Application of TVM Theories in The Economic Evaluation of Investment Projects

Table of Contents

Topic.

Introduction.

Background of the Research.

Research aim..

Research objective.

Research question.

Rationale of the research.

Literature Review..

The Economic Model: Capital Appraisal of A Company’s Project

Capital Budgeting using TVM concepts.

Hypothetical Case.

Advice.

Research Methodology.

Introduction.

Review of research philosophies.

The justification for the selection of positivism philosophy.

Research Approach.

The justification for selecting Inductive Approach.

Research design.

The justification for selecting a exploratory research design.

Methods of data collection.

Ethical Consideration.

Conclusion.

Reference List

Topic

A Research Proposal on the application of TVM theories in the economic evaluation of investment projects

Introduction to Time Value of Money

Background of the Research

Time Value of Money (aka TVM) is a very important and necessary concept in the segment of financial management. TVM includes various sub concepts like present value, future value, discounting and compounding, etc. and typically states that the value of a single dollar owned today will not remain same in coming future, but less than its current value. In other words the theory of TVM says that it is more beneficial to own money today, rather than any period in future due to its earning capacity and compounding effects. Therefore, it is very important for a professional in financial industry to have knowledge about the various techniques and applications of TVM. In this research proposal, I will present the traditional notions of TVM and will illustrate its applications in the field of investment projects, project appraisal and capital budgeting.

Research Aim

The aim of the research is to determine the methods of applying the concepts of time value of money in financial management.

Research Objective

The objectives of the research are as follows:

  1. To understand the concept of Time value of money
  2. The methods and reasons to calculate the present or future value of future potential cash flows
  3. To analyze, how TVM helps professionals and businesses solve their real life problems
  4. To critically analyze the methods of capital budgeting of an investment project

Research Question

  • What are the important and relevant concepts of Time value of money?
  • What are the methods to calculate the present or future value of future potential cash flows and the reasons behind such calculations?
  • How TVM can help the professionals and businesses in solving their real life problems?
  • How TVM theories are applied in the economic evaluation of investment projects?

Rationale of The Research

Time Value of Money (aka TVM) has always remain a concept with highest priority in the departments of corporate finance and financial management where it has wide applications including investment appraisal, bond and stock valuation, capital budgeting and cost of capital. There are various TVM tools available for specific purposes like NPV, IRR, DDM, DCF; etc which are typically known as traditional methods, but with technological advancements, various modern techniques has been introduced in the list of TVM formulas like real options theory, regression, etc. which increase efficiency and accuracy.

The Concept of TVM

The concept of TVM states that the value of a dollar to be received tomorrow (or in coming future) has less value than the value of a dollar owned today. And there are specific reasons that a dollar tomorrow is less in worth than a dollar today, which are:

  • People give larger preference to present consumption and avoid any delay to future. In order to induce individuals to delay consumption to future, it is required offering them a larger value in the future.
  • Due to monetary inflation, the value of money witnesses decrement over time. That means people will not be able to purchase the same commodity in future with the same amount of money owned today.
  • With uncertainties (or risk) associated with future cash flow, its potential value will be decreased or it will be less valuable.

The importance of Time Value of Money

  • As per first bullet point above, banks (and other investment institutes) offer people returns against delaying their current consumption. They can lend their owned money to the banks and in exchange receive the principal amount along with interests after a specified period. However, such transactions involve costs and resources for both parties including the borrower and the lender.

Literature Review of Time Value of Money

The study of Siziba and Hall (2019), examines the evolution TVM methods and the techniques of capital budgeting. The findings of the two researchers showed that there are six techniques of capital budgeting, which are highly popular for evaluating investments projects in the business firms of India, UK, USA and South Africa. These 6 methods are NPV (the net present value), IRR (the internal rate of return), PBP (the payback period), ARR (the accounting rate of return), ROI (the return on investment) and ROM (the real option method). Techniques, including ROV and ROI are the least used while the method of NPV has been increasingly used while evaluating capital investments.

As per Rupić, Obradović and Rupić (2017), the investors are interested in knowing the expected future and the modern performance measures are required to provide accurate assessments of the possible intrinsic or fair value of the company at present considering the future performance of the company. The essence is to maximize or guarantee the return derived by investing in a particular company. That means analysts are required to estimate the future cash flows that company can generate through its business operations and then use such estimations to calculate the net present value (NPV) of the company.

The analysts can use free cash flow as the starting point, and use methods like discounted cash flow (DCF) to calculate the intrinsic value of the company. In knowledge economy, the primary objective of a business firm is to generate high value for the firm and owners. This determines the increasing importance of NPV and FCF methods that makes the investor able to efficiently and accurately compute the true value of the companies.

