Why is it important to understand the concepts of inflation, present value, and future value as Saudi Arabia moves towards Saudi Vision 2030? What are some of the important terms and concepts that managers must understand in making decisions in today’s global environment? How will these factors affect Saudi Vision 2030, if at all?
Search thelibrary or the Internet for an academic or industry-related article. Select an article that relates to any of these concepts (inflation, present value, or future value) in the context of doing business in Saudi Arabia.
For your discussion post, your first step is to summarize the article in two paragraphs, describing what you think are the most important points made by the authors (remember to use citations where appropriate). For the second step, include the reference listing with a hyperlink to the article. Do not copy the article into your post and limit your summary to two paragraphs. Let your instructor know if you have any questions and enjoy your search.
FIN500
Principles of
Finance
Live Session
1
2
Module 5 Learning Outcomes
? Comprehend
the meaning of present
and future value and calculate the
values.
? Understand and calculate amortized loan
scenarios.
? Understand the principles of interest and
the processes of its calculation.
? Gain the knowledge necessary to use a
financial calculator.
3
Module Lecture
? Time
Value Calculations using Financial
Calculator and Excel
4
Using Timelines to
Visualize Cash Flows
Timeline of cash flows
5
Simple Interest
? Interest
is earned only on principal.
? Example: Compute simple interest on
$100 invested at 6% per year for three
years.
1st year interest is $6.00
2nd year interest is $6.00
3rd year interest is $6.00
Total interest earned: $18.00
6
Compound Interest
? Compounding
is when interest paid on an
investment during the first period is added
to the principal; then, during the second
period, interest is earned on the new sum
(that includes the principal and interest
earned so far).
7
Compound Interest
? Example:
Compute compound interest on
$100 invested at 6% for three years with
annual compounding.
1st year interest is $6.00 Principal now is
$106.00
2nd year interest is $6.36 Principal now is
$112.36
3rd year interest is $6.74 Principal now is
$119.10
Total interest earned: $19.10
8
Future Value
?Future Value is the amount a sum will grow to
in a certain number of years when
compounded at a specific rate.
FVN = PV (1 + r)n
?FVN = the future of the investment at the end
of “n” years
?r = the annual interest (or discount) rate
?n = number of years
?PV = the present value, or original amount
invested at the beginning of the first year
9
Future Value Example
? Example:
What will be the FV of $100 in 2
years at interest rate of 6%?
FV2 = PV(1 + r)2 = $100 (1 + 0.06)2
= $100 (1.06)2
= $112.36
10
How to Increase the
Future Value?
? Future
?
?
?
Value can be increased by:
Increasing number of years of
compounding (N)
Increasing the interest or discount rate (r)
Increasing the original investment (PV)
? See
example on next slide
11
Changing R, N, and PV
a.You deposit $500 in bank for 2 years. What is
the FV at 2%? What is the FV if you change
interest rate to 6%?
FV at 2% = 500*(1.02)2 = $520.2
FV at 6% = 500*(1.06)2 = $561.8
b.Continue the same example but change time
to 10 years. What is the FV now?
FV = 500*(1.06)10= $895.42
c.Continue the same example but change
contribution to $1500. What is the FV now?
FV = 1,500*(1.06)10 = $2,686.27
12
Figure 5-1
13
Figure 5-2
14
Figure 5-2
? Figure
5-2 illustrates that we can increase
the FV by:
?
?
Increasing the number of years for which
money is invested; and/or
Investing at a higher interest rate.
15
After 1 year
FV1 = PV + INT1 = PV + PV (I)
= PV(1 + I)
= $100(1.10)
= $110.00
16
After 2 years
FV2 = FV1(1+I) = PV(1 + I)(1+I)
= PV(1+I)2
= $100(1.10)2
= $121.00
17
After 3 years
FV3 = FV2(1+I)=PV(1 + I)2(1+I)
= PV(1+I)3
= $100(1.10)3
= $133.10
In general,
FVN = PV(1 + I)N
18
Three Ways to Find FVs
? Solve
the equation with a regular
calculator (formula approach).
? Use a financial calculator.
? Use a spreadsheet.
19
Financial Calculator Solution
Financial calculators solve this
equation:
FVN + PV (1+I)N = 0.
There are 4 variables. If 3 are
known, the calculator will solve
for the 4th.
20
See Instructions on how to set up
calculator for annual interest rates

21
Here’s the setup to find FV
INPUTS
3
N
10
-100
I/YR PV
0
PMT
OUTPUT
FV
133.10
Clearing automatically sets everything
to 0, but for safety enter PMT = 0.
Set: P/YR = 1, END.
22
Computing Future Values
using Calculator or Excel
? Assume
? Excel
10% interest rate compounded
Function for FV:
= FV(rate,nper,pmt,pv)
23
Spreadsheet Solution
? Use
?
