Maximina St., Villa Arca Subd.

Project 8, Quezon City

Written Report in Business Finance

Group 5 Basic Long-Term Financial Concepts

Submitted by:
** BARRERA, Ma. Melissa
* TAGAYUNA, Jerwin
FERNANDEZ, Georgie
ROSEOS, Miekhaella

Submitted to:

Mr.KJ MARQUEZ
Learning Competencies:

1. Calculate Future Value of Money

2. Calculate Present Value of Money
3. Compute for the effective annual interest rate
4. Make a short assessment regarding Future and Present Value of Money
5. Compute Loan amortization using mathematical concepts
6. Compute Loan amortization using the present value tables
7. Apply mathematical concepts and tools in computing for finance problems
8. Apply mathematical concepts and tools in computing for investment problems
9. Explain the Risk-return trade-off
10. Short Assesment Regarding the Basic Long-term Financial Concepts

COMPOUND INTEREST

Is simply earning interest on interest. This means that the basis for the computation of the
applicable interest of a certain period is not only the original price/principal but also any
interested earned in the previous period assuming all cash flows would be paid or received
in lump sum upon maturity.

FUTURE VALUE OF MONEY

The value of money of a current asset at a specified date in the future based on an
assumed rate of growth over time.
PRESENT VALUE OF MONEY

The current worth of a future sum of money or stream of cash flows given a specified
rate of return.

TIME VALUE OF MONEY

Describes the greater benefit of receiving money now rather than later

THE CONCEPT OF INTEREST

The most basic finance-revealed formula is the computation of interest. It is computed

as Follows:

I= P x R x T

Where:

I= Interest

P= Principal

R= Interest Rate

T= Time Period

INTEREST

Is earned or incurred for the use of the principal amount over the relevant time period

SIMPLE INTEREST

Is a quick method of calculating the interest charge on a loan

MULTIPLE CASHFLOW

Let us say that you are contemplating on purchasing a new laptop computer which is
worth P70 000 if you the whole amount today. The computer store allows buyers to pay in
installment requiring the buyer to pay P25 000 annually at the end of each year for the next
three years. You regularly invest your savings in a time deposit account that provides an annual
return of 5%. You are now deciding whether to avail of the installments plan to plan or pay for
the whole amount today to aid you in your decision, you need to get the present value of the
multiple cash flows and compare it with the P70 000 cash price. Since the perspective taken is
that of the individual disbursing money, you need to choose the cheaper option (lower present
value)

Step 1:

Draw a timeline:

TIME= 0 1 2 3

25 000 25 000 25 000

Step 2 and 3:

Compute the individual resent value and get the sum.

Total Present Value = P25 000 + P25 000 + P25 000

(1+R)^T (1+R)^T (1+R)^T

= P25 000 + P25 000 + P25 000

(1+5%)^1 (1+5%)^1 (1+5%)^1

= P25 000 x PVIF (5%,1) + P25 000 x PVIF (5%,2) + P25 000 x PVIF
(5%,3)

= P25 000 x 0.9524 + P25 000 x 0.9070 + P25 000 x 0.8638

= P23 810 + P22 675 + P21 595

Total Present Value = P68 080

P60 000 is cheaper than the P70 000 cash price which means you should pay through
installment instead. Simply adding the three P25 000 Payments may lead you to think that the
P70 000 is cheaper but the more relevant figure should be the present values of these multiple
cash flow.
ANNUITIES

A series of equal cash flows-payments in this case, required for a specific number of
periods.

Present Value of an Annuity =

PRESENT VALUE INTEREST FACTOR

A present value interest factor for an ordinary annuity (PVIFA) table can also be
developed using the formula above. Simply find the intersection of the relevant time
period (T) presented in the rows of the table and the relevant interest rate presented in
the columns of the table.

Using our example, the PVIFA given 3 years and a rate of 5% is equal to 2.7232. this
is the intersection of time period =3 and interest rate =5% in the PVIFA table.

To get the present value of our example:

P68 000 = P25 000 x 2.7232

Our example is called an ordinary annuity since the cash flow is required at the end
of each year. If the cash flow happens at the start of the year, then it is called an
annuity due.

