Task 1.Write a comprehensive essay on application of time value concepts in various financial management decisions. Your essay should be covered
a.Fundamentals of time value concepts
b.Discounting and compounding process and their uses (what is the rational for using discounting process rather than compounding process in decision making?)
c.Discount rate and main components of the discount rate (why do we use different discount rates for evaluating different decisions?).
d.Use of time value in valuation of financial instruments such as bonds, equity and preference shares.
e.Capital budgeting and time value.
f.The other issues
Task 2.Answer questions in the case study given below (Extracted from “Cases in Financial Management (2nd Edition), Sulock, Joseph and Dunkelberg, John, John Wiley & Sons, Inc”, Some contents of the case have been altered to suit the local condition).
Concept of Time Value of Money
 Fundamentals of Time Value Concept :
Time Value of money is widely used concept since long, we use Time value of money in felid of economics and finance, such as in Capital budgeting, valuation of business, valuation of securities and many more.
As the name suggests basic approach of time value of money is that it is better to have the money today is present instead of having that same amount in future, as if one have that amount of money in his hands at present then one can invest it somewhere and can earn money by investing funds at present.
To make this clear in more better way we will explain it with an example ;
If you have $1000 today in your hand and any way of investment at the rate of 10% per annum, you will have $1100 a year from now, and on the other hand a $1000 a year from now, at the same rate of 10 % per annum, are just $909 today (Woodruff 2018)
 Discounting and compounding process and their uses
Time value of Money concept says that worth of a unit today will be changed in future, for putting it simply, the value of one dollar today will decrease in future, the entire concept s about the present value of money and future value of money
There are two ways of ascertaining the value of money at different point of time, one is compounding and another is discounting (Gardner 2017)
Compounding method is used to determine future value of present money.
Discounting method is used to determine present value of future money.
Both have different rates for calculation for compounding , compounding rate of interest is used and for discounting, discounting rate of interest is used.
Compounding and discounting both helps in rational decision making, as compounding helps in determining the future value of present cash flow, and on the other hand discounting helps in determining the present value of future cash flows.
Discounting is rational process to use for making appropriate decisions in comparison with compounding reason being, in compounding we use rate of return of future which is not certain at present, which leads to inappropriate decision making, however on the other hand in discounting method we need to determine present value of future return, and rate used for discounting is known at present which gives more appropriate results for decision making (Keythman 2015)
For Compounding following formula is used:
Compounding and Discounting Methods
FV = PV (1 + R) ^ n
For Discounting following formula is used:
PV = FV / (1 + R) ^ n
 Discount rate and main components of the discount rate
The term discount rate is most widely used fundamental term in finance in economics. Discount rate is used to determine present value of expected cash lows. These is an inverse relationship between present value and discount rate, higher the discount rate is used, lower will be the present value of cash flows, and lower the discount rate, higher will be the present value of cash flows.
As simple is to understand the concept of discount rate more difficult to determine appropriate discount rate, in determining the appropriate discount rate following must be Considered and assessed properly before determining any discount that that is to be used to discount future expected cash flows:
 Pure Interest
 Risk
 Inflation
 Reinvestment Risk
 Variability of returns
We use different discount rates or evaluating different decisions based on the above mentioned factors, more the risk, more will be the discount rate and viseversa, each and every point mentioned above will affects the discount rate, this will depend on case to case basis (Dalfard 2016)
Discount rate may be calculated by using following formula :
 Use of time value in valuation of financial instruments such as bonds, equity and preference shares :
