Week 6 Overview

Time Value of Money

Welcome to the sixth week of BUSN 5200: Basic Finance for Managers. This week we take up one of the most central issues in finance: the Time Value of Money.

What Time Value of Money is all about...
When people speak of the time value of money they are talking about the fact that dollars to be received or paid at different times are worth different amounts today. For example, if someone offered to sell you a note that promised the bearer a dollar a week from now, you would not be willing to give them a dollar for it today. That is because if you pay someone a dollar today you give up the ability to purchase things with it for a week while you are awaiting the payment of the promised dollar a week from now. You will not give up the ability to purchase things for a week unless you are compensated for it, and this compensation takes the form of a discount on the amount you are willing to pay for the dollar today. You might, for example, be willing to pay $.80 in exchange for the dollar next week, but you would not be willing to pay a whole dollar for it. In other words, a dollar to be received next week is worth less than a dollar today. That's why we say money has time value.

Why the time value of money concept is important in finance...
The fact that a dollar to be received next week is worth less than a dollar to be received today is important in finance because the value of a business firm is, fundamentally, the sum of the values today of all the dollars expected to be received by the business firm in the future. Recall in week 1 of the course we established that the objective of a business is to maximize the wealth of its owners, and that wealth is measured by the value of the owners' holdings in the firm today (for corporations that means the value of the owners' common stock). Therefore in the most fundamental sense, the job of a business manager is to maximize the sum of the values today of all the dollars expected to be received by the business firm in the future. This means business managers must be intimately familiar with the Time Value of Money.

This week we will also continue our discussion of the Case Study of McDonald's Corporation. This week you complete your ratio analysis of McDonald's.

Objectives

By the end of this week, students will be expected to:

• Explain why the time value of money concept is important in business
• Describe how the time value of money concept is used in decision making
• Solve simple time value of money problems, including solving for a rate of return