?
the FV function
= FV(I, N, PMT, PV)
= FV(0.10, 3, 0, -100) = 133.10
24
Present Value
? Present
value reflects the current value of
a future payment or receipt.
25
Present Value
PV = FVn {1/(1 + r)n}
FVn = the future value of the investment at
the end of n years
n = number of years until payment is
received
r = the interest rate
PV = the present value of the future sum of
money
26
PV example
? What
will be the present value of $500 to
be received 10 years from today if the
discount rate is 6%?
? PV = $500 {1/(1+0.06)10}
= $500 (1/1.791)
= $500 (0.558)
= $279
27
Figure 5-3
28
Figure 5-3
? Figure
?
?
5-3 illustrates that PV is lower if:
Time period is longer; and/or
Interest rate is higher.
29
What’s the PV of $100 due in 3
years if I/YR = 10%?
Finding PVs is discounting, and it’s the
reverse of compounding.
0
PV = ?
10%
1
2
3
100
30
Solve FVN = PV(1 + I )N for PV
PV =
FVN
(1+I)N
= FVN
1
PV = $100
1.10
1
1+I
3
= $100(0.7513) = $75.13
N
31
Financial Calculator Solution
INPUTS
OUTPUT
3
N
10
I/YR
PV
-75.13
0
PMT
100
FV
Either PV or FV must be negative. Here
PV = -75.13. Put in $75.13 today, take
out $100 after 3 years.
32
Spreadsheet Solution
? Use
?
the PV function
= PV(I, N, PMT, FV)
?
= PV(0.10, 3, 0, 100) = -75.13
33
Calculate Interest Rate (I)
0
-1
?%
1
2
I)N
FV = PV(1 +
$2 = $1(1 + I)3
(2)(1/3) = (1 + I)
1.2599 = (1 + I)
I = 0.2599 = 25.99%
3
2
34
Financial Calculator
INPUTS
OUTPUT
3
N
I/YR
25.99
-1
PV
0
PMT
2
FV
35
Spreadsheet Solution
? Use
?=
?
the RATE function:
RATE(N, PMT, PV, FV)
= RATE(3, 0, -1, 2) = 0.2599
36
Annuity
? An
annuity is a series of equal dollar
payments for a specified number of years.
? Ordinary
annuity payments occur at the
end of each period.
37
FV of Annuity
Compound Annuity
? Depositing or investing an equal sum of
money at the end of each year for a
certain number of years and allowing it to
grow.
38
FV Annuity – Example
? What
will be the FV of a 5-year, $500 annuity
compounded at 6%?
? FV5 = $500 (1 + 0.06)4 + $500 (1 + 0.06)3
+ $500(1 + 0.06)2 + $500 (1 + 0.06) + $500
= $500 (1.262) + $500 (1.191) + $500 (1.124)
+ $500 (1.090) + $500
= $631.00 + $595.50 + $562.00 + $530.00 + $500
= $2,818.50
39
Table 5-1
40
FV of an Annuity –
Using the Mathematical
Formulas
FVn = PMT {(1 + r)n – 1/r}
FV n = the future of an annuity at the end of
the nth year
PMT = the annuity payment deposited or
received at the end of each year
r = the annual interest (or discount) rate
n = the number of years
41
FV of an Annuity –
Using the Mathematical
Formulas
? What
will $500 deposited in the bank
every year for 5 years at 6% be worth?
? FV =
PMT ([(1 + r)n – 1]/r)
= $500 (5.637)
= $2,818.50
42
Present Value of an Annuity
? Pensions,
insurance obligations, and
interest owed on bonds are all annuities.
To compare these three types of
investments we need to know the present
value (PV) of each.
43
Ordinary Annuity vs. Annuity
Due
Ordinary Annuity
0
I%
1
2
3
PMT
PMT
PMT
1
2
3
PMT
PMT
Annuity Due
0
PMT
I%
44
What’s the FV of a 3-year
ordinary annuity of $100 at
10%?
0
10%
1
2
100
100
3
FV
100
110
121
= 331
45
FV Annuity Formula
? The
future value of an annuity with N periods and
an interest rate of I can be found with the
following formula:
= PMT
(1+I)N-1
I
= $100
(1+0.10)3-1
0.10
= $331
46
Financial Calculator Formula
for Annuities
? Financial
calculators solve this equation:
FVN + PV(1+I)N + PMT
(1+I)N-1
I
=0
There are 5 variables. If 4 are
known, the calculator will solve for
the 5th.
47
Financial Calculator Solution
INPUTS
OUTPUT
3
10
0
-100
N
I/YR
PV
PMT
FV
331.00
Have payments but no lump sum PV,
so enter 0 for present value.
