the end of every year for 4 years worth in the future Future Value of Ordinary Annuity Payment x Future Value Annuity Factor Annuity Due How much is a dollar received at the beginning of every year for 4 years worth in the future Future Value of Annuity Due Payment x Future Value of Annuity Factor x 1 i Adjust Table Factor by multiplying by 1 i Present Value of an Annuity Ordinary How much is a series of future payments occurring at the end of each period worth today Present Value of Ordinary Annuity Payment x Present Value Annuity Factor Annuity Due How much is a series of future payments occurring at the beginning of each period worth today Present Value of Annuity Due Payment x Present Value Annuity Factor x 1 i Adjust Table Factory by multiplying by 1 i ANNUITY KEY POINTS Payment the amount of each individual payment Lump Sum Present Value Equation FV x PVF Future Value PV x FVF FV and PV are NOT reciprocals Annuity Ordinary Future Value Equation Payment x FVAF Annuity Due Future Value Payment x FVAF x 1 i Ordinary Present Value Payment x PVAF Annuity Due Present Value Payment x PVAF x 1 i Question How much is this lump sum worth TODAY if we know the value of it in the future How much will a lump sum be worth at a certain time in the FUTURE Question How much is a dollar received at the END of every year for years worth in the future How much is a dollar received at the BEGINNING of every year for years worth in the future How much is a series of future payments occurring at the END of each period worth TODAY How much is a series of future payments occurring at the BEGINNING of each period worth TODAY When evaluating different alternatives its always easiest to find PRESENT VALUE
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