Money Matters You, money and the company Money Medium of exchange - - PowerPoint PPT Presentation

Money Matters

You, money and the company

Money

• Medium of exchange
• Buy and sell
• Unit of account
• Measure and record value
• Store of value
• Transfer purchasing power from

present to the future

• Most liquid asset

Business Entity

Customers Who Buy Products and Services Sold by the Business Sources of Debt Capital Bank and other Financial Institutions who Loan Money to the Business on which Interest is Paid Government Agencies Collect Taxes from the Business Employees who are paid wages and salaries and provided other benefits Vendors of Materials, Services, Supplies, Parts, Tools, Equipment and Machines Bought by the Business Sources of Equity Capital Individuals and Financial Institutions who Invest money in the business as owners, not creditors the business has to

Six-Spoke Wheel of Business

You are NOT the company.

Time from Invention to Production

Year of Invention

Technology Time Lag

1852 Fluorescence 82 years 1887 Radar 46 years 1891 Zipper 34 years 1907 Television 29 years 1940 Transistor 10 years

Now Later Yes

Spende r Lender

No

Borrow er Saver

Time

Mone y

Yes No Yes

Fund Allocato r Investor

No

Entrpre- neur Small saver

Ideas for Business Money

Low High Small

Fixed Deposit, Government Securities Mutual Funds

Large

Fixed Maturity, Money Markets Private Equity, Venture Capitalists

Risk Money Money, Time, Risk, People and Business

Function of Financial Markets

• 1. Allows transfers of funds from person or

business without investment opportunities to one who has them

• 2. Improves economic efficiency

Function of Financial Intermediaries

Risk Sharing

• 1. Create and sell assets with low risk

characteristics and then use the funds to buy assets with more risk (also called asset transformation, by pooling of funds).

• 2. Also lower risk by helping people to

diversify portfolios

Time Value of Money

Obviously, Rs 10,000 today. You already recognize that there is TIME VALUE TO MONEY!!

Which would you prefer – Rs 10,000 today or Rs 10,000 in 5 years?

TIME allows you the opportunity to postpone consumption and earn INTEREST. Why is TIME such an important element in your decision?

Why Time?

Types of Interest

• Compound Interest
• Interest paid (earned) on any previous

interest earned, as well as on the principal borrowed (lent).

• Simple Interest
• Interest paid (earned) on only the
• riginal amount, or principal, borrowed

(lent).

Simple Interest Formula

Formula SI = P0(i)(n)

SI: Simple Interest P0: Deposit today (t=0) i: Interest Rate per Period n: Number of Time Periods

• SI = P0(i)(n)

– = Rs 1,000(.07)(2) – = Rs140

Simple Interest Example

• Assume that you deposit Rs 1,000 in an

account earning 7% simple interest for 2 years. What is the accumulated interest at the end of the 2nd year?

• FV

= P0 + SI = Rs 1,000 + Rs 140 = Rs 1,140

• Future Value is the value at some future

time of a present amount of money, or a series of payments, evaluated at a given interest rate.

Simple Interest (FV)

• What is the Future Value (FV) of the

deposit?

• The Present Value is simply the Rs

1,000 you originally deposited. That is the value today!

• Present Value is the current value of a

future amount of money, or a series of payments, evaluated at a given interest rate.

Simple Interest (PV)

• What is the Present Value (PV) of the

previous problem?

5000 10000 15000 20000 1st Year 10th Year 20th Year 30th Year

Future Value of a Single $1,000 Deposit

10% Simple Interest 7% Compound Interest 10% Compound Interest

Why Compound Interest?

Future Value (Rs)

Future Value of a Rs 1,000 Deposit

Assume that you deposit Rs 1,000 at a compound interest rate of 7% for 2 years.

Future Value Single Deposit

0 1 2

Rs1,000

FV2 7%

FV1 = P0(1+i)1 FV2 = P0(1+i)2 General Future Value Formula: FVn = P0 (1+i)n

• r FVn = P0 (FVIFi,n)

General Future Value Formula

etc.

