Running head: FINANCE 1

Finance Reviewed
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Time Value Money

Time value of money is a basic financial concept that shows money in the present

value of a project. It is also an important metric for estimating how much a project will be

worth later in future. The aim of investing in any project is to get returns. Currently, financial

analysists are able to estimate how much a project is expected to gain in future through

forecasting methods such as net present value. However, the future is faced with many risks

therefore this is only a projection (Irena, 2017). The time value of money is related to the

concept of purchasing power and inflation in future. It considers both factors when making

the projections to show whether the rate of return will be realized after an investor risks their

money on a project. Inflation is an important factor when looking at future value of money

since constantly affects the value of an asset, purchasing power and production cost.

The time value of money concept was used to estimate whether the project should be

implemented. It was important to conduct the analysis before initiating the project to be able

to advice the management on the viability of the project. Purchasing a new machinery usually

require the company to use most of its cash. Therefore, a project that will not generate profit

would leave the company under big debts or lead it to bankruptcy.

The proposed project is expected to use $70,000 to purchase a new machinery with

the aim of expanding operations. The project’s discounted rate was 12%. The company

expects to repay the funds used by to purchase the machinery at $10,000, $20,000, $30,000

and $30,000 in its first, second, third and fourth year respectively.

The management needs to be able to estimate how much money the machinery is

expected to generate to be able to pay back the money invested. The net present value of the

project was calculated using the formula; FV=PV x [(1+(i/n)](n x t) where FV is the future

value, I is the interest, is number of years being considered, in our case is 4 years and n is the

compounding period of interest per year.

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To arrive at the present value, the annual cash flow is multiplied by the discounting

factor (1+12%) ^-n. The present values are added to arrive at the total present value

amounting to $ 65,291.40. This present value is subtracted to $ 70,000 to arrive at a negative

NPV, that is, ($ 4, 708.60). The NPV showed that the project would be viable. By the fourth

year, the expected cash flow would be $ 65,291. The present value was calculated by

multiplying discount factor by the present value. By the fourth year, the projects future value

was expected to be $19,066. However, by the fourth year, the company will not have

managed to generate enough cash flow to payback the invested capital. Therefore, the project

should only be undertaken if it will go past four years.

The projects present value and net present value are shown in table 1 bellow.

Year 1 2 3 4
         
Discount Factor                            

   0.89    0.80    0.71    0.64

         
Undiscounted                        

Cash Flow 10,000 20,000 30,000 30,000

         
                        
Present Value
8,929 15,944 21,353 19,066
         
     
Present Value      
65,291
Recommendation

Since machineries are long term projects, and capital intensive, a company should be

able to ascertain that it will yield profits. Conducting forecasting of future cash flows and

future value of the asset while considering factors such as inflation should be conducted

before buying the asset. Time value of money in future should be carefully reviewed to
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reduce the risk of buying assets that would be a liability rather than profit generating (Chen,

2020).

The present value is the measure of wealth creation relative to the discounting rate.

From the analysis, the negative NPV, ($ 4, 708.60) means that the present value of the

machinery exceeds the present value of the revenue at the agreed discounting rate of 12%. At

7%, the net present value is at positive, $ 4190, which is recommendable. A zero rate of

return, which is also recommendable, suggest that the investment earns a rate of return equal

to the discounting rate (Chen, 2020). In order to arrive at a 0 NPV rate of return, we use the

what-if analysis from the excel spreadsheet. Using the What-If-Analysis, we wish to set the

NPV at 0 in order to change the rate of return. We use the Goal seek minor tab, by setting the

NPV ($ 4,708.60) to o by changing the discounting rate of 12%. A rate of 9% is generated

meaning that if the managers wish to invest with the new machine, then it should have a rate

of return from 9% an above. This is good for investment.

Discounted Rate of 9%

Cash flow Discount (9%) Present Value

End of Year 1 10000 0.91544536 $9,154.45
End of Year 2 20000 0.838040207 16760.80415
End of Year 3 30000 0.767180019 23015.40058
End of Year 4 $30,000 0.702311389 21069.34167
$70,000.00
$70,000.00
Net Present Value $0.00
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References

Chen, J. (2020, January 24). Time Value of Money (TVM). Corporate Finance and

Accounting , p. 4.

Irena, M. (2017). Introduction: What is time value of money? Economic Sciences

Series , 2-3.