Free Essay About Time Value Of Money
The section requires having a summary of each of the chapter found in the book that pertains to financial management.
Analysis & Findings
The first chapter of the book is on the topic of Time Value of Money (TVM). According to the summary from the book, Time Value of Money is basically a concept of Finance, which has been used specifically in the Capital Budgeting Process. It is found a method through which the future value of an investment or cash flow can be analyzed in the present term, like what the future cash flow or investment has the current present value. One of the major examples is the term deposit in the banks to analyze the current value of the future investment return receive by an individual after a certain amount of time period.
Topics like Future Value and compounding is the second chapter of the report. From the summary of this chapter, it is found that the value which is expected to receive by an investor after a specific time period is known as the future value. It can be associated with a project or an investment vehicle which is intending to give future monetary benefits to the individuals. For Example, a bank deposit which is intending to give 5% yearly return on their investment. Compounding relates to the frequency of the investment that after how much time the investment vehicle will give the return. It can be on different basis like yearly, semi-annually and quarterly. The same example of the bank can be taken into account in which the bank is paying 3% on semi-annual basis.
The third chapter of the report talks about present value and discounting. The concept of present value is almost the same as Time Value of Money (TVM) in which the future value of the investment will be discounted to have its present value. Book stated that Present Value is the present term of the future investment, while discounting is the phenomenon from which the future value will be computed on the present terms. For example, an individual invested 100,000 $ in the bank in having a return of 6% after a year. Now 6% can be considered as the discount rate and the present value computed through the formula will be the actual worth of the future value of the investment in the present term.
Projects may have different cash flows and the same has been defined in the fourth chapter of the book. According to the crux of this chapter, A capital budget project in which the existence of cash flow will be both positive and negative after a given time period is known to have Multiple Cash Flows. Multiple Cash Flows is a common example like if a project that will be considering by the company for the investment purpose will give 100$ in the first three years and then -50$ in the couple of years. These cash flows can be analyzed through the Modified Internal Rate of Return (MIRR) concept.
The fifth chapter of the report reveals something about different types of cash flows which are Annuities and Perpetuities. As per the summary, an annuity is basically a fixed payment on a contractual product from a financial institution each year, and having a big balloon payment at the end of a specific time period. It is long for a definite time period in a project. For example, the investment in shares which are paying a certain amount of dividend each year is annuity. On the other hand, the amount of benefit that will be enlarged and continue for an unlimited time period is perpetuity. Life insurance premiums can be an example of perpetuity.
Cash flows usually grow on constant rate or sometimes on non-constant basis. The sixth chapter of the report found interactive in Cash Flows which Grows at Constant Rate. Summary of the chapter revealed that an incremental cash flow which has the ability to grow with a constant rate is known as constantly growing Cash Flow. Example of a project can be taken into account whose cash flows have the ability to increase with a constant rate of 5% in a year.
Interest rates and its types have been defined in the 7th chapter of the report. As summary of this part, it can be said that most of the times financial institutions quote interest rate without having the effects of the potential and hidden charges in the interest rate, and it are quoted as Effective interest rate which is little bit high than the actual quoted interest rate. For example the cost of borrowing from a bank is 6% on annual basis; however at the end of the day, the borrower is giving something extra on their borrowed amount.
Part-2-(WSJ Article Summary)
Summary of the Article
This particular part of the assignment requires selecting an article from the Wall Street Journal that specifically associated with the stance of Time Value of Money. As mentioned above it is one of the most important finance based concepts that has its recognition in different parts of the world also has the recognition in the analysis of the borrowed funds and amount.
The article which has been selected for the same assignment is “Should you Refinance”. The article was written by Brett Arends in the year 2009. The article is all about investing in the Mortgage Funds and Venture Capital Funds which has been referred as one of the most important types of funds which are maintaining their core position in the market. According to the article, mortgage funds are like Mutual Funds which are far away than that of risk factors (market risk) because of their sustainable behavior and stance.
The article had pointed out the government initiatives to give a certain percentage of return to the investors who are interested to park their money in the stocks of the mortgage plans and other important aspects. Brett pointed out clearly in the article that there are some perquisite which the investors have to undertake behavior initiating an investment strategy for the return because of the inclusion of different cost and fees.
It is also emphasized in the article to perform the things according to a prescribed manner and gave a strong aspect on their core productivity. The article found that investors should discount their future cash flow with the same amount of percentage they will be given to nullify the investment to discount it and gain an added advantage in terms of its investment. Apart from the individuals, organizations or entities which are interested to park their money in the risk free investment should also analyze their stance of present value for their future cash flows. Brett Arends have diverted the attention of different investors to a very serious issue in the investment stance and world which is the exclusion of taxation from the investment return; however it is a direct cost which will be applicable on the investment return sooner or later. Therefore, while discounting the future cash flow of a project or other aspects, it is also very important for the investors to subtract the amount of taxation as well from their core investment to reach on the final conclusion of having the effectiveness of the investment of not. The article can be perfect guide for a starter who is taking or about to take a course in the financial management subject because the term of Time value of Money is very important for the application and implication on the analysis purpose, and both companies and individuals are required to apply this concept on their own hands. The article also revealed the importance of TVM concept in the field of Capital Budgeting which has been made specifically on the concept of analyzing the mutually exclusive projects which can bring positive economic change for the companies. The article needed to be applied on almost every organization of the world for their long run productivity. The practice of utilizing the concept of TVM is the only thing that can differentiate among two similar companies in terms of managing their core corporate projects.