If the cash flow stream lasts forever or is indefinite, then it is called perpetuity. The
present value of a perpetuity is determined by simply dividing the equal cash flow
stream by the appropriate interest rate. Let us say, you expect to receive P25 000
annually (5% interest rate) in perpetuity then the present value is determined by:

Present Value of Perpetuity = Perpetuity_

R

P500 000 = P25 000__

5%
How to Compute the PRESENT VALUE OF INTEREST FACTOR FOR AN ORDINARY ANNUITY?

Where : C = Cash flow per period

r = Interest rate
n= Number of payments
Example: Your mother is expecting to get P18 000 every year at the end of the next 2 years
after investing in government securities that yield 6% annually.

PVA = P18,000 [1- (1+0.06)^-2] PVA = P18 000 (1.83)

.06 PVA= P33,001.07
PVA = P18,000 [0.11]
0.06

LOAN AMORTIZATION

A classic example of a business transaction that pays out an equal cash flow stream
regularly is an amortizing loan. Most housing and car loans are amortizing loans that require
the borrower to pay that equal amount either annually, semi annually, quarterly, or most of
the time, monthly.

EQUAL REGULAR PAYMENTS

Example
You plan to purchase a house worth P3 000 000. Assuming you incur 10-year loan
that equal to annual instalments with an interest of 10%. What is the annual
mortrage payment?

C = Present Value of Annuity C = P3 000 000___

PVIFA 6.144
C = P3 000 000___ C= P 488 236.57
PVIFA (10%,10)
EFFECTIVE ANNUAL INTEREST RATE

Interest rates are normally quoted as annual rates but the compounding frequency may
differ per transaction. This meams that if the annual rate is 12% but compounding is done
more frequently, for example every quarter, then the effective annual rate is higher than
12%. To determine the effective annual rate, the following formula is used:
Effective annual rate = (1 = R/M)^M-1
Where:
R= Annual Interest Rate
M=Frequency of Compounding

For example, credit card companies usually charge a monthly interest rate of 3.5%
(exclusive of other changes). The annual effective rate is not simply determined by
multiplying 3.5% by 12 months since this transaction assumes monthly compounding. To
get the annual rate, we compute the following:

Effective annual rate = (1 = R/M)^M-1

EAR = [1 + (3.5% x 12/12)]612-1

EAR = 51.11%

This means that if you purchase as P1 000 dress at the start of the year and did not pay for it
until one year, then uoi should pay P1 511 already exclusive of the other charges.

An annual rate of 12% will translate into the following effective annual rates:

Annual Compounding = [1 = (12%/1)]^1-1 = 12%

Semi-annual Compounding = [1 = (12%/2)]^2-1 = 12.36%

Quarterly Compounding = [1 = (12%/4)]^4-1 = 12.55%

Monthly Compounding = [1 = (12%/12)]^12-1 = 12.68%

BASIC APPLICATION OF THE TIME VALUE OF MONEY ON INVESTMENT PROBLEMS

One very useful application of the time value of money is when the net present value
method is used to determine whether a project should be accepted or rejected by a
company. The best decision rule is to accept the project if the net present value is positive
and reject if the net present value is negative. This capital budgeting technique is applied
 by determining first all the relevant cash flows, positive and negative. As a project then
calculating the present values of these cash flow using appropriate discount rate (given the
riskiness of the project).
For example, a project requires an initial outlay of P100 000. The relevant inflows
associated with the project are P60 000 in year one and P50 000 in years two and three.
The appropriate discount rate for this project is 11%. To compute the net present value.

Net Present Value = -P100 000 + P60 000 + P50 000 + P50 000
(1 + R)^t (1 + R)^t+1 (1 + R)^t+2

Net Present Value = -P100 000 + P60 000 + P50 000 + P50 000
(1 + 11%)^t (1 + 11)^t+1 (1 + 11)^t+2

Net Present Value = -P100 000 + P60 000 x PVIF(11%,1) + P50 000 x PVIF(11%,2) +
P50 000 x PVIF(11%,3)

Net Present Value = -P100 000 + P54 054.05 + P40 581.12 +P36 560.40

Net Present Value = P31 195.57