Value Of Money And Business Decisions Based On Time Value

Value Of Moneybusiness Decisions Are Based On The Time Value Of Money

Value of Money business decisions are based on the time value of money. Bonds, stocks, loans, and other business investments are valued by determining the present value of an expected cash flow, which is also called discounting the cash flow. The time value of money finds considerable application in the decision-making processes of a business. In this assignment, you will apply the basic principles of the time value of money to business decisions.

Tasks: Part 1: You are the chief financial officer of a firm. The firm has an expected liability (cash outflow) of $2 million in ten years at a discount rate of 5%. Calculate the amount the firm would need on the present date as savings to cover the expected liability. Calculate the amount the firm would need to set aside at the end of each year for the next ten years to cover the expected liability. Part 2: Using the Argosy University online library resources, identify an article that demonstrates the application of time value of money principles to a business decision. Explain the specific business decision that management made after computing this value. Analyze how management used the concept of the time value of money principles to make this decision. Analyze factors other than the time value of money that management considered or should have considered in reaching the business decision.

Paper For Above instruction

The concept of the time value of money (TVM) is fundamental in financial decision-making, emphasizing that money available today is worth more than the same amount in the future due to its potential earning capacity. Understanding how to evaluate and leverage TVM enables firms to make informed decisions regarding investments, liabilities, and strategic transactions. This paper discusses the application of TVM principles to a hypothetical corporate scenario and explores real-world business decision-making exemplified through scholarly literature.

In the hypothetical scenario, as the Chief Financial Officer (CFO), the primary task is to determine how much the company needs today to cover a future liability of $2 million due in ten years, assuming a discount rate of 5%. This involves calculating the present value (PV) of the future cash obligation, which reflects how much money must be invested today at the given discount rate to accumulate to $2 million in ten years.

The formula for present value is PV = FV / (1 + r)^n, where FV is the future value, r is the discount rate, and n is the number of years. Substituting the given values yields PV = $2,000,000 / (1 + 0.05)^10 ≈ $2,000,000 / 1.629 ≈ $1,227,153. This means the firm should set aside approximately $1,227,153 today to fully cover the liability in ten years.

Additionally, to determine the amount the firm needs to set aside annually to reach this sum, the concept of the future value of an ordinary annuity can be applied. Using the annuity formula, the annual savings (A) necessary to accumulate $1,227,153 over ten years at 5% interest is found by rearranging the future value of an annuity formula: FV = A [(1 + r)^n – 1] / r. Solving for A gives A = FV r / [(1 + r)^n – 1], which results in A ≈ $1,227,153 0.05 / (1.629 – 1) ≈ $1,227,153 0.05 / 0.629 ≈ $97,533.

This means the firm should set aside approximately $97,533 annually at the end of each year for ten years to fund the future liability, assuming consistent contributions and interest rate conditions.

Moving beyond theoretical calculations, it is essential to understand how these principles influence real-world decision-making. An article from the Argosy University online library demonstrated a case where a company's management calculated the present value of future cash flows related to an expansion decision. The company faced a choice between investing in a new project or delaying the expansion. By discounting the project's expected future cash inflows and outflows at an appropriate rate, management could evaluate whether the project's net present value (NPV) was positive, guiding their investment decision.

In this scenario, management used the TVM principles to discount estimated cash flows, considering the project's risks and the company's cost of capital. A positive NPV indicated that the project was expected to generate value exceeding its costs, thereby justifying the investment. Conversely, a negative NPV would suggest the project would diminish the firm's value, advising against proceeding.

Management also considered other critical factors alongside TVM. These included strategic alignment, market conditions, industry trends, and regulatory environment. They evaluated potential risks, such as technological obsolescence or competitive responses, which may not be captured solely through traditional discounted cash flow analysis. Ethical implications and organizational capacity to manage the project were also vital considerations.

While TVM offers a robust quantitative foundation for investment decisions, integrating qualitative factors ensures that management's decisions are comprehensive. Ultimately, the combination of financial calculations and strategic assessments allows firms to optimize value creation while managing risks effectively.

References

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