In general, a dollar received today is more valuable than a dollar received one
ID: 2771661 • Letter: I
Question
In general, a dollar received today is more valuable than a dollar received one year from now. We can invest the dollar we have today to earn interest so that at the end of one year we will have more than one dollar. It’s crucial to look at the value in today’s dollar of a sum of money to be received in the future. This helps us determine the desirability of investment projects. The fact that there is no payment due for the next six months PLUS free interest may drive customers to purchase products or services. Though sales may increase in the short run, the rate of bad debts could potentially increase.
Fortunately, when customers pay companies up front for a specific product or service, the monetary value of cash received would be worth more than money paid off over time in separate smaller installments. Cash received from customers now can be invested right away, giving companies additional time to make up for the discount previously given. Ultimately, the company is getting a good deal for the small monetary loss of a special offer promotion.
I would potentially use present value calculations to determine if I am really getting a good deal on my purchase: PV= [1/(1+r)^n]
i need a report .
Explanation / Answer
The Time value of money always makes the up front payments more attractive than the deferred payments . The deferment of payment not only affects the liquidity of the company but also raises the risk of bad debts and uncollectible amounts.
Taking an example when $1000 is receivable. In case 1 , the customers pays upfront and gets 5% cash discount. The receipt after discount is invested @10% pa.
In case 2 , 50% payment is made after 6 months and 50% after 12 months without any discount. To meet working capital requirements , in case 2 $1000 is borrowed for 6 months and $500 for 12 months.
You can refer to the working below where the upfront payment gives a total benefit of $123 in spite of offereing a 5% discount . This is an example of tome value of money and how upfront payment is always beneficial that deferred payment terms.
Collection $ Up front After 6 Months After 1 year Case1 1,000 Less 5 % discount (50) Net Collection 950 Interest earned by in a yearinvesting @10% 95 Total Amount after 1 year 1,045 Case 2 Collection 500 500 Interest on borrowed fund 50 50 Net Amount after interest 450 450 Interest earned on partial receipt for 6 months 22.5 Net Collection in hand after a year 922.5 Net difference in case 1 &2 123