time Value of money

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Feb 20, 2024

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1 TIME VALUE OF MONEY Saurabh Nabar Department of Business, University of Cumberlands BADM 534: Managerial finance Dr. Mitchell Miller 1 st February 2024

2 Time Value of Money. The concept of the time value of money is crucial to understand in a corporate setting. It is essential to comprehend that the dollar value of an investment today is far different from the value invested in the future. Financial managers should understand the time value of money and its impact on the stock price, rate of return, and shareholder’s trust. Capital budgeting is one of the most crucial uses of the time value of money. Companies invest in assets, projects, or R&D facilities that generate significant returns over time. Companies can evaluate their discounted future cash flow to the current value using math equations, allowing them to make financial decisions that are viable for the company in the long run. Companies have multiple future options they can compare each one of them with the time value of money and determine which investment gives them the highest return. For example, a company plans to start a new production line. By discounting future cash revenue generated by the production line, the net present value of the investment can be calculated. A positive net current value indicates that the investment will earn more and is viable. The time value of money has a critical impact when deciding on capital budget financing. When companies are trying to build or expand a facility, they need significant capital, which makes it essential to understand the nuances of the time value of money. Suppose the company decides to take a loan based on the interest rate, time period, capital, and compounding period. The time value of money can determine the periodic payment necessary to repay the debt. Moreover, if they decide to issue bonds to fund the project, they must consider the time value of money before deciding on the interest rates for the bond. For instance, a company has decided to open a new plant and is planning to issue bonds to raise funds. The interest rates for these bonds must be determined by the time value of money to cover the finances accurately.

3 Companies that take the time value of money seriously have the upper hand in making financial decisions. It gives management a clear view of the financing choices and capital management and seamlessly plans the expansion process. Moreover, companies who do a meticulous analysis of the time value of money not only understand the return on investment but also understand the risk associated with cash flow each year and can create buffers to accommodate unforeseen circumstances. On the other hand, companies that neglect the time value of money cannot plan a new project efficiently if they do not consider finances over a timeline. They might not understand the actual capital required for a project, which might lead to poor financial decision-making. In conclusion, the time value of money gives a company a template that can be utilized to make informed financial decisions that will provide a high return on investment.

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4 References Brigham, E. F., & Houston, J. F. (2016). Fundamentals of Financial Management. Cengage Learning. Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2018). Essentials of Corporate Finance. McGraw-Hill Education.

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