Long-Term Financial Concepts

Two Basic Finance-Related Problems

1. Where to put the money? – This is the investment decision
2. Where to get the money? – This is the financing decision

Investment can be in:

a) Real asset investment – purchasing machinery and equipment, building an office or factory; purpose is
to generate revenue over the useful lives of these assets
b) Financial asset investment – purchasing shares of stocks, lending money to others, purchasing fixed
income securities such as Treasury Bills from the government or corporate bonds
Financing can be from:
a) Equity securities – issuance of shares of stock
b) Debt securities – issuance of corporate bonds
c) Borrowings from Bank

Both investing and financing decisions involve cash flows that occur at extended periods of time
“A peso today is worth more than a peso tomorrow” is a basic principle in finance because:
1. You can invest the peso now and earn a return from this investment; and
2. A Peso expected to be received in the future is riskier and less certain

Number 1 relates to the concept of the Time Value of Money. We can determine the Future Value or the
Present Value of investments.
Concept of Interest
Interest is earned or incurred for the use of the principal amount over the relevant time period.
I=PxRxT
Where:
I = Interest
P=Principal
R=Interest Rate
T=Time Period

Quiz : Compute the Interest Expense in the following:

1) Your mother invested P18,000 in treasury bills that yield 6% annually for 2 years.
2) Your father obtained a car loan for P800,000 with an annual rate of 15% for 5 years.
3) Your sister placed her graduation gift amounting to P25,000 in a special savings account that
provides an interest of 2% for 8 months.
Simple Interest – interest earned is always based on the original principal (excel)
Compound Interest – interest earned is based not only on the principal but also on any interest earned in the
previous period (excel)
Future Value of Money
FV = initial value x (1 + R)^t
FVIF = future value interest factor = (1+R)^t
R – interest rate
t – time period
USE THE FVIF TABLE

Present Value = Future Value x 1/(1 + R)^t

PVIF = 1/(1+R)^t = discount factor
Discounting – process of determining the present value.
Discount Rate – interest rate used to get the present value
USE THE PVIF TABLE.
To make cash flows comparable, we either determine their future value at a common future date or compute
their present value today.

Example:
Your father told you that he will entrust you with the funds for your graduate program education. He gave you
two options: (1) receive the money now in the amount of P200,000 or (2) receive P500,000 ten years from
now. The available investment opportunities to you provide a 10% rate of return. Which option would you
prefer?
Solution: Either determine the future value of P200,000 and compare it with the expected cash flow of
P500,000 ten years from now, or compute the present value of the P500,000 and compare it with the
P200,000.
Choose the second method, get the present value of the P500,000.
Present Value = Future Value/(1 + R)^t
= 500,000/(1 + 10%)^10
Present value = P192,771.64 Since the PV < P200,000, it is better to choose the P200,000 now instead
of the P500k.
Choose the first method, get the future value of the P200,000.
Future Value = Present Value x (1 + R)^t
= 200,000 x (1 + 10%)^10 = P518,748.50
Using the PVIF Table
Find the intersection of the relevant time period (t) presented in the rows of the Table and the relevant interest
rate (R) presented in the columns of the Table.
1/(1+10%)^10 = 0.3855
PV = 500,000 x 0.3855
= 192,771.64
Your School’s annual tuition fee is P100,000 per year if you pay at the start of the school year. Another option
is to pay for the tuition fee at the end of school year at a higher amount of P110,000. The prevailing interest
rate is 12%. Which is the better option?