CHAPTER 5: Basic Long Term Financial Concepts

Demi Diane De Castro

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 AGENDA
AGENDA

Definition of Basic Financial

Understanding Risk
Concept

Simple and Compound Interest Present and Future Value of

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Single Amount
 Definition of Basic
Financial Concept

Different definition and explanation of the financial

concept as we enter the new chapter in business finance

subject.
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 Basic Financial Concepts
Compounding Effects of Money
Time value of money

By far the most important Maybe the second most important

financial concept, describes
how important the value of
time is in building wealth.
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basic financial concept to
understand. Understanding is the
key to being able to forecast future
growth.
 Basic Financial Concepts
Diversity your risks and
investments
Another important concept to
keep your business finances
balance. Allocate the
investment/resources to minimize
the risk
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Keep a budget
This basic financial concept is
needed to really understand the
breakdown of your company's
finances and to learn how to
optimize them.
 Basic Financial Concepts
Opportunity Costs Interest Rates

Understand that wherever you You must understand how interest

spend your time and money is a rates and overall rate of returns
cost that you cannot spend effect almost everything in your
elsewhere. financial life.
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 Basic Financial Concepts
Understand the Stock Market

A basic understanding of the stock market can be applied to your

everyday finances to help you manage your business money better.
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 Understanding Risk

Different definition and explanation of the risk and how

important knowing it specially in making decision in a

company.
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 What is
Risk?
The variability in the
expected return from a
project.
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 ELEMENTSOF RISK

Various components cause the variability in expected returns, which are known
as elements of risk.
SYSTEMATIC RISK UNSYSTEMATIC RISK
These risk are further subdivided These risks are subdivided into
into interest rate risk, market risk business risk and financial risk.
and purchasing power risk.
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 MEASUREMENT RISK

Quantification of risk is known as measurement of risk.

Two approaches are followed in measurement of risk:

Mean-variance approach
Correlation or regression method
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 Simple and Compound
Interest

Understand and know how to compute a simple and

compound interest
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 Simple and Compound Interest

The charge against the use of by the borrower. The same is profit
earned by the lender of money.
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 Simple Interest
If the charged only on the principal amount. The following formula can be used to
calculate simple interest:

Simple Interest: (Is) = P x i x t

Where,
P is the principle amount;
i is the interest rate per period
t is the time for which the money is borrowed or lent.
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 Example # 1
Linda invested P 1,000 last January 1, 2021 at 10%
simple interest rate for 3 years. Calculate the total simple
interest on the amount.
Simple Interest: (Is) = P x i x t

Is = 1,000 x 10% x 3
= 1,000 x .10 x 3
(1000 x .10 = 100
100 x 3 = 300)
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= P 300
 Example # 2
Tony borrowed P 500,000 this year to Joe and promise
him to pay in 3 years at 10% simple interest rate.
Calculate the total simple interest on the amount.

Simple Interest: (Is) = P x i x t

Is = 500,000 x 10% x 3
= 500,000 x .10 x 3
(500,000 x .10 = 50,000
50,000 x 3 = 150,000)
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= P 150,000
 Compound Interest
If the charge on the principal plus any interest accrued till the point of time at which
interest is being calculated.

Compound Interest: Ic = [P (1 +r/n)^nt] - P

Where,
P is the principle amount;
r is the interest rate per period
t is the time for which the money is borrowed or lent.
n is the number of periods
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(annually n= 1; semi-annually n= 2; quarterly n= 4; monthly n= 12)

 Example # 1
Liza invested P 1,000 last January 1, 2021 at 10% compounded interest rate
annually for 3 years. Calculate the total compounded interest in 3 years

Compound Interest: Ic = [P (1 +r/n)^nt] - P

Ic = [1,000 (1 + .10/1)^(1)(3)] – 1,000

= [1,000 (1 + 0.10)^3] – 1,000
= [1,000 (1.10)^3] – 1,000
= [1,000 (1.331)] – 1,000
= 1,331 - 1,000
= P 331
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 Comparison of Simple vs Compound Interest

