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TOPIC ONE

TVM and Decision Making

Why is the time value of money concept important? In what quantitative decisions might the time value of money be used? How do you apply the time value of money concept to make decisions in your personal life? How might you use the Time Value of Money concept as a quantitative reasoning tool in business?

DISCUSSION 1

According to Newton (2016), "The time value of money is a fundamental financial principle. Its basic premise is that money gains value over time. As a result, a dollar saved today will be worth more in the future, and a dollar paid today costs more than a dollar paid later in time (para. 2, p. 1)." This is the basic concept of TVM. For example, saving $1 today may grow to $1.50 in 3 years. The TVM concept is important because it "is an important consideration in any long-term, and even short-term, investment or financial obligation (Newton, 2016, para. 3, p. 1)." In personal life, to be able to understand the TVM is beneficial because it is involved in making common financial decisions such as car loan, mortgage, credit cards, saving accounts, etc. Can I afford a car loan of $40,000 with 5.5% APR in 6 years? Can I afford a mortgage for a $170,000 house with 6% APR for 30 years? Further, Newton (2016) stated, "Financial managers and advisers frequently use time value of money formulas to determine the true costs of various investment opportunities (para. 3, p. 1)." In business, calculating TVM is an important decision-making tool in forecasting growth, profit, revenue or loss. Since there are factors affecting TVM, a business manager must weigh its options and do thorough calculations of the money involved. Newton (2016) also stated, "Determining the time value of money is an important calculation in several different financial transactions such as purchasing an asset, investing in securities, paying debt and calculating tax obligations (para. 3, p. 7)."

Source:

Newton, H. (2016). Time Value of Money -- Research Starters Business, 1-10.

RESPONSE FROM THE TEACHER

Good discussion. It is important to realize that TVM concepts are important for business in providing an quantitative methodology for making decisions like capital budgeting, but also important for individuals in reviewing personal financial decisions like retirement investing or borrowing to purchase a home or car. TVM concepts, if mastered, can be used in a myriad of situations, personal and professional.

DISCUSSION 2

The time value of money concept is important because a company is aware if future cash flows are worth the upfront investment. Many companies went out of business because of poor investments and not being able to budget. Understanding that money today is not of the same value in the past, nor will it be the same n the present is very crucial to decision making.

Applying it to my personal life, I remember growing up and I used to ask my parents for $1 to go to the convenient store for snacks. With that dollar, I was able to buy 2 bags of chips, a bottle of juice, and a Debbie cake. Compared to now, I cannot buy one bag of chips for $1. I believe the economy and the market decrease the amount of the dollar. As time goes on, it seems as if everything is increasing, yet a dollar will remain a dollar. I also look at purchasing a vehicle when thinking of the time value of money concept. Once you drive off the car lot, the value of your car decreases. A year later, your car is not worth as much as it was when you first purchased it. So if you decide to sell it in the future, you will not get what you paid for it.

If and when I own my own business (which is a clothing boutique), I will use the time value of money concept as a quantitative reasoning tool by the use of probability. I will purchase merchandise based on the current fashion trend and what I believe people will like to wear. Using variables such as demographics, location, resources, and trends are amongst some of the things that will help me determine what merchandise I can make money on. Forecasting will also help me when it comes to what merchandise to buy for what seasons, inventory planning, and eliminate over and under-stocking amongst a few things. Overall, the time value of money is very crucial to decision making and maintaining healthy financially.

RESPONSE FROM THE TEACHER

DISCUSSION 3

posted by Andrew , Mar 09, 2016, 12:31 PM

The time value of money is an important concept because it affects the business decisions we make. According to the California State Board of Equalization (2016) The value of a dollar changes over time so in looking at the TVM concept we're comparing values over different periods of time. If we're valuating future money its called compounding, and conversely valuating prior money is discounting (California State Board of Equalization (2016). Simply comparing face value of money over various periods of time is like comparing apples to oranges. However, in looking at the change of value over time, we begin to explore equivalent comparisons in regards to actual value by accounting for things like inflation.

Time value of money can be used for business decision whereas time and rate becomes variables of the equation. According to Schmidt (2014) looking at compounding equations we can find the future value of single sum, determine future value of a series of payments, or determine payments needed to achieve a future value. Additionally, in looking at discounting problems we can determine present value of a single sum, present value of a series of payments, or amount needed to amortize a present value (Schmidt, 2014).

