Using A Timeline: The Financial Manager At Starbucks Industr

Using a time lineThe Financial Manager At Starbucks Industries Is Consi

Using a timeline, the financial manager at Starbucks Industries is considering an investment that requires an initial outlay of $25,000 and is expected to result in cash inflows over six years. The cash inflows are $3,000 at the end of year 1, $6,000 at the end of years 2 and 3, $10,000 at year 4, $8,000 at year 5, and $7,000 at year 6.

a. Draw and label a timeline depicting these cash flows.

b. Use arrows to demonstrate, on the timeline in part a, how compounding to find future value can be used to measure all cash flows at the end of year 6.

c. Use arrows to demonstrate, on the time line in part b, how discounting to find present value can be used to measure all cash flows at time zero.

d. Which approach—future value or present value—do financial managers rely on most often for decision making, and why?

Paper For Above instruction

Investing decisions are fundamental to financial management, and understanding the concepts of time value of money—specifically, future value (FV) and present value (PV)—is essential in evaluating investment projects. The scenario involving Starbucks Industries provides a practical example of how these concepts are applied to assess the viability and value of potential investments. This paper will systematically address the tasks outlined, focusing on developing a timeline of cash flows, illustrating the mechanics of compounding and discounting, and analyzing decision-making preferences among financial managers.

Part a: Drawing and Labeling the Cash Flow Timeline

A timeline is a graphical representation that helps visualize cash flows occurring at different points in time, which is crucial for understanding the value of future cash inflows. For the Starbucks investment, the timeline begins with an initial outlay of $25,000 at time zero (present time). Following that, cash inflows occur over the next six years. The timeline should be drawn as a horizontal line, with vertical arrows pointing upwards to indicate cash inflows and downward arrows to depict the initial outlay. It is important to label each cash flow with its respective amount and timing.

Starting at point zero, a downward arrow illustrates the initial investment of $25,000. Moving rightward along the timeline, upward arrows labeled $3,000, $6,000, $6,000, $10,000, $8,000, and $7,000 mark the cash inflows at the end of years 1 through 6, respectively. This visual helps contextualize the timing and magnitude of each cash flow for subsequent analysis.

Part b: Demonstrating Future Value through Compounding

To assess the total value of all future cash inflows at the end of year 6, the compounding process is utilized. Each cash inflow occurring in years 1 through 6 needs to be grown forward to year 6 using the compound interest formula: FV = PV × (1 + r)^n, where PV is the present value at the time the cash flow occurs, r is the annual interest rate, and n is the number of periods until year 6.

On the timeline, arrows can be drawn from each cash inflow point labeled with their respective amounts, pointing forward (to the right) to the year 6 position. These arrows illustrate the process of growing each cash inflow to its corresponding FV at year 6. For example:

• The $3,000 inflow at year 1 is compounded for 5 years to reach year 6: FV = $3,000 × (1 + r)^5.
• The $6,000 inflow at year 2 is compounded for 4 years: FV = $6,000 × (1 + r)^4.
• Similarly, $6,000 at year 3 is compounded for 3 years, $10,000 at year 4 for 2 years, $8,000 at year 5 for 1 year, and the $7,000 at year 6 for zero years (no growth needed).

Connecting these points with arrows culminates in the total future value at year 6, computed as the sum of all these compounded cash inflows, minus the initial outlay if considering net investment value.

Part c: Demonstrating Discounting to Measure Present Value

Conversely, to evaluate the current worth of future cash flows, discounting is employed. Discounting involves bringing all future inflows back to present value terms using the formula PV = FV / (1 + r)^n. On the timeline, arrows point backward (to the left) from each cash inflow at year n to the present point (time zero), illustrating the process of discounting.

For each year's inflow:

• The $3,000 received at year 1 is discounted back 1 year, PV = $3,000 / (1 + r)^1.
• The $6,000 at year 2 is discounted back 2 years: PV = $6,000 / (1 + r)^2.
• This process continues for each inflow until year 6, where no discounting is needed.

By summing all these discounted cash inflows, the total present value is determined, which helps in assessing whether the investment's current value justifies the initial expenditure of $25,000.

Part d: Which Approach Do Financial Managers Rely on Most? And Why?

Financial managers predominantly rely on the present value approach for investment decision-making. The core reason is that present value assesses the worth of future cash flows in today's dollars, allowing managers to compare the value of different projects directly against the initial investment. It aligns with the objective of maximizing shareholder wealth by focusing on the current worth of potential earnings.

While future value calculations are useful for projecting how investments will grow over time, present value analyses provide a more accurate and relevant metric for decision-making, especially when comparing projects with different durations or cash flow timings. The ability to discount future cash flows accounts for the time preference of money—reflecting that a dollar today is worth more than a dollar in the future due to potential earning capacity.

Hence, most financial managers favor present value methods such as net present value (NPV) and discounted cash flow (DCF) analyses for evaluating investment opportunities, given their practical and decision-oriented nature.

Conclusion

Understanding and applying the concepts of compounding and discounting through timelines is fundamental in financial analysis. The visualizations of cash flows—both projected into the future with compounding and evaluated in present terms with discounting—equip financial managers with vital tools to make informed investment choices. The reliance on present value methods underscores the importance of assessing investments based on their current worth, ensuring that decisions align with value maximization principles and prudent financial management.

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