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

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

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

Money, Time, Risk, People and Business Ideas for Time Business Yes No Now Later Yes Fund Investor Yes Spende Lender Money Allocato Mone r r y No Borrow Saver No Entrpre- Small er neur saver Risk Low High Small Fixed Mutual Deposit, Funds Money Government Securities Large Fixed Private Maturity, Equity, Money Venture Markets Capitalists

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

Which would you prefer – Rs 10,000 today or Rs 10,000 in 5 years? Obviously, Rs 10,000 today. You already recognize that there is TIME VALUE TO MONEY!!

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

Types of Interest • Simple Interest • Interest paid (earned) on only the original amount, or principal, borrowed (lent). • Compound Interest • Interest paid (earned) on any previous interest earned, as well as on the 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

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? • SI = P0(i)(n) – = Rs 1,000(.07)(2) – = Rs140

Simple Interest (FV) • What is the Future Value (FV) of the deposit? • 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 (PV) • What is the Present Value (PV) of the previous problem? • 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.

Why Compound Interest? Future Value of a Rs 1,000 Future Value of a Single $1,000 Deposit Deposit 20000 Future Value (Rs) 10% Simple 15000 Interest 7% Compound 10000 Interest 10% Compound 5000 Interest 0 1st Year 10th 20th 30th Year Year Year

Future Value Single Deposit Assume that you deposit Rs 1,000 at a compound interest rate of 7% for 2 years. 0 1 2 7% Rs1,000 FV2

General Future Value Formula FV1 = P0(1+i)1 FV2 = P0(1+i)2 etc. General Future Value Formula: FVn = P0 (1+i)n or FVn = P0 (FVIFi,n)

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

Compounding Example 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. • Calculation based on Table : Calculation based on general formula: • • FV5 = Rs10,000 (FVIF10%, 5) = Rs10,000 (1.611) FVn = P0 (1+i)n • = RS16,110 [ Due to Rounding ] FV5 = $10,000 (1+ 0.10) 5 = Rs16,105.10 • 0 1 2 3 4 5 10% Rs10,000 FV5

Double Your Money!!! Quick! How long does it take to double Rs 5,000 at a compound rate of 12% per year (approx.)? The “Rule-of-72” Approx. Years to Double = 72 / i% – 72 / 12% = 6 Years – [Actual Time is 6.12 Years]

Future Value of Rs 1 Table “The greatest mathematical discovery of all time is compound interest.” Albert Einstein 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

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

Continuous Compounding • With continuous compounding the number of compounding periods per year approaches infinity. • Through the use of calculus, the equation thus becomes: FV n (continuous compounding) = PV x ( e k x n) 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. FV n = 100 x (2.7183).12 x 5 = $182.22

Nominal and Effective Rates • 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 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 The stage of return for new venture development venture financing

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 Legal Liability Providers of Capital l Debt Inves tors Equity Inves tors Financial Interes t & Accounting Principal Auditors Attes t Statements Dividends Compen- Profes s ional Debt Debt s ation Reputation Equity Inves tments Contracts Contracts & Ethics Inves tment Companies (Managers ) Audit Fees

Accounting As An Information System Information Sys tem Information Information Decis ions Us ers Provided Supported  Inves tors  Performance  Creditors  Profitability evaluations  Managers  Stock inves tments  Owners  Financial pos ition  Tax s trategies  Cus tomers  Labor relations  Employees  Cas h flows  Res ource  Regulators allocations  SEBI  Lending  CBDT  Borrowing  DCA