Week 3:
Emergency Fund,
Time Value of Money
and its Application
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Emergency Fund
• In life you should expect the unexpected,
and this is why you need an emergency
fund. The best you can do is to prepare for
emergencies that require access to
additional money and having an emergency
fund is the ideal solution.
Chapter # 2
Emergency Fund
• Financial emergencies can come
in the form of a job loss,
significant medical expenses,
home or auto repairs or
something you’ve never dreamed
of.
Chapter # 3
Where to Save The Emergency
Fund
Three Criterias:
Easy Access
Liquidity
Safety (low risk)
Chapter # 4
Emergency Fund
Single: 3 x income or expenses
Small family with 2 kids: 6 – 9 x income or expenses
Big family with 3 kids or more: 9 – 12 x income or
expenses
Chapter # 5
Opening Case
You have won lottery and are being asked to
choose between two alternatives:
1. Receive IDR 400 million and will be paid
right away (NOW)
2. Receive IDR 55 million every year for the
next ten year
Assume interest rate at 5% a year.
Time Value of Money
A dollar today is worth more
than a dollar received in the
future because it can be
invested and earn interest
Types of TVM Calculations
Single sum Annuity
one lump sum series of equal
investment payments made
with no
at fixed time
additional
additions or intervals for
subtractions specified number
of periods
Ways to Calculate TVM
• Formulas
• Tables TVM: B1, B2, B3 & B4
Notation
• We use the following notation for the various inputs:
FV = future value
PV = present value
r = annual rate of interest paid.
n = number of periods (typically years)
Future Value
The value invested money will grow to,
by earning a specific rate of interest
over a given time period
“compounding” – using compound
interest to grow today’s present
value to a larger future value
Calculating the Future Value of
a Single Sum
Example:
What will $5000 grow to become
if invested at 5% for 6 years?
Calculating the Future Value of
a Single Sum
• Using Formula:
• FV = PV (1 + r)n
FV = $5,000 x (1+
5%) 6
FV = $5,000 x 1.34
FV = $6,700
Calculating the Future Value of a
Single Sum
Tables
Find Future Value Factor for 6 years and
5% (in Table B1)
FV = PV x Factor i,n
FV = PV x FVIF 5%,6years
FV = $5000 x 1.340 = $6,700
Calculating the Future Value of
an Annuity
Example:
What would you accumulate if you
could invest $5000 every year for
the next 6 years at 10%?
Calculating the Future Value of
an Annuity
• Using Formula:
• FVA = $5,000 x [(1+ 10%) 6 – 1]
10%
FVA = $38,578.05
Calculating the Future Value
of an Annuity
Tables
(Find Future Value Annuity Factor for 6 years
and 10% in Table B3)
FVA = PMT x Factor i,n
FVA = PMT x FVIFA 10%,6 years
FVA = $5000 x 7.716 = $38,580
Rule of 72
Estimates how long it will take to double
a sum at a given interest rate
Number of years = 72
to double money Annual compound
interest rate
Present Value
Amount needed today to invest at a
specific interest rate over a given time
period to reach desired future amount
“Discounting” – reverse of
compounding
working from future value
back to present value
Calculating the Present Value of
a Single Sum
Example:
You wish to accumulate a retirement fund
of $300,000 in 25 years. If you can invest
at 5%, what single lump-sum deposit
must you make today in order to achieve
your goal?
Calculating the Present Value
of a Single Sum
• Using Formula:
PV = $300,000
(1+ 5%) 25
PV = $88,590.83
Calculating the Present Value
of a Single Sum
Tables
Find Present Value Factor for 25 years and
5% (Table B2)
PV = FV x Factor i,n
PV = FV x PVIF 5%,25 years
PV = $300,000 x 0.295 = $88,500
Calculating the Present Value of
an Annuity
Example:
Your rich uncle wishes to give you a
sum of money today to use for the next
4 years of college. If you need $10,000
a year and will leave the remainder
invested at 7%, how much should you
tell him you need?
Calculating the Present Value
of an Annuity
• Using Formula:
• PVA = ($10,000/7%) x [1-1/(1+7%) 4]
• PVA = $33,872.11
Calculating the Present Value
of an Annuity
Tables
(Find Present Value Annuity Factor for 4 years
and 7% in Table B4)
PVA = PMT x Factor i,n
PVA = PMT x PVIFA 7%,4 years
PVA = $10,000 x 3.387 = $33,870
HOW..?
• How to calculate the series of
cash flow BUT with the different
amount ?
Opening Case (Again..)
You have won lottery and are being asked to
choose between two alternatives:
1. Receive IDR 400 million and will be paid
right away (NOW)
2. Receive IDR 55 million every year for the
next ten year
Assume interest rate at 5% a year.
Advice:
• Always draw a time line to
visualize (diagram Cash Flow)
Exercises: Use Future or Present Value
technique to solve the following problems
• a. Starting with $10,000, how will
you have in 10 years if you can
earn 8% on your money? If you
can earn only 5%
Exercise:
• b. If you inherited $25,000 today
and invested all of it in a security
that paid a 7% rate of return, how
much would you have in25
years?
Exercise:
• c. If the average new home costs
$210,000 today, how much will it
cost in 10 years if the price
increase by 5% each year?
Exercise:
• d. If you can earn 5%, how much
will you have to save each year if
you want to retire in 35 years
with $1 million?
Case
• Milley and Selena both are 25 years old and is preparing to
save for their old days when their age reach 65 using two
different ways.
• Milley start investing IDR 5 million annually for the next 10
years subsequently. After the 10 year period, she stop
investing but keep the previous investment growing.
• Selena postponing for 10 years and start investing at 35
years old for the next 30 years with the amount of IDR 7
million annually. Assuming 10% annual interest rate. Who is
going to be richer at 65 years old?
