Time value of money-inflation-interest rate-opportunity cost, Other Engineering

Assignment Help:

Time Value of Money

Consider your cheese steak hoagie business. Assume that Phillies will win another World Series, and your business will be hired to serve a party that will generate an additional $2,000 times 1.15X years from now the Phillies win the championship again. What would you choose the value of X equals 1, 2, 3, or 4 years from now? What factors would you consider to make your decision?

If you hoagie business owes money and is paying a high interest rate for the loan, you will certainly would like X to be 1. Or, if you do not owe money but you can invest the money to expand your business, you will prefer the money now. What about if instead of $2,000 now, you will receive $3,000 but X will be 4? The factors that you will need to evaluate your alternatives are:

Interest rate
Opportunity cost

This is what is known as the time value of money (TVOM). The money has value trough the planning horizon and it will affected by an interest rate every time period. For example, you loan $4,000 to a bank at 10% and by the end of each year you will an interest rate to the bank, so at the end of year one you will owe to the bank $4,400 dollars. Also, you may have at the end of year 3 a positive cash flow of $3,000 and you decide to loan the money to a friend, so you can no longer invest the $3,000 in expanding your business and forego the opportunity to earn a return on your $3,000, which is know as the opportunity cost.

Other terms that are used to express the TVOM are interest rate, discount rate, hurdle rate, minimum attractive rate of return, and cost of capital.

What it is clear is that $4,000 today are not the same to $4,000 ten years ago, or 3 years for now. In other words, a brand new Honda Civic in 2004 cost approximately $11,500, and in 2009 costs approximately $18,5000.

Therefore, we can not add or subtract money that occurs at different time periods. If we want to do that then we need to bring the money to a same time period applying the corresponding mathematical operations and the corresponding discount rate. This is what is known as discounted cash flow (DCF) which has four DCF rules:

1. Money has time value of money;

2. Money cannot be added or subtracted unless it occurs at the same point(s) in time;

3. To move the money forward one time unit, multiply by one plus the discount or interest rate;

4. To move money backwards one time unit, divide by one plus the discount rate or interest rate.

Therefore, to evaluate different alternatives (or add money occurring at different points in time) we have to develop mathematical relationships of money at different points in the planning horizon. We will develop these relationships in the following chapters.

Related Discussions:- Time value of money-inflation-interest rate-opportunity cost

Class number arrangement - library management, Class Number Arrangement   ...

Class Number Arrangement   Unlike the Cities Numbers of Dewey Decimal Classification the Colon Class Numbers have not only Arabic Numerals but also capital letters of the Roman

Propeller overspeed governors, PROPELLER OVERSPEED GOVERNORS: These dev...

PROPELLER OVERSPEED GOVERNORS: These devices protect against overspeed, they are separate governors to the P.C.U. and direct oil during an overspeed situation to coarsen the bl

Find the standard deviation of this portfolio''s returns, Suppose you have ...

Suppose you have $50,000 that you want to invest in two companies, Bethlehem Books and Allentown Audio. Bethlehem has a return of 10% and standard deviation 15%, while Allentown ha

Susceptibility - fire safety management, Susceptibility: Susceptibilit...

Susceptibility: Susceptibility to products of combustion, which includes metabolism, lung capacity, pulmonary disease, allergies, or other physical limitations that affect sur

The ideal operational amplifier, THE IDEAL OPERATIONAL AMPLIFIER Althou...

THE IDEAL OPERATIONAL AMPLIFIER Although the characteristics of an ideal operational amplifier are unattainable, modern integrated circuit types can provide an extremely close

Subtractive rapid prototyping process and additive process, Q.4 Explains su...

Q.4 Explains subtractive rapid prototyping process and compare with additive process.                                                   OR What are additive and su

Sustainability concepts associated with ubiquitous computing, Question: ...

Question: (a) Spreading the spectrum for signal transmission helps alleviate the narrow band interference problem. What is narrow band interference? State and describe 2 differ

Divided entrance duct - aircraft engine, Divided entrance duct On a sin...

Divided entrance duct On a single engine aircraft with fuselage mounted engines, either a wing root inlet or a side scoop inlet may be used. The wing root inlet presents a pro

Flames obtained in an oxyacetylene gas welding process, Q.  Describe the t...

Q.  Describe the types of flames obtained in an oxyacetylene gas welding process giving the applications. There are three types of flames in the gas welding on the base of the

Write Your Message!

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd