17-Financial Mathematics.

Introduction To Simultaneous Equations VU

LECTURE 17
MATHEMATICS FINANCIAL MATHEMATICS
INTRODUCTION TO SIMULTANEOUS EQUATIONS

OBJECTIVES
The objectives of the lecture are to learn about:
• Review Lecture 16
• Financial Mathematics
• Introduction to Linear Equations

Module 4
Module 4 covers the following:
• Financial Mathematics (Lecture 17)
• Applications of Linear Equations
• ( Lecture 17-18)
• Break-even Analysis
• ( Lectures 19-22)
• Mid-Term Examination

PROJECT FINANCIAL ANALYSIS

Project Financial Analysis covers the following:
• Cost estimates
• Revenue estimates
• Forecasts of costs
• Forecasts of revenues
• Net cash flows
• Benefit cost analysis
• Internal Rate of Return
• Break-Even Analysis

EXCEL FUNCTIONS FOR FINANCIAL ANALYSIS

List of Excel Financial functions is as under. The name and utility of each function is
given below:
AMORDEGRC

Returns the depreciation for each accounting period. If an asset is purchased in the middle of the
accounting period, the prorated depreciation is taken into account. The function is similar to
AMORLINC, except that a depreciation coefficient is applied in the calculation depending on the
life of the assets.
Syntax
AMORDEGRC(cost,date_purchased,first_period,salvage,period,rate,basis)

Important Dates should be entered by using the DATE function, or as results of other formulas
or functions. For example, use DATE(2008,5,23) for the 23rd day of May, 2008. Problems can
occur if dates are entered as text.

Cost cost of the asset.

Date_purchased date of the purchase of the asset.
First_period date of the end of the first period.
Salvage salvage value at the end of the life of the asset.
Period period.
Rate rate of depreciation.
Basis year basis to be used.

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Basis Date system

0 or omitted 360 days (NASD method)
1 Actual
3 365 days in a year
4 360 days in a year (European method)
Remarks

• Microsoft Excel stores dates as sequential serial numbers so they can be used in
calculations. By default, January 1, 1900 is serial number 1, and January 1, 2008 is serial
number 39448 because it is 39,448 days after January 1, 1900.
• This function will return the depreciation until the last period of the life of the assets or
until the cumulated value of depreciation is greater than the cost of the assets minus the
salvage value.
• The life of the asset is calculated by (1 / "rate"). The depreciation coefficient depends on
the life of the asset.
• If the life of the asset is between 3 and 4 years, the coefficient is 1.5.
• If the life of the asset is between 5 and 6 years then the coefficient is 2.
• If the life is the asset is greater than 6 years then the coefficient is 2.5.
• The depreciation rate will grow to 50 percent for the period preceding the last period and
will grow to 100 percent for the last period.
• If the life of assets is between 0 (zero) and 1, 1 and 2, 2 and 3, or 4 and 5, the #NUM!
error value is returned.

See its example in next lecture.

AMORLINC

Returns the depreciation for each accounting period. If an asset is purchased in the middle of the
accounting period, the prorated depreciation is taken into account.
Syntax
AMORLINC(cost,date_purchased,first_period,salvage,period,rate,basis)
Cost cost of the asset
Date_purchased date of the purchase of the asset.
First_period date of the end of the first period.
Salvage salvage value at the end of the life of the asset.
Period period.
Rate rate of depreciation.
Basis year basis to be used.
Basis Date system
0 or omitted 360 days (NASD method)
1 Actual
3 365 days in a year
4 360 days in a year (European method)

AMORLINC-EXAMPLE
Data Description
A2 2400 Cost
A3 8/19/2008 Date purchased
A4 12/31/2008 End of the first period
A5 300 Salvage value
A6 1 Period
A7 15% Depreciation rate
A8 1 Actual basis (see above)

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Formula Result Description

=AMORLINC(A2,A3,A4,A5,A6,A7,A8) First period depreciation (360)

CUMIPMT
Returns the cumulative interest paid between two periods.
For description see lecture 8.

CUMPRINC
Returns the cumulative principal paid on a loan between two periods
For description see lecture 8.