48
Spreadsheet Solution
? Use
?
?
the FV function: see spreadsheet.
= FV(I, N, PMT, PV)
= FV(0.10, 3, -100, 0) = 331.00
49
What’s the PV of this ordinary
annuity?
0
1
2
3
100
100
100
10%
90.91
82.64
75.13
248.69 = PV
50
PV Annuity Formula
? The
present value of an annuity with N periods and
an interest rate of I can be found with the
following formula:
= PMT
= $100
1
I
1
0.1
?
?
1
I (1+I)N
1
0.1(1+0.1)3
= $248.69
51
Financial Calculator Solution
INPUTS
OUTPUT
3
10
N
I/YR
PV
100
0
PMT
FV
-248.69
Have payments but no lump sum FV,
so enter 0 for future value.
52
Spreadsheet Solution
? Use
?
?
the PV function: see spreadsheet.
= PV(I, N, PMT, FV)
= PV(0.10, 3, 100, 0) = -248.69
53
Find the FV and PV if the
annuity were an annuity due.
0
1
2
100
100
10%
100
3
54
Annuities Due
? Annuities
due are ordinary annuities in
which all payments have been shifted
forward by one time period. Thus, with
annuity due, each annuity payment
occurs at the beginning of the period
rather than at the end of the period.
55
PV and FV of Annuity Due
vs. Ordinary Annuity
? PV
of annuity due:
? = (PV of ordinary annuity) (1+I)
? = ($248.69) (1+ 0.10) = $273.56
? FV
of annuity due:
? = (FV of ordinary annuity) (1+I)
? = ($331.00) (1+ 0.10) = $364.10
56
PV of Annuity Due: Switch from
“End” to “Begin”
BEGIN Mode
INPUTS
OUTPUT
3
10
N
I/YR
PV
-273.55
100
0
PMT
FV
57
FV of Annuity Due: Switch from
“End” to “Begin”
BEGIN Mode
INPUTS
OUTPUT
3
10
N
I/YR
0
100
PV
PMT
FV
-364.10
58
Excel Function for Annuities
Due
? Change the formula
? =PV(0.10,3,-100,0,1)
? The
to:
fourth term, 0, tells the function
there are no other cash flows. The fifth
term tells the function that it is an
annuity due. A similar function gives
the future value of an annuity due:
? =FV(0.10,3,-100,0,1)
59
Making Interest Rates
Comparable
? We
cannot compare rates with different
compounding periods. For example, 5%
compounded annually is not the same as
5% percent compounded quarterly.
? To make the rates comparable, we
compute the annual percentage yield
(APY) or effective annual rate (EAR).
60
Nominal rate (INOM)
? Stated
in contracts, and quoted by
banks and brokers.
? Not used in calculations or shown on time
lines
? Periods per year (M) must be given.
? Examples:
?
?
8%; Quarterly
8%, Daily interest (365 days)
61
Periodic rate (IPER )
? IPER
= INOM/M, where M is number of
compounding periods per year. M = 4 for
quarterly, 12 for monthly, and 360 or 365 for
daily compounding.
?
Used in calculations, shown on time lines.
?
Examples:
?
8% quarterly: IPER = 8%/4 = 2%.
?
8% daily (365): IPER = 8%/365 = 0.021918%.
62
Table 5-4
63
Amortized Loans
? The
periodic payment is fixed. However,
different amounts of each payment are
applied toward the principal and interest.
With each payment, you owe less toward
principal. As a result, the amount that
goes toward interest declines with every
payment (as seen in Figure 5-4).
64
Figure 5-4
65
Amortization Example
? Example:
If you want to finance a new
machinery with a purchase price of
$6,000 at an interest rate of 15% over 4
years, what will your annual payments
be?
66
Amortization
? Construct
an amortization schedule for a
$1,000, 10% annual rate loan with 3 equal
payments.
67
Step 1: Find the required
payments.
0
10%
-1,000
INPUTS
OUTPUT
1
2
3
PMT
PMT
PMT
3
10
N
I/YR
-1000
PV
0
PMT
402.11
FV
68
Amortization Table
BEG
BAL
$1,000
PMT
$402
2
698
402
70
332
366
3
366
402
37
366
0
YEAR
1
TOT
1,206.34
PRIN
INT
PMT
$100 $302
206.34 1,000
END
BAL
$698
69
Interest declines because
outstanding balance declines.
$450
$400
$350
$300
$250
$200
$150
$100
$50
$0
Interest
Principal
PMT 1
PMT 2
PMT 3
70
? Amortization
tables are widely used–for
home mortgages, auto loans, business
loans, retirement plans, and more. They
are very important!
? Financial calculators (and spreadsheets)
are great for setting up amortization tables.
