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Unformatted text preview: CHAPTER 8 The Time Value of Money THINKING BEYOND THE QUESTION How much will it cost to borrow money? A shorter borrowing period means that a creditor will receive repayment of a loan sooner than if the borrowing period is longer. Consequently, the money that is borrowed is at risk over a shorter period. The lender has the opportunity to lend the money out again and renegotiate the in- terest rate on the loan when it is paid back sooner. Interest rates depend on the lenders evaluation of the ability of the bor- rower to repay the loan on a timely basis. A borrower with high operating cash flows and net income and relatively low amounts of debt is less likely to have difficulty repaying a loan than a company with low cash flows and profits and high amounts of debt. A good credit history also is important. A borrower who has a history of repaying loans and interest on a timely basis is likely to obtain lower interest loans than one who has had payment problems. Lenders examine the income statement to determine a companys profit- ability and whether profits are increasing or decreasing over time. They examine the statement of cash flows to determine the amount of operat- ing cash flow a company is generating, how it is using that cash flow, and how much debt and interest the borrower is paying. They examine the balance sheet to determine how much debt and other liabilities the company has outstanding. Good financial statement numbers usually result in lower interest costs. QUESTIONS Q8-1 Future value and present value are based on the concept of interest. Both recognize that, when invested at a rate of interest, an amount of money will grow to a larger amount as time passes. Future value is the amount that an investment will grow to over time. Higher rates of interest or longer investment periods result in higher future value. Present value is the amount that must be invested today to grow to a desired amount in the future. Higher interest rates or longer investment periods result in lower present value. 201 202 Chapter 8 Q8-2 The concept of future value assumes that money has a time value. It assumes, for example, that a specific amount of money invested today will grow to a larger amount over time. Therefore, $1,000 invested today at a rate of return greater than zero will grow to an amount larger than the amount originally deposited. Q8-3 The concept of present value assumes that money has a time value. It assumes, for example, that a specific amount of money to be received at some future time has a lesser value (or benefit) than if that same amount were available to be received today. Q8-4 Any interest factor found on Table 1 reveals the amount that $1 will grow to if invested at the given interest rate for the number of periods indicated. Here, the number 5.55992 reveals that $1 invested at 10% for 18 periods will grow to approximately $5.56....
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This note was uploaded on 06/18/2011 for the course ACC 300+ taught by Professor Gh during the Spring '11 term at Saint Joseph's University.
- Spring '11