Time value of money is one of the most important concepts in the financial world. The principles of time value analysis have many applications, ranging from setting up schedules for paying off loans to decisions about whether to acquire new equipment for a company. Time value of money is also called discounted cash flow analysis.
Your task for this module is to apply the concept of present value to your chosen SLP company. Suppose your company is selling a bond that will pay you $100,000 in one year from today. Keep in mind that if your company has financial difficulties in one year, you might not get your full $100,000. Given that a dollar one year from now is almost always worth less than a dollar today, you most certainly would not pay a full $100,000 for this bond.
If you are highly risk averse or strongly prefer having money today to having money tomorrow, then you would pay significantly less than $100,000 for this bond. Higher inflation or high interest rates would also lead you to pay less for the bond. Also, the greater the chance of bankruptcy of your company the less you should be willing to pay for the bond.
Given the concepts of the time value of money, answer the following questions in a 2- to 3-page paper:
1) How much would you pay for this bond today? Take into consideration your own personal risk preferences, interest rates, inflation, and the probability your company will not be able to pay you back in one year. Note: You do not need any math equations for this part; just explain how much you would personally pay for a $100,000 bond from this company.
2) Based on your answer to the previous question, what would be your discount rate for this bond? Use the present value formulas from the background materials and show your work.
3) Pick two other companies in the same industry as your SLP company. Pick one that you would pay less for a $100,000 bond than you would for your SLP company’s bond, and another that you would pay more for a $100,000 bond you would for your SLP company’s bond. Explain why you would pay more or less for their bonds.
To answer questions 1, 2, and 3, include the following in your report:
• Total debt/equity ratios of all three companies. (Note that the higher the debt, the higher the default risk.)
• Profit margin, return on assets, and return on equity ratios of all three companies. (Remember your bond payment will depend on the profit margin and cash flow of the company.)
• Betas of all three companies. (Note that the higher the beta, the higher the risk; the higher the risk, the higher the discount rate.)
• Explanation on the riskiness of all three companies in brief (e.g., the higher the beta, the higher the risk).
• Current ratio and quick ratio of all three companies.
The above factors/ratios will help you to decide the discount rate that you will use to calculate bond prices. You can find the above information by using the website http://finance.yahoo.com/. For example, you want to use General Electric Company. You will need to key in company code “GE” and then click on “Key Statistics” (http://finance.yahoo.com/q/ks?s=GE). You will be able to find all the ratios and beta of the company.
4) What do you perceive you have learned in the Module 2 SLP? Which of the following learning outcomes do you feel you have mastered?
• Identify factors that determine present value.
• Understand and discuss the concepts of present and future value.
Provide a brief evaluation of the Module 2 SLP.
Note: Your report/assignment will not be accepted without proper citations and references. You must use the sources from the background material together with the sources you find on your own. It is also required that you answer all the questions related to learning outcomes.
In the Module 2 SLP, you are expected to:
• Describe the purpose of the paper and provide a conclusion. An introduction and a conclusion are important because many busy individuals in the business environment may only read the first and the last paragraph. If those paragraphs are not interesting, they never read the body of the paper.
• Answer the SLP questions clearly and provide necessary details. Review “Tips for Good Writing” [https://cdad.trident.edu/CourseHomeModule.aspx?course=56&term=92&module=3&page=custom1] and a guideline to write a well-structured paper.
• Write clearly and correctly—that is, no poor sentence structure, no spelling and grammar mistakes, and no run-on sentences.
• Provide citations to support your argument and references on a separate page. Use APA format to provide citations and references [http://owl.english.purdue.edu/owl/resource/560/01/].
• Answer all the SLP questions in an essay format. Do not type questions in the paper.
• Type and double-space the paper.
The following criteria will also be used to assess your paper:
>Precision: Does the paper address the question(s) or task(s)?
>Breadth: Is the full breadth of the subject addressed?
>Depth: Does the paper/report address all elements of the topic in sufficient depth? Does it include and apply the background reading and other background resources? Are they included as references?
>Critical thinking: Are the concepts of this module applied accurately, logically, and relevantly?
>Organization: Is the paper organized in a coherent and systematic manner? Are headings included in all papers longer than two pages?
>Clarity: Is the writing clear and are the concepts articulated properly? Are paraphrasing and synthesis of concepts the primary means of response to the questions, or are thoughts conveyed through excessive use of quotations?
Finally, this paper will be graded with the following criteria in mind:
A. Provide a direct answer to all three assignment questions—focus only on these three questions.
B. Reference all of your sources of information, both within the text as well as with a bibliography at the end.
C. For all calculations, show all of your work and demonstrate that you understand the steps.
Module 2: Time Value of Money
Required/Case Assignment/SLP Reading
Basic concepts of present and future value:
Do not fixate on just the formulas. While you need to know the formulas for the assignments, you also need to understand the logic and intuition behind the formulas. The following links are important not only for the formulas but also to help you understand the material.
Econedlink.org (2012). The time value of money. Retrieved May 2012 from http://www.econedlink.org/lessons/index.cfm?lesson=EM37
Studyfinance.com (2012). Time value of money: Self paced overview. Retrieved May 2012 from http://www.studyfinance.com/lectures/timevalue/index.mv
Biger, N. (2008). Explanation of present values and net present values. Retrieved May 2012 from https://cdad.trident.edu/Presentation.aspx?course=56&term=92&presentation=150
Harper, D. (2009). Corporate Bonds: An introduction to credit risk. Retrieved May 2012 from http://www.investopedia.com/articles/03/110503.asp#axzz1toL7PDrX
For the following link, check out the sections on present and future values of annuities. These sections will help you with the Case Assignment:
Getobjects.com (2002). Future value. Retrieved May 2012 from http://www.getobjects.com/Components/Finance/TVM/fv.html
You might also want to read Chapter 8 of the following textbook:
Ramagopal, C. (2008). Financial management. New Age International.
The following videos are also useful to understand and learn present value of money:
Khanacademy.org (2012). Introduction to present value: A choice between money now and money later. Retrieved May 2012 from http://www.khanacademy.org/video/introduction-to-present-value?playlist=Finance
Khanacademy.org (2012). Present value 2: More choices as to when you get your money. Retrieved May 2012 from http://www.khanacademy.org/video/present-value-2?playlist=Finance
Khanacademy.org (2012). Present value 3: What happens when we change the discount rate? Retrieved May 2012 from http://www.khanacademy.org/video/present-value-3?playlist=Finance
Khanacademy.org (2012). Present value 4 (and discounted cash flow): Let’s change the discount rates depending on how far out the payments are. Retrieved May 2012 from http://www.khanacademy.org/video/present-value-4–and-discounted-cash-flow?playlist=Finance
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