Question

REQUIREMENTS:

(As close to 400 words if possible.)

Why is time value of money important to investors?

There are 5 components of All Time Value of money problems. The first one is number of compounding periods, what are the other 4 components?

You have decided to buy a car, the price of the car is $18,000. The car dealer present you with two choices:

(A) Purchase the car for cash and receive $2000 instant cash rebate - your out of pocket expense is $16,000 today

(B) Purchase the car for $18,000 with zero percent interest 36-month loan with monthly payments.

Market interest rate is 4%. Which option above is cheaper? How much do you save?

Answer 1

Time Value of money is very important as the value of money depreciate at risk free rate over the time. For taking up a project you additional risk and so you want more return than risk free rate. So, you need to know the present value of future cash flow or future value of present cash where you are comparing the cost and total discounted revenue you are getting.So, that's why time value of money is important.

5 component of all time value of money problem-

1) compounding period

2) Required rate of return

3) Present Value

4) Future Value

5) Periodic Payment

For the second option:

Monthly payment (PMT)=18000/36=500

Tenure(nper)=36

Rate(monthly)= 4%/12=0.333%

Present Value= $16935.38. calculation given below:

So, option A and paying cash upfront with $16000 would be cheaper and I will save (16935.38-16000) or $935.38