The time perspective
The time perspective in managerial economics refers to the importance of time in decision-making. It involves taking into account the time value of money, which means that the value of money changes over time due to inflation, interest rates, and other factors. Businesses need to consider the time value of money when making investment decisions, as money invested today can be worth more than the same amount invested at a future date.
Suppose a company is considering investing in a new project
that will cost $100,000 and is expected to generate a return of $150,000 in 3
years. If the company's cost of capital is 10%, it can use the time perspective
principle to calculate the present value of the future cash flows. The present
value of $150,000 in 3 years at a discount rate of 10% is $112,486. This means
that the project's net present value is $12,486, which is positive and
indicates that the investment is worthwhile.
A company needs to decide whether to buy a new piece of
equipment for $50,000 that is expected to generate savings of $10,000 per year
for the next 5 years. If the company's cost of capital is 8%, it can use the
time perspective principle to calculate the present value of the future cash
flows. The present value of the savings of $10,000 per year for 5 years at a
discount rate of 8% is $40,853. This means that the project's net present value
is $853, which is positive and indicates that the investment is worthwhile.
Discounting Principle:
The discounting principle is closely related to time
perspective and involves adjusting the value of future cash flows to reflect
their present value. This means that future cash flows are discounted to
reflect their reduced value due to factors such as inflation and interest
rates. The discount rate is used to calculate the present value of future cash
flows, and businesses use this principle to make investment decisions based on
the expected return on investment.
Suppose a company is considering investing in a project that
will cost $50,000 and is expected to generate a return of $80,000 in 4 years.
If the company's cost of capital is 12%, it can use the discounting principle
to calculate the present value of the future cash flows. The present value of
$80,000 in 4 years at a discount rate of 12% is $53,902. This means that the
project's net present value is $3,902, which is positive and indicates that the
investment is worthwhile.
A company needs to decide whether to buy a new delivery van
for $25,000 that is expected to generate savings of $5,000 per year for the
next 6 years. If the company's cost of capital is 10%, it can use the
discounting principle to calculate the present value of the future cash flows.
The present value of the savings of $5,000 per year for 6 years at a discount
rate of 10% is $24,939. This means that the project's net present value is
negative $1,061, which indicates that the investment is not worthwhile.
Overall, time perspective and discounting principle are
important concepts in managerial economics that help businesses make investment
decisions based on the present value of future cash flows. By using these
principles, businesses can evaluate the potential return on investment and make
informed decisions that maximize their profitability.
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