Module 4 Critical Thinking FIN300-1

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Colorado State University, Global Campus *

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Jan 9, 2024

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Time Value of Money: Corporate Application Colorado State University Global FIN300-1: Principles of Finance for the Private Sector Prof. Brian Weaver January 15 th , 2023 1

2 Time Value of Money: Corporate Application The time value of money is an important aspect in the world of finance, and especially so in the corporate realm. The time value of money is defined by Gitman and Zutter (2014) as the consideration that it is better to receive money sooner rather than later. This concept is vital to the corporate world because understanding both the present and future values of an investment or the value of actual cash on hand can be supplemental in making further business decisions. According to Chen (2009), there are a few different ways to compute present and future values, and these value pertain to annuities, stock valuation, and the relationships held between the values. To explore this concept more thoroughly, we will look at the corporate functions for Rhonda and her various ice cream stores. Rhonda’s Ice Cream Stores Rhonda has a small franchise of ice cream stores and is looking to purchase new equipment as well as open up a new location, and needs sound business advice. One of the best ways to assist Rhonda with these business decisions is to assess the present value and future value of both her current assets and the potential purchases. With these values it is also important to consider their depreciation as well as the profit that they are expected to generate. New Equipment Rhonda’s potential purchases on new equipment include a new ice cream machine as well as a new espresso maker, both of which are expected to yield fairly decent profits. Before we analyze these prospective purchases and what effects they may have, we must first consider the different values of the machine she currently has at one of her stores. The current machine at one of the ice cream stores was valued at $10,000 and is expected to yield a profit of $2,500. With the consideration of depreciation, this machine will be worth $8,250 at the end of the year. In retrospect, the new machine would cost $15,000 and is anticipated to generate profits of $4,000

3 and at the end of the year will be valued at $12,500. To analyze the two ice cream machines, we will determine the holding period return for both assets. The holding period return represents the rate of return that is earned on an investment over a specified period of time. This rate of return is computed by using the following formula: ending value – beginning value + cash received  beginning value. We will start with the current machine: $8,250 -$10,000 + $2,500  $10,000 = 7.5%. The rate of return for the new machine is : $12,500 - $15,000 + $4,000  $15,000 = 10%. Comparing the rate of return for both of the ice cream machines shows that the new machine will produce a higher rate of return than the machine Rhonda is currently using. Next, we will analyze the potential of adding an espresso machine at one of the locations to expand the goods available for sale at said store. Rhonda has stated that she has the savings available for this purchase, but doing so would eliminate the annual interest of 4.5% that the account accrues. The espresso machine is expected to yield an annual profit of $3,000 for the next five years, and at the end of those five years the machine could be sold for $4,000. To better analyze the decision of this new purchase we will determine the present value of the espresso machine. The present value of an amount is defined by Gitman and Zutter (2014) as the current dollar value of a future amount, or in other words, the amount that would have to be invested with a specified interest rate and period of time to be equal to the future amount. To compute the present value we take the future value that is to be received after a period of time and divide by one plus the interest rate to the power of the number of years. For the espresso machine, our equation would be $3,000  (1+.045)^5 = $2,407.36. The present value of the espresso machine shows that the purchase would be worthwhile for Rhonda, and could generate good profits for her, even with the loss of her annual rate. New Location

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