A plus writer

Q1. Time value of money refers to the notion that money in the future is not worth than money in the present (CPF Board, 2015). This fact is supported by the idea that money to be earned in the future will have higher risk than money earned in the present. Furthermore, money that is earned in the present can be invested in the present and earn more income than in the future. This is the core principle of investment in corporate finance where any amount of money is worth in the present than in the future.

Using the free cash flow, the business needs to invest the cash into projects and assets that will yield greater returns as opposed to leaving the same idle. This leads to the need for evaluating capital investment using capital budgeting methods.

Capital budgeting methods will use time value of money to determine the present value and future value of investment using discounting of money. This will be determined through the use of the interest rate which will discount the future value of the cash flows and asset to give the present value. As it is the case, milestone 1 discounts the free cash flow from page 43 on capital lease payments. The time value of money in the case is used to calculate the value of the company which is discounted in the present value to determine a suitable amount that the company can be bought in the present and in the future. This helps the company to arrive at an amount which is guided and sound in terms of judgment used in arriving at the sell price.

Q2. The time value of money is affected by the interest rate. As it is the case in determining the present value, the higher the interest rate, the lower the present value whereas it is vice versa for the future value which increases by increase in the interest rate (Fabozzi, 2014). The best example is in the case of stock and bond valuation where the market interest rate increase by 5% leads to a higher future value of the stocks which is given by the value as 24,624 against the reduction of market interest by 5% given by 16,428. It is also worth noting that the future value of a bond increases by the value of the interest rate whereas the period also affects it by increasing the risk premium. This means that a bond that has a longer period will have a higher bond value as compared to the bond which has a shorter bond period.

With the introduction of risk, a higher interest is the equivalent premium (risk premium) which is added in order to account for increased risk. With increased premium, the future value of a bond increases since risk is factored in to increase the value of the bond value. With the reduction of interest, the bond value also decreases. The implication as a company manager is the need to reduce the time period issued to bonds as well as the interest rate since the company will be forced to pay higher cash flows to the bond holders.

Q3. My advice on purchasing the company will be to purchase the company since the Net present value is positive as well as the discounted cash flows from the companies in the future is positive.

References

CFP Board Financial Planning Competency Handbook (US Edition). (2015) (p. 98).

Fabozzi, F. (2014). Duration, convexity, and other bond risk measures (p. 5). New Hope, Pa.: Frank J. Fabozzi Associates.