Healthcare Finance; Time Value of Money
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Introduction
This paper will present a study examining different considerations for management decisions to exercise express authority in acquiring property for a healthcare organization. The study will focus on what investment in a building’s purchase would cost today, considering the projected resale at a $1M profit in five years. The time value of money concepts is highlighted to determine the decision to be made in terms of purchasing a new property relative to the opportunity cost available today. (Damodaran, 2010) suggests uncertainty or risks associated with the future cash flow, resulting in less cash flow valued. Time Value of Money as demonstrated an indispensable role in informing people with spare funds and desire to invest them. Recommendations are provided premised on the calculations presented. The changing economics discussed are the other issues taken into consideration to provide a keen look at the accurate pictures of the situation involving funds’ security. (Damodaran, 2016) discusses the discount rate at which the discounting and compounding are done, reflecting three factors: the preference for current consumption, expected inflation, and the uncertainty associated with the cash flows being discounted.
Time Value of Money
The Time Value of Money concept has large applicability in managing finances in companies, healthcare, banking, on the capital market, and the current economic life. The use in financial management and within the healthcare projected selected depends on how worth a dollar is anticipated for future decisions. It delves at which a sum of money owed in the present has a greater value than the value of the same sum received at the moment in the future. Takes into consideration the opportunity present at the healthcare investment project and to obtain future gains such as interest or profit. Compounding and discounting are the technique used here to make possible the comparability and calculations or evaluations of the time value of money.
The Healthcare illustration
The compounded interest is used here as the basic financial tool in the healthcare project to determine the investments’ outcome. If the management were to put the $ 3,000,000 into an investment project at an annual rate of 8%, the project’s worth would be evaluated with the earned interest realized. The interest is earned on the principal amount as well as in each compounding period.
- 1. The calculations for the Certificate of Deposit generate a net interest greater than the opportunity cost available when the property is held and resold after five years at a $4,000,000. The CD generates Total Interest Earned: $1,407,984.23 in five years. This value is the total future cash flows expected to be generated in 5 years if the money is engaged at a fixed-rate deposit. CDs are extremely safe because of the federal government’s insurance guarantee and thus always attract investors besides the higher interest rates they pay compared to the
regular savings account. Besides, research attributes a few factors to determine the performance of a certificate of deposit, “the future value of a CD is affected by both the interest rate and the terms of the deposit agreement” (Adkins, 2017). This gives a more secure option given the security and the high-interest prospects; it should be a key determinant of drawing a safer future of funds for the healthcare organization.
The management should consider this deposit compared to purchase and resale at $4m after five years since this will amount to lower interests earned in the project. The CD will generate $407,984 more than the resale price. The risks associated are also greatly reduced, and within the same period of 5 years, it is healthy to consider the cashflows emanating from the saving arrangements.
- 2. The projected cash flows generated from the purchase compounded annually for five years accumulate to the same amount interest of generated earnings of the Certificate of Deposit. The values are generated through, considering the Present Value of the Money, the Investment Compounded, and then finally, the resultant Future Value of Money FV = PV * (1 + i) n
FV= $4,407,984.23
PV= $3,000,000.00
Interest earned= (FV-PV), $1,407,984.23
- Assuming the property is purchased, and the rent is available at each end year for five years, the property would earn.
Rent= $300,000.00 annually
The amounts will be the Purchase cost + the additional rent incomes generated for five years= 300,000*5= $1,500,000 at the given fixed rate for five years.
Total FV will represent, purchase cost, $3,000,000 + 1,500,000= $4,500,000 valued at the end of the 5 years. That means the management will have to wait longer to realize the building’s purchase cost through rent for 10 years, given the same rate of $300,000. This is not a reliable investment in terms of the payback period; it would mean only half the investment cost in 5 years and the next 5 years to fully recover the investment project’s present cost. Given the longer time it takes to recover the amount invested, the organization should consider the fixed-rate deposit that is more secure and more guaranteed to generate interests on top of the principal.
- The other alternative recognizes the deposits to a safe saving project compounded differently with 4.2% and 4% respectively in the same period of 5 years. The projects are in different banks, and the calculations presented recognize future values and annual interest rates earned.
- At 4%, and a deposit amount of $3,000,000
Interest rate 4%, compounded monthly for 5 years or an equivalent of 60 months
Annual percentage yield=4.074%
End balance= $3,662,989.78
Total Principal=$3,000,000
Total interest earned= $662,989.78
Total Annual Yield: 22.100%
- At 4.2%, and a deposit amount of $3,000,000 for a period of 5 years or an equivalent of 60 months
Annual percentage yield=4.244%
End balance=$3,692,994.63
Total interest earned=$692,994.63
Total Principal amount=$3,000,000
Total Annual Yield=23.100%
The first national bank with an interest rate compounded semi-annually at an annual interest yield of 23.100% returns a projected net cash flow greater than the later rate 4% at 22.100%. The organization should consider the alternative that yields more interest at the maturity that will realize the project has a positive net future value greater than the deposit committed.
Conclusion
The time value of the money concept premised based on evaluating profitability analysis in financial management. The decision on project selection considered the initial investment, the total cash flows generated by the investment project. An acceptable project met the financial technique that allowed for higher returns at lower risk or cost and guaranteed the healthcare organization’s guaranteed growth. Present value reminded the team of the most powerful technique funds management and a basis for the selected CD deposits as the simplest move that guaranteed the investment’s implementation. The current consumption, expected inflation, and uncertainty associated with future cash flows were the basic factors informing that choice.
References
Damodaran, A., A (2017) Primer on the Time Value of Money
Kuhlemeyer G. A., (2017) Fundamentals of Financial Management, 3, Time Value of Money, © Pearson Education Limited 2008, 12/e, Chapter. wps.pearsoned.co.uk/twps./media/objects (accessed 16.09.2020)
William Adkins, (July 2017). Managing Your Money, Leaf Group Media.