Working knowledge on how to calculate time value money

Full Answer Section

TVM is a powerful tool that can be used to make financial decisions. For example, TVM can be used to calculate the present value of a future cash flow, or to calculate the future value of a present cash flow. Calculations for New Capital Projects The following are the financial calculations needed for the new capital projects of purchasing an MRI and deciding whether to expand the emergency room or to renovate the hospital lobby: MRI The cost of purchasing an MRI is $1 million. The MRI will generate $200,000 in annual revenue. The MRI will have a lifespan of 10 years. The present value of the MRI is calculated as follows: Present Value = Future Value / (1 + r)^t where:

• Present Value = the present value of the MRI
• Future Value = $200,000
• r = the discount rate (assumed to be 5%)
• t = the number of years (10)

The present value of the MRI is $1.46 million. Emergency Room Expansion The cost of expanding the emergency room is $5 million. The expanded emergency room will generate $1 million in annual revenue. The expanded emergency room will have a lifespan of 20 years. The present value of the emergency room expansion is calculated as follows: Present Value = Future Value / (1 + r)^t where:

• Present Value = the present value of the emergency room expansion
• Future Value = $1 million
• r = the discount rate (assumed to be 5%)
• t = the number of years (20)

The present value of the emergency room expansion is $4.5 million. Hospital Lobby Renovation The cost of renovating the hospital lobby is $2 million. The renovated lobby will generate $500,000 in annual revenue. The renovated lobby will have a lifespan of 10 years. The present value of the hospital lobby renovation is calculated as follows: Present Value = Future Value / (1 + r)^t where:

• Present Value = the present value of the hospital lobby renovation
• Future Value = $500,000
• r = the discount rate (assumed to be 5%)
• t = the number of years (10)

The present value of the hospital lobby renovation is $2.8 million. Decision Making The three projects have different present values. The MRI has the highest present value, followed by the emergency room expansion and the hospital lobby renovation. This means that the MRI is the most financially attractive project. However, other factors should also be considered when making a decision, such as the need for the project, the impact on patients, and the impact on staff. In this case, the hospital may decide to expand the emergency room because it is a more pressing need. The hospital may also decide to renovate the hospital lobby because it will improve the patient experience. The decision of which project to pursue should be made after careful consideration of all of the factors involved.

Sample Solution

  Time value of money (TVM) is a concept in finance that states that money today is worth more than money in the future. This is because money today can be invested and earn interest, while money in the future is worth less because it has less time to earn interest.