Home Depot's Present Value: The Time Value Of Money

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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

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