Question

1. How do you think today's low interest rate environment is impacting the time value of money? How might this change the value of an asset or liability?

2. What is the relationship between the concepts of net present value and shareholder wealth maximization?

Answer 1

Time value of money is a vital idea in Finance and Economics. This idea underlines that money value today is more than that of tomorrow because of inflation, credit hazard and present venture openings. For the most part as the interest rates increment, present value will be low and present value will be high as interest rates diminish. This change positively impact the value of assets and liabilities. As interest rates change, resource value likewise gets changed. Present value of a benefit at an interest rate of 5% will be more than at interest rate 10% in future.

Present value = FV/(1+i)n​ where FV = future value; I = interest rate; n = no. of years or periods

As the' I' expands the Present value of an advantage diminishes with the efflux of time. Along these lines, as 'I' and 'n' builds, present value of money or a benefit will diminish.

A benefit value following one year will be $1,000 @ 10% interest, however today, the value of that advantage will be as per the following:

Present value = 1000/(1+0.10)n​ ​= 1000/1.10 = $909.09

Present value of a similar resource which will move toward becoming $1000 following 2 years @ 10%, at that point its present value is just $826.44

Present value of the advantage which will progress toward becoming $1000 after one year@20%% will be as per the following

Present value = 1000/(1+0.20)1​ = 833.33

In this way, in the above cases, we have watched that present value of a benefit is more at bring down interest and less at higher interest. Thusly assets and liabilities values are additionally change because of interest rates. At bring down interest rates, their value will be more than that of at higher interest rates.

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Net present value procedure will gauge the future value of money streams that an undertaking produces. Assume the NPV is sure, it will expand the value of the firm and prompts expansion of investors riches. A positive NPV task will win more than the required rate of degree of profitability, Hence, utilizing NPV as a rule for capital venture choices is predictable with the objective of making riches. Along these lines, all capital speculation choices with positive NPV prompts riches expansion to investors. Assume, the venture NPV is negative, to that degree, investors will free their riches.

NPV strategy considers all future money streams and change over them into present value of the aggregate future money streams and contrast this value and the underlying speculation as the two values at time 0. On the off chance that Present value of future money streams are more than introductory speculation and this positive NPV will build investors riches.

Assume a venture with starting speculation of $10,000 will create an income of $4,000 per annum for a long time. Present value of this venture @ 10% markdown rate is as per the following :

Present value of the undertaking = (- )10,000 + 4,000 x Present value of annuity (4 years, 10%)

Present value of the undertaking = (- ) 10,000 + 4,000 x 3.1699)0 = (- ) 10,000 + 12,680 = - 10,000 + 12,680 = 2,680. Here, NPV of the task is $2,680, to this degree, value of the firm increments, therefore increment the investors riches.

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Hope this answer your query.

Feel free to comment if you need further assistance. J