Investment Options
Please write this paper in a format as if someone who is not versed in finance, but understands the concepts of the assignment. If that makes sense. Not too advanced in writing. I need to understand what has been written in the paper.
ANSWER
Time Value of Money (TVM) or Present Discounted Value is the idea that money at present is worth more that same amount of it in future because of its ability to earn. The idea founds the core principle of finance that “any amount of money is worth more the sooner it is received” (Shrieves 2001). In this case, to evaluate how TVM results in a discounted cash flow in year four we will need to process the following variables
FV – Future Value of Money
PV – Present Value of Money
I – Interest Rate
N- Number of Compounding Periods per Year
T – Number of Years
To find the present value of a future $30,000 at a 12% discount rate then:
PV4 = FV / (1.0 + i)n
= $30000 / (1.0 +0.12)4
= $30000 / (1.57)
= $19,108.28
The Net Present Value (NPV) is marked by the difference between the present value of cash inflow and the present value of cash outflow over a period of time. The discount rate used in the NPV calculation is fundamental in determining the value of an investment to a business. The process to calculate the NPV is as follows:
Number of period = 4 Years
Discount Rate = 12%
Therefore NPV of future Cash Flows becomes as follows
| Period | Cash Flow | Net Present Value |
| Year 1 | 10,000 | 10,000 / (1+0.12)1 = 8,928.57 |
| Year 2 | 20,000 | 20,000 / (1+0.12)2 = 15,943.88 |
| Year 3 | 30,000 | 30,000 / (1+0.12)3 = 21,353.41 |
| Year 4 | 30,000 | 30,000 / (1+0.12)4 = 19,065.54 |
| TOTAL | 65,291.40 |
Lastly, Comparison between 12% discount rate and 7% discount rate:
| Period | Cash Flow | Net Present Value at 12% | Net Present Value at 7% |
| Year 1 | 10,000 | 10,000 / (1+0.12)1 = 8,928.57 | 10,000 / (1+0.07)1 = 9345.79 |
| Year 2 | 20,000 | 20,000 / (1+0.12)2 = 15,943.88 | 20,000 / (1+0.07)2 = 13,802.62 |
| Year 3 | 30,000 | 30,000 / (1+0.12)3 = 21,353.41 | 30,000 / (1+0.07)3 = 24,488.94 |
| Year 4 | 30,000 | 30,000 / (1+0.12)4 = 19,065.54 | 30,000 / (1+0.07)4 = 22,886.86 |
| TOTAL | 65,291.40 | 70,524.21 |
References
Shrieves, R. E., & Wachowicz Jr, J. M. (2001). Free Cash Flow (FCF), Economic Value Added (EVA™), and Net Present Value (NPV):. A Reconciliation of Variations of Discounted-Cash-Flow (DCF) Valuation. The engineering economist, 46(1), 33-52.
