Lecture 3 and 4

Time value of money and risk and return

The future value concept
Future value is an amount to which an investment will grow after earning interest
for a determined time period.

Simple interest is an interest earned only on the original investment. No interest is

earned on interest.

For example, you have $100 invested in bank account. Supposed banks are now
paying an interest rate of 6% per a year on deposits, so after a year, you’re a
account will earn interest of $6 that is calculated as follows:

Interest= interest rate x initial investment=(0.06 *$100)= $6

You start the year with $100 and you earned interest of $6, so the value of your
investment will grow to $106 by the end of the year.

Value of the investment after 1 year=$100+$6=$106. Notice that the $100

invested grows by the factor (1+ 0.06) =1.06.

In general, for any interest rate r, the value of the investment at the end of 1 year is
given by (1+r) times the initial investment. So value after 1 year =initial
investment x (1+r) =$100 x (1.06) = $106

Compound Interest Is an interest earned on interest. Supposed you leave this

money in the bank for second year, your balance now $106 will continue to earn
interest of 6%. So interest in year 2=0.06 x$106=$6.36. You start the second year
with $106 on which you earn interest of $6.36. So, by the end of the year, the value
of your account will grow to $106+$6.36=$112.36.

Thus, in first year your investment of $100 increases by a factor of 1.06 to $106, in
the second year, the $106 again increases by a factor of 1.06 $112.36. Thus the
initial $100 invested grows twice by a factor of 1.06. Value in your account after 2
years=$100 x1.06 x1.06=$100(1.06)2 =$112.36.
If you keep your money invested for a third year, your investment multiplies by
1.06 each year for three years, by the end of the third year, it will total $100 x
(1.06)3 =$119.10 scarcely enough to put you in the millionaire class but even
millionaire have to start somewhere .

In general for an investment horizon of t years, the original $100 investment will
grow to $100 x (1.06) for an interest rate of r which is given by $100(1+r) t.

Notice: In our example that your interest income in the second year is higher than
in the first year because you earn interest on the interest. This is called Compound
interest

The present Value concept

Money can be invested to earn interest. If you are offered choice $100, 000 now
and $100,000 at the end of the year, you naturally take the money now to get a year
interest. Financial mangers make the same point when they say that money in hand
today has a time value or when they quote perhaps the most basic financial
principle.

Example Saving to buy a new computer

Suppose you earn $3000 next year to buy a new computer, the interest rate is 8%
per a year, how much money should you set aside to pay for the purchase of a
computer ?e of a $3000 payment at the end of

Just calculate the present value at an 8% interest rate$3000 payment at the end of
the year. This value is

Pv=fv(1+r)t or Pv=fv x 1/(1+r)t

Fv=$3000 r=8% t=1

Pv=3000/(1.08)1=$2.778 or

Pv=3000 x 1/(1.08)1=2.778

Finding the interest rate

When we look at the Coca-Cola company example, we used the interest rate to
compute a fair market price. Some time you are given the price and have to
compute the interest rate that is being offered for example, Coca-Cola borrowed
money by offering to sell commodity by $129 which still yield $1000 after 25
years to companies. What is the interest rate?

Fv = Pv x (1+r) 25 = $128 x(1+r)25=$1000

(1+r) 25 = $1000/$129

(1+r) 25 = 7.75

(1+r) = (7.75)1/25 =1.0853

= 1.0853-1

r =.0853 or 8.53

Risks and Return

Return on Investment (ROI)

A calculation of the monetary value of an investment versus it cost. The ROI

formula = (profit-cost/cost). If you made $10,000 from a $1000 if fort, your return
on investment would be 0.9 or 90%, this can also be usually obtained through an
investment calculator. ROI can be useful to assess the potential profitability of a
particular investment, your marketing campaign for marketing accountability or
when developing business plan to start your business. Return on ad spend(ROAS)
is a similar metrics but it focuses more on specific tactics such as an individual ad
campaign to grow your business.

There are many different metrics businesses used to evaluate profitability and
financial health. Whether when investing capital or implementing a marketing
strategy such as PRC campaign, is return on investment (ROI)

What is ROI?
In Business, your investments are the resources you put into improving your
company like times and money, the return is the profit you make as a results of
your investment.

ROI is most useful to your business goals when it refers to something concrete and
measurable, to identifies your invest gains and financial return. Analyzing
investment in term of monetary cost is the most popular methods because it is
easier to quantify, although it also possible to ROI using time as an investment.

