FIN 320 Module 4 Time Value of Money Assignment example

Three Decisions, One Principle: Applying the Time Value of Money at a Composite Pet Supply Retailer

[Student Name]

Southern New Hampshire University

FIN 320: Principles of Finance

Module Four Assignment

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Three Decisions, One Principle: Applying the Time Value of Money at a Composite Pet Supply Retailer

Introduction

Money received now beats the same sum received next year, since the earlier money can be invested in the meantime. That principle, the time value of money, sits under most financial decisions, including several that Brightwater Pet Supply, Inc., the composite retailer analyzed in this course project, faces this year (Dahlquist & Knight, 2022). Its liquidity has tightened and its short-term borrowing costs 7 percent, which makes each of the three decisions below more than an academic exercise.

Decision 1: Should Brightwater Take the Supplier's Discount?

Brightwater's largest pet food supplier offers terms of 2/10 net 45: the company may deduct 2 percent if it pays within 10 days, or pay the full invoice in 45 days. To conserve cash, the accounts payable team has been paying on day 45. Skipping the discount is a form of borrowing. By not paying on day 10, Brightwater keeps 98 dollars of every 100 dollar invoice for 35 more days and pays 2 dollars for the privilege.

The implied annual rate is the cost per dollar borrowed, 2 divided by 98, times the number of 35-day periods in a year, 365 divided by 35: 0.0204 times 10.43, or about 21.3 percent. Because that cost repeats every 35 days, the effective annual rate, which accounts for compounding, is 1.0204 raised to the power 10.43, minus 1, or about 23.5 percent. Paying suppliers late looks like free financing, but at these terms it is one of the most expensive sources of money the company has. Brightwater should draw on its 7 percent credit line to pay within 10 days; each dollar of discount taken saves far more than the interest on the borrowed dollar.

Decision 2: What Will the Term Loan Cost Each Month?

To reduce its reliance on short-term borrowing, Brightwater is negotiating a 40 million dollar, seven-year term loan at a 6.2 percent annual rate, repaid in equal monthly payments. Rearranging the ordinary annuity present value relationship gives the monthly amount as the principal times r, divided by the quantity 1 minus (1 + r) to the power of negative n, where r is the monthly rate and n the number of months. The monthly rate is 0.062 divided by 12, or 0.5167 percent, and there are 84 payments. The payment is about 588,185 dollars a month, or about 7.06 million dollars a year.

Early payments are mostly interest. In the first year, about 2.35 million dollars of the 7.06 million dollars paid is interest, and the balance falls to about 35.29 million dollars. Over the full seven years, total interest is about 9.41 million dollars. These figures matter for planning: the annual payment of about 7.1 million dollars must come from operating cash flow, which in fiscal 2025 was strained by the inventory build, and the finance team should confirm that the business can carry the payment in a slow year before signing (Ross et al., 2022).

Decision 3: Lease or Buy the Point-of-Sale Systems?

Brightwater must replace its store point-of-sale systems. The vendor offers two options: buy the systems for 6.0 million dollars today, or lease them for five years at 1.45 million dollars a year, with each payment due at the start of the year. Because lease payments are made at the beginning of each period, they form an annuity due. Its present value uses the ordinary annuity factor for five years at 6.2 percent, multiplied by 1.062 because every payment arrives one period sooner than in an ordinary annuity. At a 6.2 percent discount rate, the factor is about 4.449, and the present value of the lease is about 6.45 million dollars.

Buying costs 6.0 million dollars today; leasing costs the equivalent of about 6.45 million dollars today. On this basis, buying is cheaper by about 450,000 dollars. The lease payment would have to fall to about 1.35 million dollars a year before the two options cost the same. This comparison deliberately leaves out taxes, maintenance and the value of the systems after five years; a full analysis would add them, and a lease that includes upgrades or maintenance could justify some premium. The lease also preserves 6.0 million dollars of cash now, which has value for a company whose cash has been falling, but that benefit should be weighed against simply borrowing the 6.0 million dollars at 6.2 percent, which is what the discount rate already assumes.

Checking the Answers

Time value calculations are easy to get wrong by a factor that looks plausible, so each result was checked against a simple benchmark. For the loan, 84 payments of about 588,185 dollars total about 49.41 million dollars; subtracting the 40 million dollar principal gives the 9.41 million dollars of interest, and that interest is less than 40 million dollars times 6.2 percent times seven years, about 17.4 million dollars, as it must be, because the balance declines as payments are made. For the lease, the five payments total 7.25 million dollars before discounting; the present value of 6.45 million dollars is lower, as expected, but not by much, because the rate is modest and the payments begin immediately. For the discount, a quick check is that paying 2 percent to keep money for about a tenth of a year must cost roughly 20 percent a year, which matches the 21.3 percent calculated. Checks like these catch the most common errors: using an annual rate with monthly periods, treating an annuity due as an ordinary annuity, or confusing the discount percentage with the annual cost.

The Common Thread

Each decision required converting money at different dates into a common date before comparing it. The supplier's terms looked like a 2 percent cost but were a 23.5 percent annual rate once time was considered. The term loan's total cost appears only when monthly payments are traced through an amortization schedule. The lease looked affordable in annual installments but cost more in present value than the purchase. Financial managers make these conversions routinely; surveys of chief financial officers find that most rely on discounted cash flow methods when evaluating investments (Graham & Harvey, 2001). The discount rate chosen matters in each case, and in the next module the project will estimate Brightwater's cost of capital, the rate it should use for longer-term investment decisions.

References

Dahlquist, J., & Knight, R. (2022). Principles of finance. OpenStax. https://openstax.org/details/books/principles-finance

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7

Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2022). Fundamentals of corporate finance (13th ed.). McGraw Hill.