Bonds, preference shares and equity shares are most common ways that are used while doing investment, to take appropriate decision as in which kind of securities investment must be made, it is necessary to determine value of these securities, there are many kinds of ways to determine value of these securities and Time value is widely used in valuation of Shares, Debentures, to determine value of these securities first one has to determine value of business, In valuation of Business present value of cash flows for explicit period and present value of terminal value is calculated and added to arrive at Gross Value of the business. This value is for all funds providers, i.e. Debenture holders, Equity share holders and Preference shareholders.
Valuation is not only done to determine the most appropriate way of investment however valuation is a most crucial decision for a company to determine value of its securities like bond, debentures, Preference shares and equities, as all the holders of these securities are very much concerned with the value if their existing investment, hence every company would like to use most appropriate way of doing valuation of business and securities like bonds, debentures, Preference shares and equities, as no company would like to lose its current investors and potential investors. Discounted cash flow method of valuation is most trusted way for determining value of securities (Sanders 2017)
The Role of Discount Rate in Discounted Cash Flow Analysis
To arrive at the value of equity share holders under Firm approach of valuation, we can use following formula :
Value of Equity holders = Present value of Cash flows for explicit period + Present Value of Terminal Value – Opening balance of loan as on Valuation date + Opening Surplus cash which is not considered for working capital requirement + realizable Value of Surplus assets etc.
 Capital budgeting and time value:
Time Value of money is a very important part of capital budgeting, and it provide small business holders a base with the help of capital budgeting to take appropriate decisions, with the help of discounting and capital budgeting small business holders can adjust cash flows with the passage of time and this process is known as discounting to present value and allows preference to dollar received today over the dollar received tomorrow.
Time Value of Money is used in following concepts of capital budgeting :
 Net Present Value (NPV)
 Internal Rate of Return (IRR)
 Total Cost Approach (TCA)
 Project profitability Index (PPI)
 Net Present Value (NPV):
Net present value is most used technique of capital budgeting, In net present value technique of Capital budgeting, time value of money is used to determining profitability of project, by discounting future expected cash flows and its terminal value. If the projects net present value is grater or equal to zero the project is acceptable.
NPV = Present value of future cash Inflows – Present Values of cash out flow (Freedman 2018)
 Internal Rate of Return (IRR)
Internal rate of return is another most widely used technique of Capital budgeting, The IRR method is applies in manner which is reverse of NPV method of capital budgeting technique, This Method tends to find out a discount rate, for undiscounted cash flows of the projects, in such a way resulting NPV of project to Zero, that Zero represents the BEP i.e. breakeven point of project profitability.
 Total Cost Approach (TCA)
The TCS approach allows small business owners to evaluate multiple projects together at one time. In this Method, all cash inflows and outflows are adjusted to determine competing alternative. All the projects which gives positive NPV are acceptable, however the project with the greatest NPV is preferred and most profitable.
 Project profitability Index (PPI)
Where there is a situation that funds available are limited, a small business owner can calculate profitability index to determine preferable project, by dividing NPV of project with the Investment made, this capital budgeting technique is known as PPI, higher PPI values imply more desirable project. (Wiley 2018)
There is always a biggest obstacle with time value of money is to determine discount rate or compound rate to be used to determine present value of cash flows, as discount rate and compound rates are dependent on various factors, and these factors changes form one business to other, thereby discount rate used for determining present value of cash flows may be different from discount rate used to determine present value of cash flows of any other business.
Application of Time Value of Money in Capital Budgeting Techniques