A very simple example of this was during my recent visit to Costco. You can get a hotdog and soda at the cafeteria for $1.50. Great deal, not the healthiest option though. I was mentioning this to someone who pointed out that this deal has not changed in over 25 years. Now granted, there is obviously some marketing to go along with this, but clearly not a great financial decision. With inflation and rising costs of products it's clearly a way better deal today than it was 25 years ago.

An area where I use this is in purchasing larger ticket items that offer 0% down for a period of time. I bought some furniture a few years ago. Having planned ahead, I put the cash aside in advance and went shopping. In stead of buying with cash I financed it at 0% for 72months. I will note that there were no hidden fees. If paid within 72 months the price did not change. So I put the cash in a low risk, high interest savings for 71 months where it accrued compound interest. In paying for the furniture within the 72 months I essentially got another 5% off the price of the furniture. Now granted, with additional risk, I could have incurred higher savings, but it did not make sense to hand over cash knowing that a dollar of the future was worth less than a dollar today.

I would use the concept of TVM as quantitative reasoning in all aspects of horizontal analysis where time becomes a key component. In applying TVM to common sized statements, this ensures that you're making equivalent comparisons over given periods of time.

California State Board of Equalization. (2016). Time Value of Money - Six Functions of a dollar. Retrieved from https://www.boe.ca.gov/info/tvm/lesson1.html

Schmidt, R. (2014). What You Should Know About the Time Value of Money. PropertyMetrics.com. Retrieved from http://www.propertymetrics.com/blog/2014/06/17/time-value-of-money/

DISCUSSION 4

In business and personal life, time value of money is important. In an article published on newagepublishers.com the article identifies the basic concept of time value of money.

" Most financial decisions such as the purchase of assets or procurement of funds, affect the firm's cash flows in different time periods. For example, if a fixed asset is purchased, it will require an immediate cash outlay and will generate cash flows during many future periods. Similarly if the firm borrows funds from a bank or from any other source, it receives cash and commits an obligation to pay interest and repay principal in future periods. The firm may also raise funds by issuing equity shares. The firm's cash balance will increase at the time shares are issued, but as the firm pays dividends in future, the outflow of cash will occur. Sound decision-making requires that the cash flows which a firm is expected to give up over period should be logically comparable. In fact, the absolute cash flows which differ in timing and risk are not directly comparable. Cash flows become logically comparable when they are appropriately adjusted for their differences in timing and risk. The recognition of the time value of money and risk is extremely vital in financial decision-making. If the timing and risk of cash flows is not considered, the firm may make decisions which may allow it to miss its objective of maximizing the owner's welfare. The welfare of owners would be maximized when Net Present Value is created from making a financial decision. It is thus, time value concept which is important for financial decisions." (newagepublishers.com)

In an article posted by Laura Acevedo on ehow.com, she states "Successful business decisions rely on quantitative methods to narrow possibilities and help predict what options will have the greatest chance of success. Whether you are making purchasing, marketing or financing decisions, it is essential to obtain a quantitative foundation to assist in the decision-making process. Using math and numbers to back up your business decisions helps you make more informed choices and can help increase your company's success."

In my personal life, my wife and I weighed the pros and cons of investing in a prepaid college tuition plan for our daughter. Our investigation into the idea, would allow us to pay for her college at today's prices. There a variety of plans and these plans are managed by the states. The risk is low, and in turn the return was something like 4 to 5 percent interest earnings. Additionally, this option would limit our daughter's choice of school. What we decided was to add additional monies toward our 401K plans where we can borrow or withdraw at a later time.

In business, I have put together capital projects where I had to create a business case that included, a timeline for return on investment, immediate savings and long term saving while reducing our manufacturing footprint within the facility. We are a facility filled with older machines, utilizing floor space and that requires many operators. A newer machine, with newer technology not only reduces floor space, but removes wastes in the process. When making these types of decisions TVM is critical in our success.

