BUSINESS FINANCE

Business

BASIC LONG-TERM Trends

FINANCIAL CONCEPT
Presented by Group 6

Finance
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 Time Value of Money
FV = Future value of money
 PV = Present value of money
 i = interest rate
The time value of money (TVM) is the concept that a sum
of money is worth more now than the same sum will be at  n = number of compounding periods per year
a future date due to its earnings potential in the interim.  t = number of years

Based on these variables, the formula

for TVM is:
Depending on the exact situation, the formula for the time value of money
may change slightly. For example, in the case of annuity or perpetuity
payments, the generalized formula has additional or fewer factors. But in
general, the most fundamental TVM formula takes into account the following
variables
 EXAMPLES
Let's assume a sum of $10,000 is
invested for one year at 10% interest
You have $5,000 and can expect
compounded annually. The future value
to earn 5% interest on that sum
of that money is:
each year for the next two years.

FV=$10,000×(1+ -1 )
10% (1x1)
Assuming the interest is only

1×1
compounded annually, the future
=$11,000
value of your $5,000 today can
be calculated as follows:
(1x2)
FV = $5,000 x (1 + (5% / 1)
= $5,512.50
 WORD PROBLEM

INPUT PROCESS OUTPUT

Using the example above, let's say you This means the $15,000 you get
Let's say someone would like to can invest the money from selling the for the car today will be worth
buy your car and they can offer car today for $15,000 in a CD that $15,612 in two years. If you wait
you $15,000 for it today or pays 2% every year, compounded until two years from now to
$15,500 if they can pay you two monthly. To calculate the value of the receive the $15,500 payment,
years from now. TVM teaches us money in two years, here's how it you will lose out on $112 in
that $15,000 today is worth works: interest you could have earned in
more than $15,500 in two years.
(12x2) that time. With investments that
FV = $15,000 x (1+(0.2/12))

have higher returns, such as
=$15,612
stocks or real estate, the missed

opportunities will be even bigger.

TVM
 The interest rate is the amount a
lender charges a borrower and is a
percentage of the principal—the
INTEREST
RATE amount loaned. The interest rate
on a loan is typically noted on an
LOAN annual basis known as the annual
percentage rate (APR).

Interest rate
 2

INTEREST RATE The interest rate is the amount charged on

top of the principal by a lender to a
borrower for the use of assets.

1 3

Most mortgages use simple interest. However, some

A borrower that is considered low risk by the
loans use compound interest, which is applied to lender will have a lower interest rate. A
the principal but also to the accumulated interest loan that is considered high risk will have a
of previous periods higher interest rate.
INTEREST
FORMULAS
 SIMPLE
INTEREST RATE
The example earlier was calculated using this annual simple interest rate formula:

Simple interest = (principal) x (interest rate) x (time)

E.g.

Simple interest = P400,000 x 3.5% x 50 year = P1,100,000

COMPOUND
INTEREST RATE
Some lenders prefer compound interest, which means the borrower will pay a greater amount
of interest.

Compound interest, also known as interest on interest, is applied not only to the principal but
also to the previous periods' accumulated interest.

The lender assumes that the borrower owes the principal plus interest for the first year at the
end of that year. The lender also assumes that at the end of the second year, the borrower
owes the principal plus interest plus interest on interest for the first year.
COMPOUND
INTEREST RATE
When compounding, the interest owed is greater than the interest owed when using the simple
interest method. Monthly interest is charged on the principal plus accrued interest from
previous months. For shorter time periods, the interest calculation will be similar for both
methods. However, as the lending period lengthens, the difference between the two types of
interest calculations grows.

With the previous example, at the end of the fifty years, the total interest to be payed will
be P2,233,970 on a P400,000 loan. the compound interest has a difference of P1,133,970 to
the simple interest.
COMPOUND
INTEREST RATE
The previous calculation was computed using this formula:

Compound interest = p x [(1 + interest rate)^n − 1]

Where:
p = principal amount
n = number of compounding periods
 Future Value
Future value (FV) is the value of a current asset at some point in
the future based on an assumed growth rate.

Investors are able to reasonably assume an investment’s profit

using the FV calculation.

Determining the FV of a market investment can be challenging

because of market volatility.
 Types of Future Value

Future Value Using Simple Annual

Interest

where:
The FV formula assumes a constant rate of growth I=Investment amount
and a single up-front payment left untouched for the R=Interest rate
duration of the investment. The FV calculation can be T=Number of years​
done one of two ways, depending on the type of

interest being earned. If an investment earns simple For example, assume a $1,000 investment is held
interest, then the FV formula is: for five years in a savings account with 10%

simple interest paid annually. In this case, the FV
FV=I×(1+(R×T)) of the $1,000 initial investment is $1,000 × [1
+ (0.10 x 5)], or $1,500.
 Types of Future Value

Future Value Using Compounded Annual Interest

With simple interest, it is assumed that the interest

rate is earned only on the initial investment. With where:
compounded interest, the rate is applied to each I=Investment amount
period’s cumulative account balance. In the R=Interest rate
previous, the first year of investment earns 10% × T=Number of years​
$1,000, or $100, in interest. The following year,

however, the account total is $1,100 rather than For example, assume a $1,000 investment is held
$1,000; so, to calculate compounded interest, the for five years in a savings account with 10%
10% interest rate is applied to the full balance for simple interest paid annually. In this case, the FV
second-year interest earnings of 10% × $1,100, or of the $1,000 initial investment is $1,000 × [1
$110. + (0.10 x 5)], or $1,500.