Same as discussed above applies to compounding rate, as it is also based on various factors, and those factors may be variable form one business to another, hence compound rate used for compounding cash flows of one business may be different for compounding cash flows of another business.
Hence to determine correct and appropriate discount rate is a critical matter.
Another issue with Time Value of Money is to determine future expected cash flows and there time of occurrence, as only expectation can be done, nothing can be said with certainty, and various fluctuation may come, these fluctuations may lead a decision based on TVM wrong.
The following goals Studebaker is focusing upon is the diversification of the business and buy and hold goal. Diversification is described as some technique where all the investment is not invested in one portfolio and it is allocated to different baskets so that if one basket fails then the entire investment doesn’t fall out. Diversification helps in reducing the risk. It gives the portfolio in a nonrisky position. It is a type of strategy which is a risk management technique which actually mixes different variety of investments in a portfolio. It actually strives to remove the unsystematic risk in a portfolio so that the positive investment outlast the negative ones and balances them. further change benefits can be expanded by investing in distant securities as they are less related to domestic investment. It is a good corporate strategy so that one can enter in to new market and helps in managing risk.
The next strategy is buy and hold is opting for good profits and returns as compared to long run and not getting involved in day to day activities and one need to have good investment ways before the actual investment and also less attention is involved. In our opinion policy opted by Studebaker are helpful for him and goals are identified therefore which will help them in future.
 In this LIC policy the sum that is invested will be increasing at a good rate with a return of around and it will automatically increase the investment overall which was there hence the sum will be calculated as below:
Year 
Life Insurance value at beginning (Figures in $) 
Return of 6 % that is earned (Figures in $) 
LIC policy value at the end (Figures in $) 
1 
550,000 
33,000 
583000 
2 
583,000 
34,980 
617980 
3 
617,980 
37,079 
655,059 
4 
655,059 
39,305 
694,3624 
5 
694,364 
41,662 
736,025 
6 
736,025 
44,162 
780,186 
7 
780,186 
46,812 
826,998 
8 
826,998 
49,620 
876,618 
9 
876,618 
52,597 
929,213 
10 
929,213 
55,753 
984,966 
11 
984,966 
59,098 
1,044,064 
12 
1,044,064 
62,644 
1106,709 
13 
1,106,709 
66,403 
1,173,111 
14 
1,173,111 
70,387 
1,243,497 
15 
1,243,497 
74,610 
1,318,107 
16 
1,318,107 
79,086 
1,397,193 
17 
1,397,193 
83,832 
1,481,029 
18 
1,481,029 
88,864 
1,569,890 
19 
1,569,890 
94,195 
1,664,085 
20 
1,664,085 
99,847 
1,763,930 
As calculated above, Morton has worked out in same way.
Installment formula is as follows:
Installment = [P * r * ( 1 + r )^N] / [ ( 1 + r )^N – 1 ]
Installment = [450000 * 9% * ( 1 + 0.09 )^20] / [ ( 1 + 0.09 )^20 – 1 ]
The amount of investment is $77230.26. (WordPandit 2018)
Year 
Beginning balance ( $) 
Installment figure ( $) 
Payment of Interest ( $) 
Repayment of the Principal Amount($) (Figures in $) 
Ending balance ( $) 
1 
705000.00 
77230.26 
63450.00 
13780.26 
691219.75 
2 
691219.75 
77230.27 
62209.78 
15020.49 
676199.26 
3 
676199.26 
77230.26 
60857.93 
16372.33 
659826.93 
4 
659826.93 
77230.26 
59384.42 
17845.84 
641981.10 
5 
641981.10 
77230.26 
57778.30 
19451.96 
622529.13 
6 
622529.13 
77230.26 
56027.62 
21202.64 
601326.49 
7 
601326.49 
77230.26 
54119.38 
23110.88 
578215.62 
8 
578215.62 
77230.26 
52039.41 
25190.85 
553024.76 
9 
553024.76 
77230.26 
49772.20 
27458.03 
525566.73 
10 
525566.73 
77230.25 
47301.01 
29929.25 
495637.48 
11 
495637.48 
77230.26 
44607.37 
32622.89 
463014.59 
12 
463014.59 
77230.26 
41671.31 
35558.95 
427455.64 
13 
427455.64 
77230.26 
38471.00 
38759.27 
388696.40 
14 
388696.40 
77230.25 
34982.68 
42247.58 
346448.81 
15 
346448.81 
77230.26 
31180.39 
46049.87 
300398.94 
16 
300398.94 
77230.26 
27035.90 
50194.36 
250204.59 
17 
250204.59 
77230.26 
22518.41 
54711.85 
195492.74 
18 
195492.74 
77230.26 
17594.35 
59635.91 
135856.82 
19 
135856.82 
77230.26 
12227.11 
65003.15 
70853.68 
20 
70853.68 
77230.26 
6376.85 
70853.44 
0.29 
9 percent mortgage in Exhibit 4, find the loan balance at the end of years 19
Challenges with Time Value of Money
and 20?
Answer : 19^{th} year end balance will be $466986.70 and 20 the will be $440393.35, which is calculated as follows :
Amortization Amount 705000 / 9 % Mortgage Rate and the loan id for 30 Years. 