Reference(s)

New Age Publishers: Concept of Time Value of Money. Retrieved from: http://www.newagepublishers.com/samplechapter/001945.pdf

Acevedo, L.(ND).Quantitative Methods for Business Decisions. Retrieved from: http://www.ehow.com/way_5329921_quantitative-methods-business-decisions.html

DISCUSSION 5

TMV and Decision Making

Money's time value is a significant aspect to investors since the TVM can be used in calculating interest or capital gains if invested. The time value of money is used in calculating the monetary value of an investment over an extended time period. In my personal life, the time value of money is applied in establishing an investment project's worth by measuring the present cost against the cash flow expected from the project in future. The TMV is also used in establishing the financial soundness of borrowing costs and credit terms with regard to financial borrowing. The TMV concept might be used as a quantitative reasoning tool in business by calculating a business' profitability based on the cash flow with regard to the investment's time value (Graham, Smart & Megginson, 2012).

References

Graham, J. R., Smart, S. B., & Megginson, W. L. (2012). Introduction to corporate finance. Australia: South-Western/Cengage Learning.

RESPONSE FROM THE TEACHER

Could you explain how TVM could, "be used as a quantitative reasoning tool in business by calculating a business' profitability based on the cash flow with regard to the investment's time value"? I thought that your posting needed to go into a bit more depth.

I look forward to your additional explanation.

TOPIC TWO

Time Value of Money

The formula to calculate the value of $1 put into savings today is fv = pv*((1+i)^n). The variables are fv = future value, pv = present value, i = interest rate per period, and n = the number of periods. In the formula, n is an exponent. What does the exponent in this case state that you need to do mathematically to the (1 + i) segment of the formula? Select an interest rate and number of periods—be sure your numbers are different from other students who already answered this question—to calculate the future value of $1. How much money would you have at the end of the period you determined if you invested $1 today (pv)?

DISCUSSION 6

What at does the exponent in this case state that you need to do mathematically to the (1+i) segment of the formula?

n=time=number periods

i=interest=value

(1+i)^n

(1+value)^n

Basically you have to show how the money over value changes over time.

To calculate the future value of a $1. How much money would you have at the end of the period you determine if you invested $1 today (pv)?

Invested $1

Interest rate = 50%

Number of periods =2 years

fv=pv*(1+i)^n

fv=pv*(1+.50)^2

fv=1*(1.50)^2

fv=1*(1.5)(1.5)

fv=1*2.25

fv=2.25:

RESPONSE FROM THE TEACHER

Good work!

If the 50% rate is an annual rate, paid quarterly, then you would actually divide 50% by four, for four quarters. Any time you have compounding different than a year you adjust the interest rate and the number of periods. For quarterly compounding, you divide the interest rate by four and multiply the number of periods by four. For semiannual, you divide the interest rate by two and multiply the period by two. For monthly, you divided the interest rate by 12 and multiply the number of periods by 12 and so on...

DISCUSSION 7

What does the exponent in this case state that you need to do mathematically to the (1 + i) segment of the formula? You must add 1 to the interest rate and multiply that segment by the exponent

Invested $1

Interest rate= 10%

Number of periods= 4 years

Fv=pv*((1+i)^n)

Fv=1*((1+.10)^4)

Fv=1*1.4641

Fv= $1.46

RESPONSE FROM THE TEACHER

Good work!

If the 10% rate is an annual rate, paid quarterly, then you would actually divide 10% by four, for four quarters. Any time you have compounding different than a year you adjust the interest rate and the number of periods. For quarterly compounding, you divide the interest rate by four and multiply the number of periods by four. For semiannual, you divide the interest rate by two and multiply the period by two. For monthly, you divided the interest rate by 12 and multiply the number of periods by 12 and so on...

DISCUSSION 8

Time Value of Money

The TMV formula used for calculating the value of money invested is fv = pv*((1+i)^n). In this formula, n is an exponent that requires the value of (1+i) in the formula to be raised to the exponent (Bierman & Smidt, 2003). With regard to week five topic discussion, my interest rate shall be 37 while the periods shall be semi-annually for three years hence making the total periods six while the amount is $1.

Therefore: fv = pv*((1+i)^n). = fv = 1 X (1+37/100)6 = 6.6119. This implies that that if I invested $1 today for 3 years at a rate 37% compounded semi-annually, I would get $6.6119 at the end of 3 years. On the other hand, I would be required to invest $1 at the rate of 37% compounded semi-annually to earn $6.6119.

References

Bierman, H., & Smidt, S. (2003). Financial management for decision making. Washington, D.C: Beard Books.