Parrino Chpt 5 & 6

Parrino Chpt 5 & 6 - Session_04_Lecture MGMT640:...

Info iconThis preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
Session_04_Lecture MGMT640: Session IV The Time Value of Money Learning Objectives 1. Explain what the time value of money is and why it is so important in the field of finance. 2. Explain the concept of future value, including the meaning of principal amount, simple interest, and compound interest, and be able to use the future value formula to make business decisions. 3. Explain the concept of present value and how it relates to future value, and be able use the present value formula to make business decisions. 4. Discuss why the concept of compounding is not restricted to money, and be able to use the future value formula to calculate growth rates. Chapter Outline 5.1 The Time Value of Money A basic problem faced by managers in financial decision making is to determine the value of a series of future cash flows, whether paying for an asset or evaluating a project. The question that is being raised is: What is the value of the stream of future cash flows today?
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
We refer to this value as the time value of money . A. Consuming Today or Tomorrow People prefer to consume goods today rather than wait to consume similar goods in the future—that is, a positive time preference. The time value of money is based on the belief that people have a positive time preference for consumption. Money has a time value because a dollar in hand today is worth more than a dollar to be received in the future. The dollar in hand could be either invested to earn interest or spent today. The value of a dollar invested at a positive interest rate grows over time, and the further in the future you receive a dollar, the less it is worth today. The trade-off between spending the money today versus spending the money at some future date depends on the rate of interest you can earn by investing. The higher the interest rate, the more the likelihood of consumption being deferred. B. Time Lines as Aids to Problem Solving They are an easy way to visualize the cash flows associated with investment decisions. A timeline is a horizontal line that starts at time zero (today) and shows cash flows as they occur over time. See Exhibit 5.1
Background image of page 2
It is conventional to show that all cash outflows are given a negative value; then all cash inflows must have a positive value. C. Future Value versus Present Value Financial decisions are evaluated on either a future value basis or a present value basis. Future value measures what one or more cash flows are worth at the end of a specified period, while present value measures what one or more cash flows that are to be received in the future will be worth today (at t = 0). The process of converting an amount given at the present time into a future value is called compounding . It is the process of earning interest over time. Discounting
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 22

Parrino Chpt 5 & 6 - Session_04_Lecture MGMT640:...

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online