An Overview of the Car as an Asset - Coursework Example

However, owing to the notion of the time value of money, the buyer would be required to save an amount different from that of $25,000. Taking the 5-year interest rate of 0.78% (U.S Department of The Treasury, 2012), the saving required annually amounts to the future value of an annuity (ordinary), assuming that $125,000 will be required after 5 years. This amounts to: 125,000= C* {(1.0078^5)-1/0.0078} = $24,613.03 Where: C= unknown i= 0.78% n=5 This is based on the following formula: FV (annuity) = C * {[(1+i) ^n – 1] / i} (Brigham & Houston, 2011) Where: C = Cash flow per period i = interest rate n = number of payments Two factors highly influence the future value of the cash flows calculated today; firstly, the periods for which they are calculated and, secondly, the rates at which they are calculated (Brigham & Houston, 2011).

In both cases, the future value of the savings today is directly related to the interest rate and period. Higher the interest rate or period at which cash flows are calculated, the greater the future value of the investments made at T=0 (Brigham & Houston, 2011). Furthermore, the fact that whether savings are made at the beginning or end of a particular period, as well as the number of compounding periods, also matters (Brigham & Houston, 2011). . However, if changes are made to the number of compounding periods such that the number of compounding periods is 12 instead of 1, the resultant savings would then be: (125,000 / 76.213)= $1,640.

134, which is approximately $1,640. The total annual investment/savings would translate to $24,613 x 5= $123,065 if compounded annually. On the other hand, the net investment/savings for five years would be: $98,400 (1,640 x 12 x 5) if calculated using monthly compounding. The savings bear an annual opportunity cost of $24,665. Furthermore, it has been observed that the interest rate is apparently low owing to the riskless nature of Treasury Bills (Brigham & Houston, 2011). This is based on the simple rule underlying financial theories that the rate of return is positively associated with the level of risk (Brigham & Houston, 2011).

Ha, As opposed to T-bills, if the savings are channelled into corporate bonds, they will reap a higher return rate than T-bills because these bonds are riskier than T-bills in terms of the riskiness of principal and interest payment. Higher risk translates to higher return and vice versa. If the investment in these corporate bonds were made at a compounded rate annually, the savings required to obtain $125,000 towards the end would be lower than the amount shown in the initial calculations.

To sum up, there are two alternatives available to an individual investor to accumulate $125,000 at the end of the year: to invest in corporate bonds or invest in T-bills. The option that an investor chooses entirely depends on their attitudes towards risk and their capacity to take risk in terms of the amount of annual or monthly savings that they can generate. Thus, the net effect would be that the investor will lose money by investing in T-bills rather than corporate bonds representing an opportunity cost.