The ROI metric and ROI figure is also applied across different types of investment
and industries return on equity. Return on ad spend, return on assets, urn on social
return on investment

Examples of investment

The term investment is often used to refer to buying stocks in a company or

financing another person business venture investment you make in your own
business are distinct from these but have a similar purpose to increase your profit.

Depending on your history, the types of investment you make can look very
different. They don’t always have to be tangible, like an initial investment in new
investment or higher equality material.

An online store owner or app developer for example might make investment in
more digital goods like cloud base storages services or subscription to a new
content management software that might have maintaining cost for which it would
be desirable to identify the return of investment or ROI.

Other examples of common business investments include ad campaign and

leases for bricks and mortar retails locations.
How to calculate ROI
ROI calculation is the net profit during certain time divided by the cost
of investment, which is then multiplied by 100 to express the ration into
percentage. The equation looks like this:
ROI = (net profit/investment) x 100
The value of net profit should be taken from your profit and loss (P&L)
statement.
Calculation of ROI in practices
Here are some examples of what calculating an ROI might looks likes in a business

Scenario: Samantha’s e- commerce business

Sites that sell cats themed mercindises.it is right around the holiday season and she
want to increase awareness and sales also she decided to invest in some social
media abs. she spend a total of $1000 for ads across social media channels to
attracts holidays shoppers to her sites. Once

the holiday come to an end, Samantha calculate her net profit and learn here
commerce store has earn $5000 more than it did during the same periods last year.
She can then calculate ROI of the ads as

ROI = $5000/$1000) X 100= 500%

This means that for every dollar Samantha spent on the ads, she got back $5 in net
profit. Encouraged by this strong ROI, she can begin to budget for an increased
spent for the next holiday season.

Scenario 2 Mario Pizzeria

Mario owned a Pizzeria on a side street in New York City. His notice
businesses are slow and start brainstorm ways he can improves his
business. Guessing that the quality of his pizza might not be meeting
customers’ expectations. Mario decided to swap out his outdated pizza
oven for a cutting edge replacement.
The new pizza oven cost $500. By the end of the year, his pizzeria ends
up earning $200 more than it had the year before. Given that the new
pizza oven was the only typical investment for that year can be
calculated as follows:
ROI = ($2000/$500) x 100 =400%
Why is ROI important?
1. It is used by the business and individuals as an indicator to
profitability
2. The ability to calculate ROI is extremely valuable for any business
regardless of its sizes or industry
3. After all , knowing if you are getting your money worth is a basic
concept that both individuals and businesses need to understand in
order to strengthen their business
4. By calculating ROI, you can better understand how your business
is doing and which area would use improvement to help you
achieve your goals.
Challenges to determine ROI

1. Communication, first there is a distinct lack of communications between

learning leaders and other leaders within the organization
2. Knowledge , even if that organization is there, training teams are then
stymied by the “ how”
3. The answer, these obstacles aren’t impossible to overcome
4. Lack of qualitative information
5. Lack of integrated tools

Factors that determining ROI

1. Financial profit
2. Sale revenue
3. Brand a awareness
4. Educational impacts
5. Engagement
 5 Factors to Consider When Measuring ROI

Within any industry, ROI is an important factor when determining the success of
your business. Many fail to realize however that ROI is more than just monetary.

It’s understandable to be wary of shelling out money when you’re unaware of the
potential return you’ll receive but there are many more factors to consider when
measuring ROI!

We’ve put together these 5 factors to consider when measuring the ROI of an event
so that you are best equipped to organize your strategy and successfully grow your
business.

1. Financial Profit

The most common reason you may want to measure ROI is to determine the profit
you’ve made. In this case, you need to go after numeric indicators and make a total
evaluation of the money you’ve earned. The total revenue refers to the money you
received after an event. The real profit, on the other hand, is the actual earnings
that go into your pocket (or into your company’s pocket) after extracting all the
investments you made to execute your services.

2. Sales Revenue

Another aspect you may be interested in is finding out how your sales pipeline
grew after an event. This can be done by evaluating the number of closed sales. By
focusing on this measurement concept, you’ll be able to understand the effect your
marketing had on the event. On the other hand, you’ll be able to use these
measurements to find ways to ensure a future event has a greater sales result.