 Present Value
Present value states that an amount of money today is worth more than the same amount in
the future.

In other words, present value shows that money received in the future is not worth as much as
an equal amount received today.

Unspent money today could lose value in the future by an implied annual rate due to inflation
or the rate of return if the money was invested.

Calculating present value involves assuming that a rate of return could be earned on the funds
over the period.

or seasonal working capital also. Seasonal requirement or temporary working capital has peaks
and troughs. The two areas of troughs below the long-term financing line indicate that there
are idle long-term funds incurring unnecessary interest cost.

 Present Value Calculation

How Do You Calculate

Present Value?

The discount rate is a very important factor in
influencing the present value, with higher discount
Present value is calculated by taking the future
rates leading to a lower present value, and vice-versa.
cashflows expected from an investment and Using these variables, investors can calculate present
discounting them back to the present day. To do so, value using the formula:
the investor needs three key data points: the

Present Value= (1+r)nFV​

expected cashflows, the number of years in which

the cashflows will be paid, and their discount rate.

Where:

FV=Future Value
r=Rate of return
n=Number of periods​

Valuing Multiple Cash Flows However, if the cash flows do

happen at regular intervals,
are a fixed size, and earn a
(Cash Flow) - The sum of cash uniform interest rate, there is
revenues and expenditures over a period an easier way to find the total
FV. Investments that have
of time. these three traits are called
"annuities. "
Future Value (Multiple Cash Flow)
(FV) of a single payment
Finding the future value (FV) of multiple cash flows
To find the FV of multiple cash means that there are more than one payment/
flows, sum the Future Value of each investment, and a business wants to find the total FV
cash flow.​ at a certain point in time. These payments can have
varying sizes, occur at varying times, and earn
varying interest rates, but they all have a certain
value at a specific time in the future.​
 EXAMPLE
We invest P2000 at the end of each of the next 5 years. The current balance is zero, and
the rate is 10%. What is the future value of this investment at the end of year 5?
0 1 2 3 4 5 FV?

2,000 2,000 2,000 2,000 2,000

FV=2,000
FV=2,200
Sum all (FV), 2,000
2,200
FV=2,420
2,420
+ 2,662
FV=2,662 2,928.2
P12,210.20
FV=2,928.2
 Present Value, Multiple Flows​
The PV of multiple cash flows is To discount annuities to a time prior
simply the sum of the present to their start date, they must be
discounted to the start date, and then
values of each individual cash flow.​
discounted to the present as a single
cash flow.

Multiple cash flow investments that

are not annuities unfortunately cannot
Key Points :
be discounted by any other method
To find the PV of multiple cash flows, each but by discounting each cash flow and
cash flow much be discounted to a specific summing them together.
point in time and then added to the others.
 EXAMPLE
A project having a life of 5 years with the following cash flow. Determine the
present value of all the cash flows if the relevant discount rate is 6%.

Discount
Cash flow for year 1: $400 Rate 6%
Cash flow for year 2: $500 Future cash flow, C = $400
Cash flow for year 3 : $300 YEAR 1 2 3 4 5 Discount rate, r = 6%
Number of periods, n = 1
Cash flow for year 4: $600 year
Cash flow for year 5: $200 Cash
Flows
$400 $500 $300 $600 $200

Add all (PV) to get the total (PV)

PV = $377.36 + $445.00 + $251.89 + $475.26
+ $149.45
PV = $1,698.95 or $1,699
 Annuties Why do people buy What are the benefits and
risks of variable annuities?
annuities?

People typically buy annuities to help manage their Some people look to annuities to “insure”
income in retirement. their retirement and to receive periodic
What are annuities?​ Examples: payments once they no longer receive a
Periodic payments for a specific amount

of time
salary. There are two phases to annuities,
An annuity is a Death benefits. the accumulation phase and the payout

contract between Tax-deferred growth.

phase.​

you and an
insurance
kinds of annuities Variable annuities
company that
requires the (Fixed annuity) The insurance company promises you a
minimum rate of interest and a fixed amount of periodic Understand that variable annuities are designed as
insurer to make payments. an investment for long-term goals, such as
payments to you, (Variable annuity) The insurance company allows you to retirement. They are not suitable for short-term
direct your annuity payments to different investment options, goals because you typically will pay substantial
either usually mutual funds. taxes and charges or other penalties if you
withdraw your money early. Variable annuities also
immediately or involve investment risks, just as mutual funds do.​
(Indexed annuity) This annuity combines features of
in the future. securities and insurance products.
 WHAT IS LOAN AMORTIZATION? TYPES OF AMORTIZING LOAN
Loan amortization is the process of Amortizing loans include installment loans

scheduling out a fixed-rate loan intoequal payments. where the borrower pays a set amount each

A portion of month and the payment goes to both interest

each installment covers interest and the and the outstanding loan principal. Common

remaining portion goes toward the loan principal. types of amortizing loans include:

The easiest way to calculate

payments on an amortized loan is to use • Auto loans

a loan amortization calculator or table template. • Student loans
However, you can calculate • Home equity loans
minimum payments by hand using just the loan amount, interest rate and loan term. • Personal loans
• Fixed-rate mortgages

WHAT IS AN AMORTIZED LOAN?

