Question

Give specific examples of how a company uses TVM in the business environment. Your example can be either present value or future value application. It is not necessary to provide sources for your research.

Answer 1

Give specific examples of how a company uses TVM in the business environment.

1. A project needs an initial investment of $1,00,000. It is expected to give a return of $20,000 per annum at the end of each year, for six years.

The project thus involves a cash outflow of $1,00,000 in the ‘zero year’ and cash inflows of $20,000 per year, for six years.

In order to decide, whether to accept or reject the project, it is necessary that the Present Value of cash inflows received annually for six years is calculated and compared with the initial investment of $1,00,000. The firm will accept the project only when the Present Value of cash inflows at the desired rate of interest exceeds the initial investment or at least equals the initial investment of $1,00,000.

2.  A firm has to choose between 2 projects. One involves an outlay of $10 million with a return of 12% from the first year onwards, for 10 years. The other requires an investment of $10 million with a return of 14% per annum for 15 years starting from the beginning of the 6th year of the project.

In order to make a choice between these 2 projects, it is necessary to compare the cash outflows and the cash inflows resulting from the project.It is possible only when the time element is incorporated in the relevant calculations. This reflects the need for comparing the cash flows arising at different points of time in decision-making.