As per Arjunan (2019), the capital appraisal study (or feasibility analysis) is referred towards the most initial evaluation of a proposed project, plan or investment. It basically investigates the practicality and calculates the viability of such project, plan or investment. In other words a project manager, analyst, investor or business organization before undertaking a project, plan and makes potential investment of time and money, it is required to conduct a capital budgeting analysis or valuation analysis of that project or company’s ability and its future potential. The appraisal study forecast the future, calculates the present values and makes the analysts or investors aware about the hereditary risks in the investment or project and determines whether such investment or project is able to generate required returns (or ROI) as expected.

Feasibility Study Examples

Examples of feasibility study can be observed in our day to day life.

  • When a house wife inspects the quality of the product she is purchasing from a grocery store, she is actually doing a material quality feasibility test.
  • The farmer in order to eliminate the use of pesticides, studies the operational and economic feasibility of organic methods of farming and its consequences on output and quality of the crop.
  • Due to increasing fuel rates and air pollution, a team of young entrepreneurs in order to launch an electric vehicle performs technical, resource and economic feasibility tests.

The Economic Model: Capital Appraisal of A Company’s Project

Capital Budgeting using TVM Concepts

Capital budgeting is a quantitative technique that enables a business to select the best possible investment proposal that carries similar risk. While conducting the process of capital budgeting, the concepts of TVM are very important and re readily applied. It includes forecast of future and bring the expected findings of the future to the present value using discounting effects. The most popular capital budgeting tools that are utilized in capital appraisals includes techniques like net present value (NPV), internal rates of return (IRR), payback period (PBP), etc.

In the below case study (hypothetical), an economic model based on the NPV method of capital budgeting will be used to represent the importance of time value of money in the management of financial industry.

Advice

Tony Stark studied the associated benefits and costs with the project and made a conclusion based on the NPV which is calculated considering the time value concepts of compounding and discounting that since NPV is high and positive, Stark Ltd should accept the proposal of the solar energy project.

Research Methodology of Time Value of Money

Introduction

Research Methodology can be defined as the process that provides a detailed overview of the direction in which the entire research work is going to move. This section of dissertation ‘the research methodology’ primarily includes the research approach, research philosophy, and research design, and apart from that it will also discuss about the techniques of sampling, data collection and the instruments for research that are being utilized. It will also provide a very brief overview of the tools used for data analysis that is going to be utilized for the research work.

Review of Research Philosophies

The research approach is completely based on the philosophy of research and has main focus on the collection of data, its analysis, findings from the analysis and its proper and efficient use. It has been observed that research philosophy helps in better selecting the research approach for completing or fulfilling the requirements of the research. The research approach helps to implement and assess the data collection and its analysis. The research philosophy for the dissertation forms the founding base of the overall research and therefore, the selection of the philosophy must be appropriate and relevant with the research being conducted. Typically, there are three types of research philosophies which are used in research works including positivism, interpretivism and realism. For the research of ‘analyzing the application of TVM theories in the economic evaluation of investment projects, the philosophy of positivism will be used. The philosophy of positivism states that knowledge is derived from natural properties, relations and phenomenon. On the other hand, interpretivism believes that qualitative research is based on social science.

The Justification for The Selection of Positivism Philosophy

The positivism philosophy considers being the best philosophy among all other philosophies. This philosophy considers the fact that few information and evidence are already stated and can be utilized for the research purpose. The positivism philosophy is the unidirectional study therefore, it support to conduct the research in an effective manner. This research will include the quantitative data and the quantitative data will be based on secondary data that will be collected from the existing research works. This philosophy displays the logic behind every analysis of the important data. Whenever the scientific quantitative methods are utilized in the research work then the positivism considered being the most suitable philosophy because it will direct the whole work in a single direction which is very helpful and useful for the study in an effective manner. The positivism philosophy will also be helpful to provide the logic behind all the analysis and findings that will take place further in the research work. The data will include different research papers, journals, books and articles that will include relevant data for applying the TVM theories.

Research Approach

Research philosophy provides specific direction to select an appropriate research approach as per the requirements. Research approach helps in conducting the data collection process and is significant for implementation plan of data analysis. It is divided into two main categories which includes research approach for a) data collection and b) data analysis. There are three types of research approaches including abductive, inductive and deductive. Deductive approach is used when the data is taken from a general point of view to specific point of view, whereas the inductive approach is used when we exaggerate and describe the information from specific set of data. The selection of the research approach is primarily based on the research philosophy, the methods of data analysis and the types of data that has been collected. For this dissertation’s research, the inductive approach will be followed due to the fact that data and information will be obtained from specific to general point of view.

The Justification for Selecting Inductive Approach

The research is mainly based on the qualitative data which will be obtained through publicly available research papers, books, articles, research journals, credible websites, business magazines, etc. Thus, the inductive approach can be the most effective approach. A specific set of data will be used in conducting a general analysis. The Deductive approach cannot be used for this kind of quantitative research because it is only useful when the analysis goes from general to specific and it is exactly the opposite of the case that is given and its requirements.

