Examine the concept of time value of money in relation to corporate managers.
The time value for money concept suggests that the worth of money at different points in time is different. The present value of money is higher than its promised worth at a particular time in the future. For instance, the worthiness of a dollar today is higher than it worth at the same time and day next year. The time value for money concept is promoted by three significant reasons: the risk of inflation, people's preference for current consumption and the earning power of money. The time value for money concept is useful for corporate managers in helping them plan the future finances of their business operations and make reinvestment decisions sooner than later v. The idea helps determine the value of cash flows for money among investment alternatives to determine the option that maximizes shareholders capital.
Propose two (2) methods in which time value of money can help corporate managers in general.
There are two methods in which time value for money can help corporate managers which are the internal rate of return and the net present value methods. The net present value method computes the value of the current amount of money to its future value if invested. Thus, it is a practical method to establish the value of an investment, and the profits stakeholders expect to get in the future for their contribution. Corporate managers can compare different investment and decide the one with the most earnings upon investment for a period.
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The internal rate of return method computes the rate of profitability of capital invested by making the net present value for all cash flows equal to zero. The technique helps to calculate, relate and contrast the rate of profitability for various investment decisions and the option with the uppermost internal return rate is the most profitable option. The internal rate of return method considers only the internal factors and assumes the external factors such as inflation and other financial risks ( Benerjee, S. (2015).
Examine the pros and cons of a sinking fund from the viewpoint of both a firm and its bondholders.
A sinking fund refers to a reserve set aside by financial providers. It is used to issue bonds and stocks to increase its credit score within the investment platforms and to enable it to pay any future liabilities. The sinking cost has pros and cons to both the firm and the bondholders. To the firm, the sinking bond keeps the company active in addressing long-term debt. The firm can ensure its future liabilities payment through the fund. The sinking fund also reflects on the firm as a robust financial provider that is not at risk of shutting down hence attracts investors. However, the sinking fund is disadvantageous to a company in that it losses expected returns when it has to wait for the lowest interest rate to restock and hence losing returns during the waiting period.
For the bondholder, the sinking fund assures the ability of the institution to pay for bonds issued hence it is a safety net. However, the bond also presents demerit to investors in that there is a risk of loss on capital due to the back wait to purchase at low interest at the par value. When an investor's bond is part of the bonds being purchased at one particular time, then the investor has to give up on the interest.
Determine the fundamental manner in which this knowledge could be helpful to a financial manager. Provide a rationale for your response.
The knowledge of sinking fund is helpful to financial managers in helping build up capital to make repayment of debts easier. The fund, therefore, helps a financial manager safeguard the firm's assets in case of inability to pay a debt by retiring the debt.
References
Benerjee, S. (2015). Contravention between NPV & IRR due to timing of cash flows a case of capital budgeting decision of an oil refinery company. American Journal of Theoretical and Applied Business , 1 (2), 48-52.
Bienias C.G., Mark W. L & Dan, P. (2012). Century 21 Accounting: Advanced, 2012 Update . Cengage Learning.
Chen, J. H. (2009). Time Value of Money and Its Applications in Corporate Finance: A Technical Note on Linking Relationships between Formulas. American Journal of Business Education , 2 (6), 77-88.
