Comparing the Three Procedures
by MaestriThe ?rst step in solving any time value problem is to understand the verbal description of the problem well enough to diagram it on a time line. Woody Allen said that 90 percent of success is just showing up. With time value problems, 90 percent of success is correctly setting up the time line.
After you diagram the problem on a time line, your next step is to pick an approach to solve the problem. Which of the three approaches should you use—numerical, ?- nancial calculator, or spreadsheet? In general, you should use the easiest approach. But which is easiest? The answer depends on the particular situation.
All business students should know Equation 2-1 by heart and should also know how to use a ?nancial calculator. So, for simple problems such as ?nding the future value of a single payment, it is probably easiest and quickest to use either the numerical approach or a ?nancial calculator.
For problems with more than a couple of cash flows, the numerical approach is usually too time consuming, so here either the calculator or spreadsheet approaches would generally be used. Calculators are portable and quick to set up, but if many calculations of the same type must be done, or if you want to see how changes in an input such as the interest rate affect the future value, the spreadsheet approach is generally more efficient. If the problem has many irregular cash flows, or if you want to analyze many scenarios with different cash flows, then the spreadsheet approach is definitely the most efficient. The important thing is that
you understand the various approaches well enough to make a rational choice, given the nature of the problem and the equipment you have available. In any event, you must understand the concepts behind the calculations and know how to set up time lines in order to work complex problems. This is true for stock and bond valuation, capital budgeting, lease analysis, and many other important financial problems.
Taken From : Five-Minute MBA – Corporate Finance
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