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Why does money have time value
Why does money have time value
Why does money have time value
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The time value of money principle states “that a dollar in your hand today is worth more than a dollar you will receive in the future because a dollar in hand today can be invested to turn into more money in the future” (What is the Time Value of Money 2018). Financial managers utilize the time value of money principle to better understand how the time value of money impacts company stock prices. Also known as discounted cash flow anaylsis, time value of money plays a crucial role in deciding whether or not to invest or purchase a company. For example, Home Depot is a global home improvement retailer who specializes in selling consumers a variety of building, maintenance, and renovation products and services. The Home Depot chain currently …show more content…
The (I) is 8% while the (N) increases as the free cash flows are discounted yearly. Therefore, 2015 is one period while 2020 is six periods. Home Depot is not making payments, so the (PMT) variable remains zero. The future values (capital leases) are listed in the millions. To calculate 2015’s present value, utilizes the following formula: PV = (0.08, 1, 0, 113) and the present value is ($104.63) million. The (I) and (PMT) variables remain constant while the (N) variable increases and (FV) variable decreases. Therefore, 2016’s formula is PV = (0.08, 2, 0, 111) and the present value is ($95.16) million. The 2017, 2018, 2019, and 2020 present values are ($85.73) million, ($74.24) million, ($66.02) million, and ($554.55) million respectively. After the individual present values are calculated, they are combined to calculate Home Depot’s 2014 present value, which is ($980.33) million (The Home Depot, Inc. Form 10-K 2015) (Ehrhardt 2017). (Appendix …show more content…
In other words, financial risk plays a significant role in determining an investor’s required rate of return. Therefore, any changes to the financial risk will impact the required rate of return in a similar fashion. If Home Depot increases its rate from 8% to 10%, the investor’s required rate of return increases. In addition, the company’s present value will decrease due to the increase in risk. “This happens beause the higher the discount rate, the lower the investment needs to be in order to achieve the target yield” (Schmidt 2013). For example, Home Depot has a 2015 free cash flows future value of $113 million. By increasing the risk discount rate from 8% to 10%, Home Depot’s present value decreases by $1.9 million from ($104.63) million to ($102.73) million. The higher discount rate enables Home Depot to invest its available $1.9 million in free cash flows into other capital leases or other growth-related opportunities. If Home Depot decreases its discounting rate to 6%, the present value for 2015 increases to ($106.60). In addition, the required rate of return decreases and the net present value increases by $88.59 million. Home Depot needs to increase its free cash flows to meet desired future value (Schmidt 2013) (The Home Depot, Inc. Form 10-K 2015) (Financial Risk
company, the benefit of bringing in a 35% net income outweighs the cost of a 2% loss of interest
These ratios can be used to determine the most desirable company to grant a loan to between Wendy’s and Bob Evans. Wendy’s has a debt to assets ratio of 34.93% while Bob Evans is 43.68%. When it comes to debt to asset ratios, the company with the lower percentage has the lowest risk. Therefore, Wendy’s is more desirable than Bob Evans. In the area of debt to equity ratios, Wendy’s comes in at 84.31% while Bob Evans comes in at 118.71%. Like debt to assets, a low debt to equity ratio indicates less risk in a company. Again, Wendy’s is the less risky company. Finally, Wendy’s has a times interest earned ratio of 4.86 while Bob Evans owns a 3.78. Unlike the previous two ratios, times interest earned ratio is measured on a scale of 1 to 5. The closer the ratio is to 5, the less risky a company is. From the view of a banker, any ratio over 2.5 is an acceptable risk. Both companies are an acceptable risk, however, Wendy’s is once again more desirable. Based on these findings, Wendy’s is the better choice for banks to loan money to because of the lower level of
1. I am asked to compute the before-tax Net Present Value or NPV of a new ski lift for Deer Valley Lodge and advise the management there of the profitability. Before I am able to make this calculation there are a few calculations that I will need to make first. First the total amount of the investment, this will be the cost of a lift itself $2 million plus the cost of preparing the slope and installing the lift $1.3 million.
The Home Depot learned the hard way that you must hire a leader that will stay true to the core values. The leader’s ethics and values will play a huge role in determining if the company will succeed or fail. The founders of The Home Depot built a culture on the foundation of respect, integrity, and compassion. The culture and customer service under the influence of the admired founders prospered.
Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the project(s) that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.
The following table demonstrates the PV of costs, the PV of benefits and the NPV respectively, over 5-year period for the investment:
Finding the perfect capital structure in terms of risk and reward can ensure a company meets shareholder expectations and protects a firm in times of recession. Capital structure refers to how a business puts its money to “work”. The two forms of capital structure are equity capital and debt capital. Both have their benefits and limitations. Striking that perfect balance between the two can mean the difference between thriving versus trying to survive.
2. Given the forecasts provided in the case, estimate the expected incremental free cash flows associated with Du Pont’s growth strategy and maintain strategy for the TiO2 market. How much risk and uncertainty surround these future cash flows? Which strategy looks most attractive (i.e., using the DCF (e.g., NPV) method)??
This object is one of the financial goals to invest properly. Marriott used discounted cash flow techniques to evaluate potential investment. It is beneficial because it is considered present time value. Projects which increase shareholder value could be formed with benchmark hurdle rates, the company can ensure a return on projects which results in profitable and competitive advantage.
Once Home Depot’s marketing plan contains a thorough description of the scissor lift, it will then focus on the branding, pricing, and distribution of the lift. The plan will also need to include a product branding and pricing strategy, as well as examine how the pricing strategy supports the branding strategy. In addition, Home Depot will prepare a distribution channel analysis from which it will create a distribution strategy, determine whether the company is going to use a push or a pull strategy, and how the distribution strategy fits the product.
The cash flows discounted by the risk-free rate of 9% allows us to compare the present values. This comparison illustrates a net advantage to buying the truck:
The continuing value for the residual earnings was determined by taking 2010s projected residual earnings and multiplying it by 1 plus
It is important to clarify some key assumptions that were made in valuing the properties to this NPV. First, the project yields a high IRR of 73 %, due largely in part to the sale of each building upon lease up. For the cash flow projections, it was assumed that all buildings are sold 18 months after construction completion. Therefore, with the exception of the last building to be sold, Heron Quay, the buildings are sold toward the end of their free-rent periods and no rent is collected.
Having a low P/E ratio with respect to the rest of the market, and the replacement cost of the firm being greater than its book value (argument 3), there is a good chance that the current stock price and the proposed offering price are too low. Although long-term debt is a better financing choice, a few of the drawbacks are pointed out. Debt holders claim profit before equity. holders, so the chances that profits may be lower than expected. increases risk to equity, may reduce or impede stock value. However, the snares are still a bit snare.
Scholastic Company is a multibillion dollar children’s book publisher and distributor with more than 9,000 worldwide employees (Scholastic Inc., n.d.). Scholastic leases some of its physical office and storage locations and equipment (as cited in Gibson, 2011). Cornaggia, Franzen, and Simin (2013) noted the reasons firms lease may be the result of a company’s financial distress which prevents sufficient capital being raised to purchase instead of leasing. They also suggested if profitability of the firm is not at issue, leasing can be used to reduce taxes thus reducing borrowing costs. Though the reason for maintaining material lease obligations is not disclosed in its financial statements (as cited in Gibson, 2011), Scholastic’s ability to satisfy its long-term commitments is important for investors, creditors, and management. The long-term borrowing capacity of Scholastic can be determined through an analysis of its times interest earned, fixed charge coverage, and debt ratios.