An amortized loan is a form of financing

that is paid off over a set period of time.

Under this type of repayment structure, the

borrower makes the same payment

throughout the loan term, with the first

portion of the payment going toward

interest and the remaining amount paid

against the outstanding loan principal.

More of each payment goes toward

principal and less toward interest until the

loan is paid off.

AMORTIZED LOANS VS. UNAMORTIZED LOANS
With an amortized loan, principal payments

are spread out over the life of the loan. This

means that each monthly payment the

borrower makes is split between interest

EXAMPLES OF COMMON UNAMORTIZED LOANS
and the loan principal. Because the

borrower is paying interest and principal

• Interest-Only Loans
during the loan term, monthly payments on

an amortized loan are higher than for an

• Credit Cards
unamortized loan of the same amount and
• Home equity lines of credit
interest rate. • Loans with a balloon payment, such as a
A borrower with an unamortized loan only

has to make interest payments during the

mortgage
loan period. In some cases the borrower
• Loans that permit negative amortization
must then make a final balloon payment for
where a monthly payment is less than the
the total loan principal at the end of the

loan term. For this reason, monthly

Interest accrued during the same period

payments are usually lower;

however, balloon payments can be difficult

to pay all at once, so it’s important to plan

ahead and save for them. Alternatively, a

borrower can make extra payments during

the loan period, which will go toward the

loan principal.
HOW LOAN AMORTIZATION WORKS HOW TO AMORTIZE LOANS
Loan amortization breaks a loan balance

The easiest way to amortize a loan is to use

into a schedule of equal repayments based

an online loan calculator or template

on a specific loan amount, loan term and

spreadsheet like those available through

interest rate. This loan amortization

Microsoft Excel. However, if you prefer to

schedule lets borrowers see how much

amortize a loan by hand, you can follow

interest and principal they will pay as part

the equation below. You’ll need the total

of each monthly payment—as well as the

loan amount, the length of the loan

outstanding balance after each payment.

amortization period (how long you have to

A loan amortization table can also help

pay off the loan), the payment frequency

borrowers:
(e.g., monthly or quarterly) and the interest

 Calculate how much total interest they can

rate.
save by making additional payments
To calculate the monthly payment on an

 Reverse engineer a loan payment to

amortized loan, follow this equation:

determine how much financing they can

• a / {[(1 + r)n]-1} / [r (1+r)n] = p, where

afford
• a: the total amount of the loan

 Calculate the total amount of interest paid

• r: the monthly interest rate (annual rate /

in a year for tax purposes (this applies to

number of payments per year)

mortgages, student loans and other loans

• n: the total number of payments (number

with tax-deductible interest) of payment per year x length of loan in

years)
 Amortization tables typically include:

• Loan details. Loan amortization calculations

are based on the total loan amount, loan term

and interest rate. If you are using an

amortization calculator or table, there will be a

place to enter this information.

• Payment frequency. Typically, the first column

AMORTIZATION TABLE in the amortization table lists how frequently

you’ll make a payment, with monthly being the

most common.

An amortization table lists all of the

• Total payment. This column includes

the borrower’s total monthly payment. If you

scheduled payments on a loan as

use an amortization table template, this

determined by a loan amortization

number will be calculated for you. You also

can calculate it by hand or by using a personal

calculator. The table calculates how much

loan calculator.
• Extra payment. If the borrower makes a payment

of each monthly payment goes to the

beyond the minimum monthly amount, the

principal and interest based on the total

amortization calculator will apply the extra amount

to the principal and calculate future interest

loan amount, interest rate and loan term.

payments based on the updated balance.

You can build your own amortization table,

• Principal repayment. This part of the amortization

table shows how much of each monthly payment

but the simplest way to amortize a loan is to goes toward paying off the loan principal. This

start with a template that automates all of

number increases over the life of the loan.

• Interest costs. Likewise, the interest column of an

the relevant calculations. amortization table tracks how much of each

payment goes toward loan interest. Monthly interest

payments decrease over the life of an amortized

loan.

• Outstanding balance. This column shows the

outstanding balance on the loan after each

scheduled payment and is calculated by subtracting

the amount of principal paid in each period from the

current loan balance.

 AMORTIZATION LOAN TABLE EXAMPLE

The amortization table is built around a

$15,000 auto loan with a 6% interest rate

and amortized over a period of two years.

Based on this amortization schedule, the

borrower would be responsible for paying

$664.81 each month, and the monthly

interest payment would start at $75 in the

first month and decrease over the life of the

loan. Absent any additional payments, the

borrower will pay a total of $955.42 in

interest over the life of the loan.

 BUSINESS FINANCE

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