Chapter 1. Alchemy of Wealth: Goals of Finance and Time Value of Money

Welcome to the world of Financial Management. Among the various fields of business administration, finance is the most logical yet dynamic discipline, dealing with the ‘flow of money.’

People often confuse finance with ‘accounting.’ However, while accounting is the task of creating reports based on past records, financial management is about making ==“decisions that create future value”== based on those reports. Today, we will explore why firms exist and why $1 today is more precious than$ 1 tomorrow.

1. The North Star of Finance: Why do we manage?

Every action of a firm must have a purpose.

(1) Profit Maximization vs. Corporate Value Maximization

In the past, simply increasing ‘Net Income’ (Profit Maximization) was the goal. However, this has critical weaknesses:

Timing: Chasing immediate profits can ruin the future.
Ignoring Cash Flows: It cannot explain situations where a firm has book profits but no cash (insolvency).
Ignoring Risk: It treats risky gambles and stable earnings equally.

Therefore, modern finance aims for ==“Maximization of Shareholder Wealth”==, specifically Maximization of Corporate Value (Stock Price). This concept integrates all future values and risks.

(2) Agency Problem: Conflict between Principal and Agent

This occurs when managers (agents) prioritize their own interests over those of the shareholders (principals). Devices like Stock Options and independent boards are used to align interests.

2. The Magic of Time: Time Value of Money (TVM)

The first law of finance is: ==“ $1 today is worth more than$ 1 tomorrow.”== This is because today’s $1 has an opportunity cost—it can be invested to become more money tomorrow.

🔄 Mechanism of Value Conversion

graph LR
    A[Present Value: PV] -->|Compounding r: Interest| B[Future Value: FV]
    B -->|Discounting r: Risk| A
    style A fill:#f9f,stroke:#333,stroke-width:4px
    style B fill:#bbf,stroke:#333,stroke-width:4px

(1) Future Value (FV) and the Power of Compounding

Einstein called Compound Interest the ‘8th wonder of the world.’ It is the principle where interest earned on principal earns more interest.

Formula: $FV_n = PV \times (1 + r)^n$
Even a slightly higher $r$ or longer $n$ can cause future value to explode exponentially.

(2) Present Value (PV) and the Magic of Discounting

The core of financial decision-making is converting ‘future earnings’ into ‘present value.’ This is called Discounting.

Formula: $PV = \frac{FV_n}{(1 + r)^n}$
The higher the discount rate (r) (the riskier it is), the less valuable future money becomes today. Conversely, valuable firms are those that lower the discount rate by securing stable future cash flows.

3. Annuities and Perpetuities: The Value of a Constant Stream

How do we calculate the value of an annuity? The formula for a Perpetuity—a stream with no end date—is remarkably simple yet powerful.

==Value of a Perpetuity = $C / r$ == (C: Cash flow per period, r: Discount rate)
This formula is a fundamental tool for evaluating company value or determining the fair price of rental real estate.

4. Conclusion: Financial Thinking as a Tool for the Future

Understanding the time value of money means having ==“the insight to rationally compare current sacrifice with future reward.”==

Every choice you make—studying, saving, or investing in a business—is a financial act of sending current value into the future or pulling future dreams into the present. May the logic of $PV$ and $FV$ serve as your most reliable economic compass.

📚 Prof. Sean’s Selected Library

[A Random Walk Down Wall Street] - Burton Malkiel: Presents a financial perspective on building wealth long-term by trusting market efficiency and the power of time.
[Fundamentals of Corporate Finance] - Ross et al.: The bible for finance students worldwide.
[The Nature of Money] - Jacob Goldstein: Explores how money has changed through history and why humans began valuing time.

Next time, we will dive into ‘Core Analysis of Balance Sheets and Income Statements’—the report card for tracking income and expenses.