As per the time value of money the company, American Apparel should refrain from borrowing money at the present time. Instead the borrowing should becarried out after six months when the company plans to build the new manufacturing facility. When the current Treasury Yield Rates are seen in the respect of the previous few decades it becomes obvious that the current rates of discount are significantly lower in the longer run although the current rates cannot be classified as the lowest in such a series. The lowest discount rates emerged around the turn of the century but these have risen again to roughly one half (roughly 3%) of the historically highest rates (7% – 8%) on a thirty year basis.
The current discount rate is attractive when considered in the medium term for a number of years possibly when considered in terms of a decade or so. However when these rates are seen in the light of a shorter period of time, it becomes clear that the reduction in the principal amount is significant. The current rates will remain attractive for the company as long as the company intends to acquire the loan and invest it within the shortest possible period of time.
Keeping the money in store will only lead to lowering its value over time both in the short term and the long run (Hovey, 2005) though the effect would be more significant in the short term. The rates that the company is being offered currently are high compared to the historical highs and lows. Historically the highest rates existed in the early to mid nineties but these decreased significantly in the early 2000 period.
When compared to the nearest period of lowest rates, the current rates seem high. However given the circumstances it is hard that the company would be offered any lower rates any time soon because of the way that historical trends and current fiscal policies are being pushed. It would therefore be safe to assume that the company is being offered the best discount rates within the next decade or so. The time value of money is important for the company as whatever the company borrows today will stand reduced tomorrow due to fiscal discounting of money.
For example if the company were to assume a loan of $10,00,000 on 11th January 2012, the discount rate for the next 6 months is an estimated 0.05%. Hence after six months the company would have roughly lost $50,000 if the money borrowed today is not utilised. This in itself represents a direct fiscal loss to the company for its inaction over the investment of the borrowed money. If the company does not come to terms with the time value of money, it would be borrowing more than it would actually be spending over its construction efforts which would present a distress in terms of repayments for the company (Crosson & Needles, 2008).
If the company chooses to wait six months to borrow the money it shows fiscal maturity on the part of the company. If the company were to borrow the money today, it would stand to lose on the borrowed money due to the time value of money. Another option could be to borrow the money and invest it for six months but this is an unlikely thing to do because extricating finance within six months would be both risky and cumbersome for the company.
Therefore in order to reduce risk and to boost value on the borrowed money, it is in the company’s best interests to borrow the money in the next six months just before it plans to commence construction. Bibliography Crosson, S. V., & Needles, B. E. (2008). Managerial Accounting (8th Ed). Boston: Houghton Mifflin Company. Hovey, M. (2005). Spreadsheet Modelling for Finance.
Frenchs Forest, N.S. W.: Pearson Education Australia.