INSTRUCTOR MANUAL
Instructor’s Manual for Principles of Finance
03/21/22 1
, Instructor’s Manual for Principles of Finance
Chapter 7
Time Value of Money I: Single Payment Value
Chapter Summary
This chapter takes on Time Value of Money concepts as applied to single lump sum payments.
Bringing future cash flows back to today is the process of discounting, while bringing present-
day cash flows into the future is the process of compounding.
Lecture Outline
7.1 Now versus Later Concepts
Given a choice between receiving a dollar today and receiving a dollar a year out, a normal
person would prefer the dollar today as opposed to waiting a year. There is intuitive recognition
that the dollar one year from now is not worth as much as a dollar today.
One factor behind this is awareness that inflation, or rising prices, erodes purchasing power.
What you can buy now for a dollar will not be equivalent to what that dollar will be able to
purchase one year out. If there is no inflation or if there is deflation, where prices fall over time,
you would, of course, come to a different conclusion.
Interest rates and Time Value of Money concepts link the present value of a dollar and its
future value.
If inflation runs at 3 percent annually but someone promises to return a dollar to you after a
year with 3 percent interest, you would be whole because though inflation would erode the
purchasing power of your dollar by 3 percent, the interest of 3 percent you would earn would
offset the erosion in the dollar’s purchasing power.
Once in a while, future cash flows are organized, predictable, and uniform. When you receive a
fixed regular payment into the future over a specified period of time, you have what is called an
annuity. The next chapter deals with this topic.
Most of the time, however, cash flows aren't orderly, and there is no discernible pattern to
their occurrence. When in doubt, evaluate individual cash flows as separate lump sum cash
flows to make sense of them.
7.2 Time Value of Money (TVM) Basics
A single lump sum present value will grow into a future lump sum value through the process of
compounding. If you invest $1,000 for one year and that investment generates 5 percent
interest, your investment will be worth $1,050 at the end of one year
(i.e., $ 1,000× 1.05=$ 1,050).
If you were to invest $1,000 at 5 percent for five years and you let the interest compound, you
would have $1,276.28.
03/21/22 2
Instructor’s Manual for Principles of Finance
03/21/22 1
, Instructor’s Manual for Principles of Finance
Chapter 7
Time Value of Money I: Single Payment Value
Chapter Summary
This chapter takes on Time Value of Money concepts as applied to single lump sum payments.
Bringing future cash flows back to today is the process of discounting, while bringing present-
day cash flows into the future is the process of compounding.
Lecture Outline
7.1 Now versus Later Concepts
Given a choice between receiving a dollar today and receiving a dollar a year out, a normal
person would prefer the dollar today as opposed to waiting a year. There is intuitive recognition
that the dollar one year from now is not worth as much as a dollar today.
One factor behind this is awareness that inflation, or rising prices, erodes purchasing power.
What you can buy now for a dollar will not be equivalent to what that dollar will be able to
purchase one year out. If there is no inflation or if there is deflation, where prices fall over time,
you would, of course, come to a different conclusion.
Interest rates and Time Value of Money concepts link the present value of a dollar and its
future value.
If inflation runs at 3 percent annually but someone promises to return a dollar to you after a
year with 3 percent interest, you would be whole because though inflation would erode the
purchasing power of your dollar by 3 percent, the interest of 3 percent you would earn would
offset the erosion in the dollar’s purchasing power.
Once in a while, future cash flows are organized, predictable, and uniform. When you receive a
fixed regular payment into the future over a specified period of time, you have what is called an
annuity. The next chapter deals with this topic.
Most of the time, however, cash flows aren't orderly, and there is no discernible pattern to
their occurrence. When in doubt, evaluate individual cash flows as separate lump sum cash
flows to make sense of them.
7.2 Time Value of Money (TVM) Basics
A single lump sum present value will grow into a future lump sum value through the process of
compounding. If you invest $1,000 for one year and that investment generates 5 percent
interest, your investment will be worth $1,050 at the end of one year
(i.e., $ 1,000× 1.05=$ 1,050).
If you were to invest $1,000 at 5 percent for five years and you let the interest compound, you
would have $1,276.28.
03/21/22 2
