An important difference in the two types of choices, short-term and long-term is the time value of money, which does not require to be taken into account when doing short-term decisions, but does so when creating long-term, capital investment decisions. A dollar got today has higher value than a dollar to be got a year from now for three different reasons – risk, rising prices and interest.
To demonstrate, let’s say I buy some products from you on credit for a hundred dollars. If I’m a frequent customer and tell you that I will put a check in the mail the next day, there is small risk that you will not be paid. If, however, I tell you I’ll pay you in one year the risk goes up significantly. I may become bankrupt in the next 12 months, I might die or I might run off to Mexico. If I tell you I’ll pay you in two years, the risk level goes up even much more. The more time the time among now and when you anticipate cash inflow from a venture, the more the doubt and the higher the risk of not receiving the cash.
Another aspect is raising prices. It is one of the most essential problems in the economics. Inflation erodes the purchasing power of money. If this coming year we have, say, 3 percent rising prices, that means that the common market basket of goods and services which costs $100 today will cost $103 this time next year. If I owe you $100 and don’t pay for a year, it has cost you $3 in buying power. You want your cash now.................read more at>>>>>>>>Time Value of Money
No comments:
Post a Comment