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M3 (KJ) RESPONSE

NEED FOLLOW-UP RESPONSE (IT ONLY NEEDS TO BE 2-3 PARAGRAPHS WITH 1 REFERENCE)

ORIGINAL QUESTION:

Assignment 1: Discussion—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.

STUDENT RESPONSE:

As a chief financial officer of a firm with an expected liability (cash outflow) of $2 million in ten years at a discount rate of 5%; the calculated amount the firm would need on the present date as savings to cover the expected liability is $1,227,826.51. This amount is calculated by using present value which is the current worth of a future sum of money or stream of cash flows given a specified rate of return. This is calculated by using the present value equation PV= FV/ (1+r) n = 2/ (1.05)10 = $1.23 million (rounded). Where FV= future value, PV= present value, and R= discount rate. The calculated amount that the firm would need to set aside at the end of each year for the next ten years to cover the expected liability is $3,257,789.25 (future value of the annuity due). This amount is calculated by using the future value formula which is =FV (rate, nper, pmt, [pv], [type]) (2*1.6289=3257789.25). 

            Using the Argosy University online library resources, an article that I reviewed that demonstrates the application of time value of money principles to a business decision is “Supporting Financial Decision-Making Based on Time Value of Money with Singularity Functions in Cash Flow Models” by Gunnar Lucko. This article explores the existing budgeting approaches in construction management and their potential to enhance cash flows in order to maximize their net present value. “The time value of money is a core concept of finance, which states that money available at the present time is worth more than the same amount in the future” (Ohio University, 2017). This article demonstrated the application of time value of money principles by examining the focus of NPV as the primary valid way to value the cash flows per their TVM and the impact on profit as a cost of doing business that may not be optimized explicitly. “Furthermore, the issue is attenuated by the uncertainty of future events and the

often-cited tight profit margins that may exist in construction projects, creating an urgent need for optimizing the financial performance of projects in detail, e.g. by front-loading expenses and other strategies if possible and permissible” (Lucko, 2012). These issues created an urgency to modify existing cash flow models to have omitted discounting which assess the value of payments of different amounts and times. By factoring in the value of money over time, they are able to forecast cash flow and identify potential risks, which influence their investment decision-making process.

            After a clear understanding of this issue, it was time to identify the various other factors at managements disposal. Factors other than the time value of money that management should have considered in reaching the business decision is identifying alternatives in converting growth into equivalent payments and improving analytical capabilities for cash flows. For example, if management considered financing terms for contractors, the new model could distinguish different interest rates for financing the outflows or investing the inflows, such as depositing them into interest-bearing business bank accounts. 

References:

Lucko, G. (2012). Supporting Financial Decision-Making Based on Time Value of Money with Singularity Functions in Cash Flow Models. Department of Civil Engineering. Retrieved from, 

http://eds.a.ebscohost.com.libproxy.edmc.edu/eds/pdfviewer/pdfviewer?vid=21&sid=557c09ae-6804-46a1-930c-344d3ec62c6a%40sessionmgr4007

Ohio University. (2017). Time Value of Money Principles and Concepts. Ohio University. Retrieved from, https://onlinemasters.ohio.edu/time-value-of-money-principles-and-concepts/

NEED FOLLOW-UP RESPONSE (2-3 PARAGRAPHS WITH 1 REFERENCE):

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