Year end 
Beginning balance ( $) 
Installment Amount(Figures in $) 
Interest Payment (Figures in $) 
Principle Repayment (Figures in $) 
Ending Balance (Figures in $) 
1 
705000.00 
68622 
63450.00 
5172.13 
699827.87 
2 
699827.87 
68622 
62984.52 
5637.62 
694190.25 
3 
694190.25 
68622 
62477.13 
6145.00 
688045.25 
4 
688045.25 
68622 
61924.08 
6698.06 
681347.19 
5 
681347.19 
68622 
61321.26 
7300.88 
674046.31 
6 
674046.32 
68622 
60664.17 
7957.96 
666088.35 
7 
666088.35 
68622 
59947.95 
8674.18 
657414.18 
8 
657414.19 
68622 
59167.28 
9454.85 
647959.33 
9 
647959.33 
68622 
58316.34 
10305.79 
637653.54 
10 
637653.54 
68622 
57388.83 
11233.32 
626420.23 
11 
626420.23 
68622 
56377.82 
12244.31 
614175.92 
12 
614175.92 
68622 
55275.84 
13346.29 
600829.63 
13 
600829.63 
68622 
54074.68 
14547.46 
586282.16 
14 
586282.16 
68622 
52765.39 
15856.74 
570425.43 
15 
570425.43 
68622 
51338.29 
17283.84 
553141.59 
16 
553141.59 
68622 
49782.74 
18839.38 
534302.21 
17 
534302.21 
68622 
48087.20 
20534.93 
513767.28 
18 
513767.28 
68622 
46239.07 
22383.07 
491384.21 
19 
491384.21 
68622 
44224.58 
24397.55 
466986.66 
20 
466986.66 
68622 
42028.80 
26593.33 
440393.33 
Exhibit 3 specifies that $1,763,925 will be collected after 20 years in the life
insurance policy. Is this true?
Answer :
It is correct and the LIC policy will be getting accumulated after
Years to 1763926 as shown in the exhibit 3 and also it is calculated in answer of the 1^{st} Question. And if Studebaker will be opting the suggestions of Morton Studebaker will be taking a loan of $250000 and the loan will be repaid at the end of 30 year . The balance of loan at the maturity time (after 20 year ) would be $440393.33.
(A) If the excess $300,000 were invested in a longterm asset yielding 8 percent a year, how much would be accumulated after 20 years?
Answer : $1,398,287, will be getting accumulated after 20 Years. Following are the calculations:
End of Year 
Long Term Assets Value at Opening of the year ($) 
Return earned at 8% ( $) 
Long Term Assets Value (closing)($) 
1 
300,000 
24,000 
324,000 
2 
324,000 
25,920 
349,920 
3 
349,920 
27,994 
377,914 
4 
377,914 
30,233 
408,147 
5 
408,147 
32,652 
440,798 
6 
440,798 
35,264 
476,062 
7 
476,062 
38,085 
514,147 
8 
514,147 
41,132 
555,279 
9 
555,279 
44,422 
599,701 
10 
599,701 
47,976 
647,677 
11 
647,677 
51,814 
699,492 
12 
699,492 
55,959 
755,451 
13 
755,451 
60,436 
815,887 
14 
815,887 
65,271 
881,158 
15 
881,158 
70,493 
951,651 
16 
951,651 
76,132 
1,027,783 
17 
1,027,783 
82,223 
1,110,005 
18 
1,110,005 
88,800 
1,198,806 
19 
1,198,806 
95,904 
1,294,710 
20 
1,294,710 
103,577 
1,398,287 
(B) Suppose Studebaker placed $26,145.31 a year into a longterm investment paying 8
percent a year. How much would be accumulated after 20 years ?
$1,292,179 is getting accumulated after 20 Years, if Studebaker Invests $26145.31/ each year collected will the investment made earlier. Calculation is as follows:
End of Year 
Long Term Assets Value at Opening of the year (Figures in $) 
Return earned at the rate of 8% during the year (Figures in $) 
Long Term Assets Value at Closing of the year (Figures in $) 
1 
26,145 
2,092 
28,237 
2 
54,382 
4,351 
58,733 
3 
84,878 
6,790 
91,668 
4 
117,814 
9,425 
127,239 
5 
153,384 
12,271 
165,655 
6 
191,800 
15,344 
207,144 
7 
233,289 
18,663 
251,953 
8 
278,098 
22,248 
300,346 
9 
326,491 
26,119 
352,610 
10 
378,756 
30,300 
409,056 
11 
435,201 
34,816 
470,018 
12 
496,163 
39,693 
535,856 
13 
562,001 
44,960 
606,961 
14 
633,107 
50,649 
683,755 
15 
709,900 
56,792 
766,692 
16 
792,838 
63,427 
856,265 
17 
882,410 
70,593 
953,003 
18 
979,148 
78,332 
1,057,480 
19 
1,083,625 
86,690 
1,170,315 
20 
1,196,461 
95,717 
1,292,178 
Repeat problem 5 but assume a 7 percent return can be earned ?
A further loan of $2,50,000 shall be required for opting the suggestion of Morton which will require a total of thirty years to repay the loan in full . However, the life insurance policy will accumulate an amount of $21,28,328 with a return of 7% as suggested in Exhibit 3 and where the suggestion of Morton is accepted, the amount LIC on maturity will amount to $4,40,396.45.
Life insurance policy will be accumulated after 20 years to $21,28,326/ as indicated in Exhibit 3 and f rate of return is 7% instead of 6%, however if Studebaker will opt the suggestion of Morton, Studebaker will have to take loan further for $2,50,000/, and that amount mortgage Loan will be repaid till the end of 30 years and balance of loan at the time of maturity of LIC (i.e. at the end of 20 years) would be $4,40,393.33 (Tonagatti 2017)
Comer’s criticisms implied that the singlepremium life insurance policy is an
unattractive investment for Studebaker. What do your previous answers suggest?
All the Comer’s criticisms is very correct that the single investment policy does not prove to be attractive investment for Studebaker which is calculated:
Studebaker's Goals for Business Diversification and Buy and Hold Strategy
Studebaker if he has adopted the Morton;s way in the investment field than at the end of 20 years Studebaker will have to invest $1763925 and it will increase the loan installment of $26145.31 each and every yearand the balance of the loan is $440393.33 and at the end the balance that @7 percent will be $2128326.
Woth the same resources the inidivual could have invested $ 300000 in a asset which is long term which yields 8 percent for 20 year and also the accumulated balance will be $1,398,287 and also and if $26145.31/ is being invested each year together and also with the invested sum @ 8%, accumulated balance at the end of 20 years would be $1,292,178/, and after taking total of both of the Investments the total collected with same incomes is $26,90,465/, as the rate of return has been incraesed, the accumulated weighing scale of the investments are greater than Morton’s proposals by $9,26,540/.
(a) Answer :
Requirement at end of 20 years 
$3,500,000.00 

