# Chapters 14 ```Chapter 14
Managerial Accounting
Time Value of Money
Prepared by Diane Tanner
University of North Florida
The Tools to Evaluate Investment
Opportunities
 Acquisition of long-term assets require more
than one year to recover the cost

The value of money over time is considered a
significant factor
 i.e., time value of money
 Money is worth more today than tomorrow
 Present value concepts determine the value
of money to be received in the future at
today’s dollars
2
American’s Got Talent
Winner is awarded a \$1,000,000 prize!
• Winners have two options
– \$25,000 a year for 40 years
before taxes
• Present value at 4%
interest is \$484,819
– A lump cash payment of
\$208,289 at 4% (again, before
taxes)
Which is the better choice?
3
Present Value
 Calculating present value
 Remove the interest cost from cash flows
expected to be received in the future
 Interest formula
 I = PRT
where P = Principal amount
R = Annual interest rate
T = Time period (portion of a year)
 Value to be received in the future
 i.e., future value
 P + I = FV or
 P + PRT = FV
4
Present Value Example
 Assume you want to accumulate \$500 at the end
of one year in a bank account that pays 4% interest
FV = P + I = 500
P + [P x 4% x 1 year] = 500
Present value = \$480.77
Interest cost = FV ― PV
I = \$500.00 ― \$480.77 = \$19.23
Present value
+ Interest for one year (480.77 x 4% x 1)
Future value
\$480.77
19.23
\$500.00
5
Tools to Determine TVM Amounts
• A financial calculator (BAII Plus Professional)
• Excel&reg; financial functions
• Mathematical formulas
• Tredious
• Trial and error calculations
• Tedious
• Present value tables
• Limited
6
Assumptions of the Timing of
Cash Flows
1. Assume annual operating periods.
Group cash flows in annual periods
2. Assume all revenues are received in cash in the same
year as earned.
Eliminates adjustment for receivables and unearned
revenues
2. Assume all expenses are paid in cash in the same
period as incurred.
Eliminates the need to adjust for accrued expenses and
deferred costs such as prepaids
3. Assume operating cash flows occur at the end of each
year.
7
Cash Flow Time Lines
 Used to identify the point in time in which the
cash flows occur
 Operating cash flows
 Occur every year as net inflows
 Inflation and other budgeting issues may
cause differences in amounts each year
 Investing cash flows
 Occur at time 0 as an outflow when the
asset is to be purchased
 Occur at the end of the useful life as an
inflow from sale of asset for its salvage value
8
Using Cash Flow Time Lines
 Label time periods as 0, 1, 2, 3 etc. stopping at
the end of the useful life of the proposed
acquisition
 Post operating activity amounts on the time
line based on when the cash flow is expected to
occur, beginning with year 1
 Post the investing cash flow for the acquisition
cost at time 0
 Show as negative amount since an outflow
 If the investment has a salvage value
 Post as an investing cash flow at end of useful life
 Show as positive amount since an inflow
9
10
Using Cash Flow Time Lines
Purchased a \$5,000 machine with an estimated
salvage value of \$500 and a 4-year estimated life.
Operating cash flows are expected to be \$2,200 per
year.
0
(5,000)
1
2
3
4
2,200
2,200
2,200
2,700
Operating \$2,200
+ Investing \$500
The End
11
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