71
Status Check
? How
is the course proceeding?
? What can I help you with?
72
Assignments and Reminders
? Critical
Thinking assignment
? Use Excel not Word
? Show your calculations
? If using financial calculators, show
amounts used for each button
Discussion (1)
Understanding the time value of money is significate since it can help managers make better
investment decisions. According to Keown, Martin, and Petty (2017), the present value is
concerned about determining the current value of a future payment, which means knowing
the value of money received in the future in today’s amount. This can help determine whether
an investment is desirable or not. On the other hand, the future value measures the future
dollar amount to which an investment will grow.
The Saudi 2030 Vision is a plan to meet current and future needs. According to BMI
Research: Middle East Monitor: The Gulf. (2016), Saudi Arabia plans is to cut down
government spending and increase non-oil revenue. Moreover, the Saudi government will
issue a large amount of domestic and external debt. Regarding inflation in Saudi Arabia,
Mensi, Al-Yahyaee, Hussain Shahzad, and Hammoudeh (n.d.) explain that the cost of living
index and the wholesale price index are the main determents of inflation.
References
BMI Research: Middle East Monitor: The Gulf. (2016). In Middle East Monitor: The Gulf
(Vol. 26, Issue 8, pp. 1–12).
Keown, A. J., Martin, J. D., & Petty, J. W. (2017). Foundations of finance: The logic and
practice of financial management (9th ed.). Upper Saddle River, NJ: Prentice Hall.
Mensi, W. ( 1,2,3 ), Al-Yahyaee, K. H. ( 2 ), Hussain Shahzad, S. J. ( 4 ), & Hammoudeh, S. (
4,5 ). (n.d.). Asymmetric impacts of public and private investments on the non-oil
GDP of Saudi Arabia. International Economics, 156, 15–30. https://doiorg.sdl.idm.oclc.org/10.1016/j.inteco.2017.10.003
Discussion (2)
Inflation refers to the rate at which the price of goods and services rises over time. It
is also the reduction of monetary value in Saudi Arabia because consumers are can only
purchase less than they previously could with the same amount of money. Saudi Vision 2030
was established to transform Saudi Arabia. The economic strategy proposes the steps to
diversify its economy by improving the growth of the private sector and reducing the
dependence on oil and other state or government state revenue generators.
It is important to understand the concept of inflation, present value and future values
as Saudi Arabia moves towards Saudi Vision 2030. Understanding these terms will create
awareness on the causes of inflation, the rising rates of inflation and the large variations in
rates. Lack of knowledge of these terms can have potential effects on economic stability and
activity which makes it a must for the decision-makers to address these determinants to
maintain a climate of price stability, of goods and services and inflation, as well as the nature
of economic policies that can be adopted to maintain economic development. Concerning
Saudi Vision 2030, a rise in inflation might deter businesses from growing and in turn, this
will slow the economic growth of Saudi Arabia and inhibit the realization of Saudi Vision
2030.
Additionally, it is fundamental to understand the concepts of present value and future
value. Present value is the price of a product currently and future value is the price of a
product in the future. Saudi Vision 2030 is hugely funded by the revenue that is generated
from oil and petroleum products, whose prices are likely to change over time. A
comprehension of these terms will mean that a manager can effectively navigate the policies
to ensure the correct amount of oil is produced to meet the monetary demands of projects
implemented to achieve the economic strategy.
There are some concepts that managers must understand in making decisions in
today’s global environment. One of the fundamental concepts is owner’s equity which is the
amount of business that a certain entity owns in the business. Regarding the Saudi Vision
2030, the sale of part of the stake of the Aramco oil company requires a manager to have
prior knowledge of the owner’s equity. Another important concept in decision making is the
return on investment (ROI). An understanding of ROI is necessary during the implementation
of the Saudi Vision 2030 because the manager will be able to determine if the projects are
economically viable.
In the context of doing business in Saudi Arabia, the article by the International
Monetary Fund indicates that there has been a reduction in the inflation rate in Saudi Arabia
(Rasasi, 2017). IMF estimates that this has had a positive impact on the growth of small and
medium businesses in Saudi Arabia.
However, the IMF also points out that this has resulted partly in the weakening of the
economic conditions brought about by the large negative output gap. IMF indicates that the
banking industry has continued to thrive because of the low rate of inflation in Saudi Arabia
(Rasasi, 2017). Furthermore, there has been an improvement in business confidence with the
businesses experiencing an increase in revenue as seen with the increase in GDP in Saudi
Arabia.
References
Rasasi, M. A. (2017). Why has inflation declined in Saudi Arabia? IMF. Retrieved
from
N_DECLI
https://www.researchgate.net/publication/320410261_WHY_HAS_INFLATIO
NED_IN_SAUDI_ARABIA

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