Module 4 Critical Thinking FIN300-1
doc
keyboard_arrow_up
School
Colorado State University, Global Campus *
*We aren’t endorsed by this school
Course
300
Subject
Finance
Date
Jan 9, 2024
Type
doc
Pages
5
Uploaded by CaptainSummer5425
Time Value of Money: Corporate Application
Colorado State University Global
FIN300-1: Principles of Finance for the Private Sector
Prof. Brian Weaver
January 15
th
, 2023
1
2
Time Value of Money: Corporate Application
The time value of money is an important aspect in the world of finance, and especially so
in the corporate realm. The time value of money is defined by Gitman and Zutter (2014) as the
consideration that it is better to receive money sooner rather than later. This concept is vital to
the corporate world because understanding both the present and future values of an investment or
the value of actual cash on hand can be supplemental in making further business decisions.
According to Chen (2009), there are a few different ways to compute present and future values,
and these value pertain to annuities, stock valuation, and the relationships held between the
values. To explore this concept more thoroughly, we will look at the corporate functions for
Rhonda and her various ice cream stores.
Rhonda’s Ice Cream Stores
Rhonda has a small franchise of ice cream stores and is looking to purchase new
equipment as well as open up a new location, and needs sound business advice. One of the best
ways to assist Rhonda with these business decisions is to assess the present value and future
value of both her current assets and the potential purchases. With these values it is also important
to consider their depreciation as well as the profit that they are expected to generate.
New Equipment
Rhonda’s potential purchases on new equipment include a new ice cream machine as well
as a new espresso maker, both of which are expected to yield fairly decent profits. Before we
analyze these prospective purchases and what effects they may have, we must first consider the
different values of the machine she currently has at one of her stores. The current machine at one
of the ice cream stores was valued at $10,000 and is expected to yield a profit of $2,500. With
the consideration of depreciation, this machine will be worth $8,250 at the end of the year. In
retrospect, the new machine would cost $15,000 and is anticipated to generate profits of $4,000
3
and at the end of the year will be valued at $12,500. To analyze the two ice cream machines, we
will determine the holding period return for both assets. The holding period return represents the
rate of return that is earned on an investment over a specified period of time. This rate of return
is computed by using the following formula: ending value – beginning value + cash received
beginning value. We will start with the current machine: $8,250 -$10,000 + $2,500
$10,000 =
7.5%. The rate of return for the new machine is : $12,500 - $15,000 + $4,000
$15,000 = 10%.
Comparing the rate of return for both of the ice cream machines shows that the new machine will
produce a higher rate of return than the machine Rhonda is currently using.
Next, we will analyze the potential of adding an espresso machine at one of the locations
to expand the goods available for sale at said store. Rhonda has stated that she has the savings
available for this purchase, but doing so would eliminate the annual interest of 4.5% that the
account accrues. The espresso machine is expected to yield an annual profit of $3,000 for the
next five years, and at the end of those five years the machine could be sold for $4,000. To better
analyze the decision of this new purchase we will determine the present value of the espresso
machine. The present value of an amount is defined by Gitman and Zutter (2014) as the current
dollar value of a future amount, or in other words, the amount that would have to be invested
with a specified interest rate and period of time to be equal to the future amount. To compute the
present value we take the future value that is to be received after a period of time and divide by
one plus the interest rate to the power of the number of years. For the espresso machine, our
equation would be $3,000
(1+.045)^5 = $2,407.36. The present value of the espresso machine
shows that the purchase would be worthwhile for Rhonda, and could generate good profits for
her, even with the loss of her annual rate.
New Location
Your preview ends here
Eager to read complete document? Join bartleby learn and gain access to the full version
- Access to all documents
- Unlimited textbook solutions
- 24/7 expert homework help
4
One of the last potential decisions that Rhonda is considering is the investment into a new
location. Rhonda has stated that the store will require renovations totaling $30,000 and that she
would like for the initial investment to be paid off within five years. Assuming that there is a
discount rate of 4.5%, we will determine the annual profits necessary to recover the $30,000
investment within the desired 5 year period. To determine the annual profits necessary we will
use the following formula assuming that P represents annual profits: $30,000 = P x (1/.045) x [1-
(1/1.045)^5]. The amount we end up with is $6,833.75, assuming that each year will earn the
same amount of profits. If we were to assess this same scenario with a discount rate of 7.5% we
would perform the same computation and would instead end up with necessary annual profits of
$7,414.75 ultimately meaning that this investment would pay for itself in a shorter period of
time.
Conclusion
Based on all of the computations made for Rhonda and her potential business decisions,
we can help offer some sound advice. For starters, the holding period returns show that the
purchase of a new ice cream machine would be beneficial in the sense that it will earn a higher
rate of return. Looking at the addition of the espresso machine, this would also be a good
investment for Rhonda to make, the only thing to consider is that if it is purchased for $20,000,
it's value will drop significantly over the projected five year period. Lastly, the new location also
appears to be a good investment as it will generate good profits, especially if it is purchased with
the 7.5% discount rate. Interest rates have great significance over the present value of
investments, and depending on the rate that she locks in these investments can be more beneficial
to Rhonda and her profits.
5
References
Chen, J.H. (2009).
Time value of money and its applications in corporate finance: A technical
note on linking relationships between formulas.
American Journal of Business Education.
(Retrieved January 12
th
, 2023).
https://files.eric.ed.gov/fulltext/EJ1052630.pdf
Gitman, L. J., & Zutter, C. J. (2014).
Principles of Managerial Finance, Brief
(7th ed.). Pearson
Learning Solutions.
https://bookshelf.vitalsource.com/books/9781323053355
Related Documents
Related Questions
6- Banks are important to the study of money and the economy because they .
Please select one;
www
a) provide a channel for linking those who want to save with those who want to invest
b) have been a source of financial innovation that is expanding the alternatives available to those
mwv m
who wanting to invest their money
c) are the only financial instution to play a role in determining the quantity of money in the economy
d) do all of the above
e) do only a and b of the aboveę
arrow_forward
What do you perceive as an immediate threat (or threats) to global corporate finance now? What do you perceive as opportunities?
arrow_forward
FINANCE2A
First Question
arrow_forward
SEE MORE QUESTIONS
Recommended textbooks for you
Related Questions
- 6- Banks are important to the study of money and the economy because they . Please select one; www a) provide a channel for linking those who want to save with those who want to invest b) have been a source of financial innovation that is expanding the alternatives available to those mwv m who wanting to invest their money c) are the only financial instution to play a role in determining the quantity of money in the economy d) do all of the above e) do only a and b of the aboveęarrow_forwardWhat do you perceive as an immediate threat (or threats) to global corporate finance now? What do you perceive as opportunities?arrow_forwardFINANCE2A First Questionarrow_forward
Recommended textbooks for you