Amount which will be getting received out of the investment of $300000 in end of 20 years as calculated in 6 (a) 
$1,398,287 

Balance Amount which is required at the end of 30 years 
$2,101,712 

End of Year 
Long Term Assets Value at Original /Beginning year ($) 
Return @8 percent ($) 
Long Term Assets Value at ending($) 

1 
42,525.05 
3,402.00 
45,927.05 

2 
88,452.10 
7,076.18 
95,528.28 

3 
138,053.3 
11,044.27 
149,097.59 

4 
191,622.64 
15,329.81 
206,952.45 

5 
249,477.50 
19,958.20 
269,435.70 

6 
311,960.75 
24,956.86 
336,917.61 

7 
379,442.66 
30,355.41 
409,798.07 

8 
452,323.12 
36,185.85 
488,508.97 

9 
531,034.02 
42,482.72 
573,516.74 

10 
616,041.79 
49,283.34 
665,325.14 

11 
707,850.19 
56,628.01 
764,478.20 

12 
807,003.25 
64,560.26 
871,563.52 

13 
914,088.56 
73,127.08 
987,215.65 

14 
1,029,740.70 
82,379.26 
1,112,119.95 

15 
1,154,645.00 
92,371.60 
1,247,016.60 

16 
1,289,541.65 
103,163.33 
1,392,704.98 

17 
1,435,230.03 
114,818.40 
1,550,048.44 

18 
1,592,573.49 
127,405.88 
1,719,979.37 

19 
1,762,504.42 
141,000.35 
1,903,504.77 

20 
1,946,029.82 
155,682.39 
2,101,712 
$2101712/ will be received after 20 years by capitalizing $42525.05/ each year.
 (B) Answer :
Requirement at the end of 20 years 
$3,500,000.00 