DB
Returns the depreciation of an asset for a specified period using the fixed-declining balance
method.
Syntax
DB(cost,salvage,life,period,month)
Cost is the initial cost of the asset.
Salvage is the value at the end of the depreciation (sometimes called the salvage value of the
asset).
Life is the number of periods over which the asset is being depreciated (sometimes called the
useful life of the asset).
Period is the period for which you want to calculate the depreciation. Period must use the same
units as life.
Month is the number of months in the first year. If month is omitted, it is assumed to be 12.
Remarks
• The fixed-declining balance method computes depreciation at a fixed rate. DB uses the
following formulas to calculate depreciation for a period:
(cost - total depreciation from prior periods) * rate
where:
rate = 1 - ((salvage / cost) ^ (1 / life)), rounded to three decimal places
• Depreciation for the first and last periods is a special case. For the first period, DB uses
this formula:
cost * rate * month / 12
• For the last period, DB uses this formula:
((cost - total depreciation from prior periods) * rate * (12 - month)) / 12

DDB
Returns the depreciation of an asset for a specified period using the double-declining
balance method or some other method you specify
Syntax
DDB(cost,salvage,life,period,factor)
Cost is the initial cost of the asset.
Salvage is the value at the end of the depreciation (sometimes called the salvage value of the
asset). This value can be 0.
Life is the number of periods over which the asset is being depreciated (sometimes called the
useful life of the asset).
Period is the period for which you want to calculate the depreciation. Period must use the same
units as life.
Factor is the rate at which the balance declines. If factor is omitted, it is assumed to be 2 (the
double-declining balance method).

Important All five arguments must be positive numbers.

Remarks
• The double-declining balance method computes depreciation at an accelerated rate.
Depreciation is highest in the first period and decreases in successive periods. DDB uses
the following formula to calculate depreciation for a period:
Min( (cost - total depreciation from prior periods) * (factor/life), (cost - salvage - total
depreciation from prior periods) )

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• Change factor if you do not want to use the double-declining balance method.

MIRR
Returns the modified internal rate of return for a series of periodic cash flows. MIRR considers
both the cost of the investment and the interest received on reinvestment of cash.
Syntax
MIRR(values,finance_rate,reinvest_rate)
Values is an array or a reference to cells that contain numbers. These numbers represent a
series of payments (negative values) and income (positive values) occurring at regular periods.
Values must contain at least one positive value and one negative value to calculate the
modified internal rate of return. Otherwise, MIRR returns the #DIV/0! error value.
If an array or reference argument contains text, logical values, or empty cells, those
values are ignored; however, cells with the value zero are included.
Finance_rate is the interest rate you pay on the money used in the cash flows.
Reinvest_rate is the interest rate you receive on the cash flows as you reinvest them.

INTERNAL RATE OF RETURN IRR

Returns the internal rate of return for a series of cash flows
Syntax
IRR(values,guess)

Values is an array or a reference to cells that contain numbers for which you want to calculate
the internal rate of return.

• Values must contain at least one positive value and one negative value to calculate the
internal rate of return.
• IRR uses the order of values to interpret the order of cash flows. Be sure to enter your
payment and income values in the sequence you want.
• If an array or reference argument contains text, logical values, or empty cells, those
values are ignored.

Guess is a number that you guess is close to the result of IRR.

• Microsoft Excel uses an iterative technique for calculating IRR. Starting with guess,
IRR cycles through the calculation until the result is accurate within 0.00001 percent.
If IRR can't find a result that works after 20 tries, the #NUM! error value is returned.
• In most cases you do not need to provide guess for the IRR calculation. If guess is
omitted, it is assumed to be 0.1 (10 percent).
• If IRR gives the #NUM! error value, or if the result is not close to what you expected,
try again with a different value for guess.

IRR-EXAMPLE
In the slide the Excel worksheet is shown.
In cell A97, the investment of 70,000 is entered with minus sign to denote negative
cash flow.
In cell A98 to A102, revenue per year (1 to 5) is entered.
=IRR(A97:A101) formula in cell A103, only years 1 to 4 were selected from the
revenue stream. The IRR is -2% in this case.
In the next formula in cell A105, the entire revenue stream was considered. The IRR
improved to 9%.
Next only first 2 years of revenue stream were considered with an initial guess of -
10%. The result was -44%.

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