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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:

The amount the firm would need on the present date as savings to cover the expected liability is $325,800,000.00.

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 is $122,800,000.00.

Explain the specific business decision that management made after computing this value

According to Merritt, Simply put, the time value of money is the idea that a particular sum of money in your hand today is worth more than the same sum at some future date. For example, given the choice between receiving $1 today or $1 a year from now, you should take the money today. You could invest that $1, and even if you only earned a 2 percent annual return on your investment, you still would have $1.02 a year from now — more than the $1 you’d have gotten if you waited. If you didn’t invest that $1 at all but simply spent it, you’d still be better off; because of inflation, the $1 usually will have more buying power today than in the future.

Analyze how management used the concept of the time value of money principles to make this decision.

Companies apply the time value of money in various ways to make yes-or-no decisions on capital projects as well as to decide between competing projects. Two of the most popular methods are net present value and internal rate of return, or IRR. In the first method, you add up the present values of all cash flows involved in a project. If the total is greater than zero, the project is worth doing; the higher the net present value, the better. In the IRR method, you start with the cost of the project and determine the rate of return that would make the present value of the future cash flows equal to your upfront cost. If that rate — called the internal rate of return — is greater than your discount rate, the project is worth doing. The higher the IRR, the better (Merritt).

Analyze factors other than the time value of money that management considered or should have considered in reaching the business decision.

According to NDSU.edu (2010), these factors should be considered:

quantity of future production,

value of future production (implies an assumption about the impact of inflation and demand on the value of the product),

time of future production,

type and quantity of future inputs (implies an assumption about production technology),

cost of future inputs (implies an assumption about the impact of inflation on input costs),

time when future inputs will be used, and

a discount rate (probably a real rate, that is, a nominal or market rate adjusted for an anticipated general rate of inflation).