FV2 = Rs1,000 (FVIF7%,2) = Rs1,000 (1.145) = Rs1,145 [Due to Rounding]

Using Future Value Tables

Period 6% 7% 8% 1 1.060 1.070 1.080 2 1.124 1.145 1.166 3 1.191 1.225 1.260 4 1.262 1.311 1.360 5 1.338 1.403 1.469

Anil wants to know how large his deposit of Rs 10,000 today will become at a compound annual interest rate of 10% for 5 years.

Compounding Example

0 1 2 3 4

5

Rs10,000

FV5

10%

• Calculation based on general formula:
• FVn = P0 (1+i)n
• FV5 = $10,000 (1+ 0.10)5 = Rs16,105.10
• Calculation based on Table :
• FV5 = Rs10,000 (FVIF10%, 5)

= Rs10,000 (1.611) = RS16,110 [Due to Rounding]

• Approx. Years to Double = 72 / i%

– 72 / 12% = 6 Years

– [Actual Time is 6.12 Years]

Quick! How long does it take to double Rs 5,000 at a compound rate of 12% per year (approx.)?

Double Your Money!!! The “Rule-of-72”

Future Value of Rs 1 Table

N 6% 8% 10% 12% 1 1.06 1.0800 1.1000 1.1200 2 1.1236 1.1664 1.2100 1.2544 3 1.1910 1.2597 1.3310 1.4049 4 1.2625 1.3605 1.4641 1.5735 5 1.3382 1.4693 1.6105 1.7623 6 1.4185 1.5869 1.7716 1.9738 7 1.5036 1.7138 1.9487 2.2107 8 1.5938 1.8509 2.1436 2.4760 9 1.6895 1.9990 2.3579 2.7731 10 1.7908 2.1589 2.5937 3.1058

“The greatest mathematical discovery of all time is compound interest.” Albert Einstein

Present Value of $1

N 6% 8% 10% 12% 1 .9434.9259.9091.8929 2 .8900.8573.8264.7972 3 .8396.7938.7513.7118 4 .7921.7350.6830.6355 5 .7473.6806.6209.5674 6 .7050.6302.5645.5066 7 .6651.5835.5132.4523 8 .6274.5403.4665.4039 9 .5919.5002.4241.3606 10 .5584.4632.3855.3220

FVn (continuous compounding) = PV x (ekxn) where “e” has a value of 2.7183

• Continuing with the previous example, find the future value of

the $100 deposit after 5 years if interest is compounded continuously.

Continuous Compounding

• With continuous compounding the number
• f compounding periods per year approaches infinity.
• Through the use of calculus, the equation thus becomes:

FVn = 100 x (2.7183).12x5 = $182.22

• The nominal interest rate is the stated or contractual rate of

interest charged by a lender or promised by a borrower.

• The effective interest rate is the rate actually paid or earned.
• In general, the effective rate is greater than the nominal rate

whenever compounding occurs more than once per year.

EAR = (1 + k/m)m - 1

Nominal and Effective Rates

For example, what is the effective rate of interest on your credit card if the nominal rate is 18% per year, compounded monthly? EAR = (1 + .18/12)12 - 1 EAR = 19.56%

Rate of Return

The main factor that determines the rate of return for new venture financing The stage of venture development

Expected Returns on Venture Capital

• Stage

Expected Annual Return

• Seed

80%

• Startup

60%

• First stage

50%

• Second stage

40%

• Third stage

30%

• Bridge

25%

As you climb higher on the ladder, you create basis for lower rates.

Financial Accounting & Its Economic Context

Financial Accounting Statements

Interes t & Principal Debt Inves tments Dividends Equity Inves tment Attes t

Auditors Profes s ional Reputation & Ethics Companies (Managers ) Compen- s ation Contracts Debt Contracts Providers of Capital l Debt Inves tors Equity Inves tors

Legal Liability Audit Fees

Accounting As An Information System

Information Us ers

• Inves tors
• Creditors
• Managers
• Owners
• Cus tomers
• Employees
• Regulators
• SEBI
• CBDT
• DCA

Decis ions Supported

• Performance

evaluations

• Stock inves tments
• Tax s trategies
• Labor relations
• Res ource

allocations

• Lending
• Borrowing

Information Provided

• Profitability
• Financial pos ition
• Cas h flows

Information Sys tem