Amount will be received out of the investment of $300000 at the end of 20 years as calculated in 6 (a) 
$1,398,287.14 

Balance Amount required at the end of 30 years 
$2,101,712.86 
End of Year 
Long Term Assets Value (Beginning) ($) 
Return earned at the rateof 8% ($) 
Long Term Assets Value at the end ($) 
1 
55,402.45 
4,432.20 
59,834.65 
2 
115,237.10 
9,218.97 
124,456.06 
3 
179,858.51 
14,388.68 
194,247.19 
4 
249,649.64 
19,971.97 
269,621.62 
5 
325,024.07 
26,001.93 
351,025.99 
6 
406,428.44 
32,514.28 
438,942.72 
7 
494,345.17 
39,547.61 
533,892.78 
8 
589,295.23 
47,143.62 
636,438.85 
9 
691,841.30 
55,347.30 
747,188.60 
10 
802,591.05 
64,207.28 
866,798.34 
11 
922,200.79 
73,776.06 
995,976.85 
12 
1,051,379.30 
84,110.34 
1,135,489.64 
13 
1,135,489.64 
90,839.17 
1,226,328.82 
14 
1,226,328.82 
98,106.31 
1,324,435.12 
15 
1,324,435.12 
105,954.81 
1,430,389.93 
16 
1,430,389.93 
114,431.19 
1,544,821.12 
17 
1,544,821.12 
123,585.69 
1,668,406.81 
18 
1,668,406.81 
133,472.55 
1,801,879.36 
19 
1,801,879.36 
144,150.35 
1,946,029.71 
20 
1,946,029.71 
155,682.38 
2,101,712.09 
If only 12 years investment is done he has to invest $55402.45/ to receive $2101712/ at the end.
$5,672.59/ will required to paid on monthly basis till 20 years for repayment of loan of $705,000/ which means yearly payment will be ($5,672.59/ * 12) $68,071.08/, however if we go for yearly installment basis then installment amount was $68,622/ .
In case of Monthly payment system total of yearly installments is less in comparison with yearly payment system, and the reason is that in Monthly installment System interest is being allocated on less principal amount as the payment iare being made monthly and main part is reducing monthly which is also in case of yearly payment system, installment is given at end of the year and also the interest is granted on proportional large sum of principle.
The calculation of Corner which has a cost of $ 47145 is for the 1^{st} year and the total interest of $21000 on the amount of $30000 at the rate of 7 percent and also 26145$ as the installment amount which has been increased
In20^{th} year Corner has designed $1,70,502 as an extra twelvemonthly cost
Increase Installment number of loan $26,145.31/
Interest lost on $300000 in 20^{th} year $75,947/
Interest which has been lost on $26145.31 with the cumulative Investment 20 years which is $68,410/
Calculation of above is mentioned below:
($)
End of Year 
Long Term Assets Value at Opening of the year 
Return earned at the rate of 7% during the year 
Long Term Assets Worth at the end 
Long Term Assets Worth at Opening of the year 
Return earned @ of 7% during the year 
Long Term Assets at closing 
Total cost which is incurred 
1 
300,000 
21,000 
321,000 
26,145 
1,830 
27,975 
47,145 
Continued Calculation 

18 
947,645 
66,335 
1,013,980 
888,915 
62,224 
951,139 
148,923 
19 
1,013,980 
70,979 
1,084,958 
977,285 
68,410 
1,045,695 
159,348 
20 
1,084,958 
75,947 
1,160,905 
1,071,840 
75,029 
1,146,869 
170,502 
The policy which was suggested by Morton don’t consider the oppurtuinity costs that is the amount that is required to be invested in the Life Insurance Policy which was 6 percent and also the market rate was 7 to 8 percent then it can be concluded that thenpolicy of Morton contain enough misakes and don’t provide good benefit to the users. (Bahner 2007)
It was found in the critical evalution it is found that the investment of all the funds in the external assets which posses a return of 8 percent per annum is portrayed better as compared to the Lifeinsurance Policy and also it is not feasible to take loan at the rate of 9 percent rate of interest and then invest that for 6 percent as the return will be low hence the Morton option is incorrect and thus only 300000 investment should be made.
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