Research Design of Time Value of Money

The research design is the combination of the set of methods and policies that are used in exploring and gathering the procedures of the variable utilized in the research work. Therefore, it can be said that research design is basically the framework or blueprint of the techniques and methods which are essential for integrating different elements of research in a logical method with the motive to work on the research problem with efficiency and effectiveness. It uses a specific methodology to conduct the research work and thus will be able to evaluate the list of questions mentioned in the research. To conduct a particular research the research design acts as a vehicle which requires the dual wheels of research philosophy and research approach to run it in the specified directions with most effectiveness. For this research work, exploratory research design will be used for data collection and its analysis.

The Justification for Selecting a Exploratory Research Design

It is the most suitable research design to collect and analyze qualitative data and provides better understanding of the research problem and is capable of providing a better solution. It generally conducts data collection and analysis process in a systematic manner. Further, the sequence and structure of the overall project is then decided and accordingly finalized.

Methods of Data Collection

The data collection process for this particular research will typically involve the collection of data from the secondary data collection methods. In the secondary data collection method, the available data in the form of previously conducted researches, journals, websites, etc are used, that means already collected data is gathered, (rather than creating fresh information) to conduct the research. Therefore, it can be referred as second hand data and thus its reliability and authenticity is a little less as compared to the primary data.

The secondary data is the publicly available data as someone-else has already collected and analyzed the same or similar data for their own study or research purposes. However, due to this reason, the new researcher has a variety of options to select the most relevant data that appears suitable for the particular study. In secondary data collection method, the filtration of data is very important and the researcher can implement multiple filters to reach and obtain the most appropriate set of information. This method of data collection involves very little cost and also consume less time as compared to the primary source of data.

Ethical Consideration

For the data analysis, the data is collected from various sources therefore, it is important to determine and the reliability and validity of the data. It is important to maintain the integrity of the data to get the best results through the survey. It has been experienced that many times the surveyor discloses the confidential information of the respondents to the other people and hampers the authenticity and credibility of the data. A proper strategy needs to be used to execute the data from any type of vulnerabilities. All the required information will be communicated honestly during the entire research. Moreover, the whole research consent of the participants must be gained before allowing them to contribute their part in the survey of the research without any obligations.

Conclusion on Time Value of Money

This study has been conducted to determine the importance of Time Value of Money and its necessary concept in the segment of financial management. TVM includes various sub concepts like present value, future value, discounting and compounding, etc. and typically states that the value of a single dollar owned today will not remain same in coming future, but less than its current value. In other words the theory of TVM says that it is more beneficial to own money today, rather than any period in future due to its earning capacity and compounding effects. Therefore, it is very important for a professional in financial industry to have knowledge about the various techniques and applications of TVM. In this research proposal, I will present the traditional notions of TVM and will illustrate its applications in the field of investment projects, project appraisal and capital budgeting.

Feasibility study is the most important test that every entity should perform in advance while undertaking a new project. It gives a clear picture of the proposed project and helps the management to choose the best out of various alternatives available by providing valid reasons to accept one and reject other(s). Feasibility analysis enhances the rate of success by saving entity’s resources, time and money. 

Financial management concepts like NPV, IRR and PBP are the founding pillars of capital budgeting theories. They hold crucial place while making decisions related to investments. NPV has been widely used in the financial industry and project appraisals. It is used in identification, selection and decision making about potential investments through TVM concepts.

Reference List for Time Value of Money

Anamonics, W.L., Bhardwaj, V. and Macnab, B., 1993. Experiments on the difference between Willingness to pay and Willingness to accept. Land Economics, 69(4).

Dillon, M., 2020. Introduction to sociological theory: Theorists, concepts, and their applicability to the twenty-first century. John Wiley & Sons.

Jayaraman, T.K. and Ward, B.D., 2019. Demand for money in Fiji: an econometric analysis.

Kahn, M.J. and Baum, N., 2020. Time Value of Money, or What Is the Real Financial Value of an Opportunity?. In The Business Basics of Building and Managing a Healthcare Practice (pp. 9-12). Springer, Cham.

Kashyap, R., 2019. Fighting Uncertainty with Uncertainty: Time Value of Knowledge and the Net Present Value (NPV) of Knowledge Machines. arrive preprint arXiv:1908.03233.

Monga, A. and Zor, O., 2019. Time versus money. Current opinion in psychology, 26, pp.28-31.

Niota, M. and Pochea, M.M., 2020. Time-varying dependence in European equity markets: A contagion and investor sentiment driven analysis. Economic Modelling, 86, pp.133-147.

Sinha, R. and Datta, M., 2020. Investment Appraisal of Sustainability Projects: An Assortment of Financial Measures. In Social, Economic, and Environmental Impacts Between Sustainable Financial Systems and Financial Markets (pp. 43-56). IGI Global.

Thornburg, A., 2019. The Money–Energy–Technology Complex and Ecological Marxism: Rethinking the Concept of “Use-value” to Extend Our Understanding of Unequal Exchange, Part 2. Capitalism Nature Socialism, 30(4), pp.71-86.

Wintergreen, E.B. and Johnston, W.E., 2019. Economic concepts relevant to the study of outdoor recreation.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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