Time Value and Capital Budgeting
3. Why is the time value of money so important in capital budgeting decisions?
Here is my answer am I on the right track?
First off time value of money is what happens to the value money over a period. How this affects capital budgeting is like this: Say a company has 10,000 in profit that they can either take now or wait a few years to take. Let’s say the company takes the money now in a 5 year period if the money was invested properly will produce an even greater amount; so after 5 years of investing the 10,000 dollars is now 60,000. Now on the other side if the company waits 5 years to receive the money they are only going to get 10,000 so the company didn’t make anything on it while waiting to get it in their possession and they had to wait to make any investments. It’s an obvious decision that any company would want to take the money immediately rather than later so they can invest and create more money or spend it to benefit the company in the immediate sense. So the money a company has now will not be the same that it has in the future.
How this relates to capital budgeting decisions allows the finance division to see what the company has on hand now, look at how it’s being invested for any depicted amount of time and determine about what profit might be made. Not always a profit is made either, if not invested properly the company can lose money which should also be taken into account.