SIMPLE INTEREST COMPOUNDED INTEREST

Is = P x i x t Ic = [P (1 +r/n)^nt] - P

Is = 1,000 x 10% x 3 Ic = [1,000 (1 + .10/1)^(1)(3)] – 1,000

= [1,000 (1 + 0.10)^3] – 1,000
= 1,000 x .10 x 3
= [1,000 (1.10)^3] – 1,000
= P 300 = [1,000 (1.331)] – 1,000
= 1,331 - 1,000
= P 331
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 Example # 2
Tony borrowed P 500,000 this year to Joe and promise him to pay in 3 years
at 10% compounded interest semi-annually. Calculate the total compounded
interest in 3 years
Compound Interest: Ic = [P (1 +r/n)^nt] - P

Ic = [500,000 (1 + .10/2)^(2)(3)] – 500,000

= [500,000 (1 + 0.05)^6] – 500,000
= [500,000 (1.05)^6] – 500,000
= [500,000 (1.340)] – 500,000
= 670,000 - 500,000
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= P 170,000
 Comparison of Simple vs Compound Interest

SIMPLE INTEREST COMPOUNDED INTEREST

Is = P x i x t Ic = [P (1 +r/n)^nt] - P

Is = 500,000 x 10% x 3 Ic = [500,000 (1 + .10/2)^(2)(3)] – 500,000

= [500,000 (1 + 0.05)^6] – 500,000
= 500,000 x .10 x 3
= [500,000 (1.05)^6] – 500,000
= P 150,000 = [500,000 (1.340)] – 500,000
= 670,000 - 500,000
= P 170,000
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 Present and Future Value of
Single Amount

Understand and know how to compute a present and

future value of single amount.

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 Time Value of Money

An important concept in financial management. It can be used to

compare investment alternatives and to solve problems involving
loans, mortgages, leases, savings, and annuities.
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Charge for borrowing money,
usually in percentage of the
amount borrowed over a
specific period of time.
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Reminder!
Calculated each period on
Computed only on the
the original amount
original amount period. It is
borrowed plus all unpaid
the return on that principal
interest accumulated to
for one time period.
date.
 Reminder!

An amount today that is

Are a series of equal, equivalent to a future payment,
Periods are evenly-spaced evenly-spaced cash flows. or series of payments, that has
intervals of time. been discounted by an
appropriate interest rate.
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 Reminder!

The amount of money that an A picture of a financial problem

investment with a fixed, A method for repaying a that shows all cash inflows and
compounded interest rate will loan in equal installments. outflows along a time line.
grow to by some future date.
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 Present Value
An amount today that is equivalent to a future payment, or series of payments, that
has been discounted by an appropriate interest date.

PV = FV [ 1/ (1+i)^n]

Where:
PV = Present Value
FV = Future Value
i = Interest Rate Per Period
n = Number of Compounding Periods
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 Present Value of Ordinary Annuity
The value of a stream or expected or promised future payments that have been
discounted to a single equivalent value today .
Pvoa= PMT [(1 – (1+i)^n)) / i]

Where:
PVoa= Present Value of an Ordinary Annuity
PMT= Amount of Each Payment
i= Discount Rate Per Period
n= Number of Periods
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 Present Value of Annuity Due
Is identical to an ordinary annuity except that each payment occurs at the beginning
of a period rather than at the end.

PVad= PVoa (1+i)

Where:
PV-ad= Present Value of an Annuity Due
PV-oa= Present Value of an Ordinary Annuity
i= Discount Rate Per Period
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 Future Value
The amount of money that an investment made today (the present value) will grow to
by some future rate.

FV= PV (1+i)^n

Where:
FV= Future Value
PV= Present Value
i= Interest Rate Per Period
n= Number of Compounding Periods
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 Future Value of Ordinary Annuity
The value that a stream of expected or promised future payment will grow to after a
given number of periods at a specific compounded interest.

FVoa= PMT [((1+i) ^n – 1) / i]

Where:
FVoa= Future Value of Ordinary Annuity
PMT= Amount of Each Payment
i= Interest Rate Per Period
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n= Number of Periods
 Future Value of Annuity Due
Is identical to an ordinary annuity except that each payment occurs at the beginning
of a period rather than at the end.

FVad= FVoa (1+i)

Where:
FVad= Future Value of an Annuity Due
FVoa= Future Value of Ordinary Annuity
i= Interest Rate Per Period
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QUESTION?
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THANK YOU!
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