Week 6 Introduction to TVM

Introduction to Time Value of Money

The financial management process calls for making judgments about cash flows that may occur far out in the future. This makes comparisons hard. For example, your firm has $1 million to invest. Two alternatives are available:

• Build a plant in Jamaica that will bring in $110,000 a year for 10 years starting five years from now.
• Buy a used Boeing 747 to transport products around the world. Benefits are expected to be $210,000 a year for the next five years.

Do you see the problem in evaluating these investments? The cash flows all occur at different times. What's better, to get $110,000 a year for 10 years starting five years from now or to get $210,000 a year for the next five years? Hard to say.

In order to evaluate investments like these managers need a way to compare all the cash flows as of the same time. That is what time value of money techniques enable managers to do.