3. Brand Awareness

While likes, retweets, and RSVP’s don’t necessarily add profit to your business, it
does help bring brand awareness and greater brand reputation. Aside from the
online interactions, clients may use word-of-mouth to recommend your services to
their friends, family, and colleagues who could benefit from attending or possibly
partnering up with your company and vendors.
 4. Educational Impact

With some events, the focus is transmitting an idea or in education professionals

about potential challenges they may encounter and ways you can help overcome
them. In this case, when you measure event ROI, focus on the number of leads you
attracted and the community growth percentage. This will give you a clear idea
about the informational impact your event had on your attendees.

5. Engagement

Similar to brand awareness, engagement is a powerful way to measure ROI. By

encouraging your guests to participate in activities you’ve set up such as live polls
or quizzes. The participation results you collect after the event will give you a clear
idea about the attendee engagement and give you a better understanding of what
they are interested in and what they aren’t.

As you can see, there are multiple ways to measure ROI. From evaluating the
social media engagement to calculating the real profit, you can always assess your
company’s impact and success. However, it’s important to remember that
analyzing event outcomes involves a well-defined strategy. That’s why, before
initiating the ROI evaluating process, always ask yourself what your intentions are
and what you want to do next with the insights you’

How to increase your ROI

9. Easy-to-Implement Tips to Improve Your ROI

Our new year has presented a unique series of challenges, but your business must
adapt quickly and move on with things to survive.

One thing that hasn’t changed is that business owners are always looking for ways
to increase their ROI. This makes sense. There’s only a finite number of resources,
so you want to make sure that all your financial and time investments are paying
off with increased revenue.

The closer you pay attention to the details on how you spend your money and time,
the better results you will achieve.
So let’s look at how to improve your return on investment. Use some of these
strategies to increase your ROI, which means higher profitability for your
company.

1.Analyze your sales data

Someone needs to be paying attention to the trends and metrics of your company’s
sales activities. Before you can do this, you must figure out what kind of data you
should be tracking and the tools you should be using to collect it.

This may require the help of a professional. If you are a small business owner, you
may be too close to the situation to see the big picture.

2.Talk with your sales team

Besides collecting and analyzing data, talk with your sales team. They are the ones
in the trenches, and they may be able to give you insights that you never
considered. Remember, your sales team is motivated by sales since they need to
meet their quotas. They want to increase your ROI as much, or even more than
your company’s leadership.

Ask your top salespeople to share their strategies. Find out why those particular
people are succeeding in finding new prospects and closing the sales.

Struggling salespeople should receive guidance from sales managers on how to

improve their sales pipeline.

3.Streamline the sales process

If you are a small business venture and you don’t have a team of salespeople,
analyze your sales process to see what changes may be necessary.

For example, whether you are a brick and mortar store or an online venture,
evaluate your checkout process. Do you lose customers because of long lines? Do
customers leave because of being ignored?
Do people click away from online carts because they are forced to register at the
beginning of the sales process? Do you ask too much information from your
customers? Is your website difficult to navigate? Is your website slow?

3.Analyze your online content

Every savvy business strategist knows the importance of creating and publishing
online content to bring people to your website. It may feel like a waste of time,
especially if you don’t receive much feedback or shares. Hopefully, one thing that
will happen for your trouble is that you will be increasing your Google ranking,
and we all know how important that is.

You are already creating online content for your business’ website, but to increase
the ROI from it, you need to learn how to repurpose it. For example, you have an
idea that you want to share with your customers. You write a long blog post about
it, and you post it on your website. You include internal and highly-valued external
links

Don’t stop at that. Create an infographic, photo essay, or meme with that same
information that is easily shared. Create a series of easy-digestible snippets from
the longer content and post them on your company’s social media platforms.

Learn how to track your progress. Find out which keywords receive the most
traffic. Analyze which articles are driving the newest leads. This may require the
help of a content specialist, but if your Google ranking improves as a result of this
expenditure, that is an excellent return on investment.

4. Limit the number of contractors and vendors

When you searched for suppliers when you opened your business, you were
probably looking for companies that would provide the best product for the lowest
price. While this business strategy made sense then, does it make sense now?

5. Increase Your ROI

How much time is spent interacting with a multitude of contractors and vendors?
Would you increase profitability by limiting the number of companies that you
interact with on a given day? Ask your current suppliers if they would give you a
discount if you purchased more products from them.
It’s always an excellent strategy to shop around periodically to see if you are
getting the best deals that you can. This is true in your personal finances as well as
your company’s finances.

6. Pay attention to your social media presence

We know we already discussed the importance of offering new, unique, and

helpful content on your company’s website, but do you have someone dedicated to
examining your company’s social media presence?

Is your Google Business page accurate and helpful for customers? Do you have a
presence on all social media websites? If so, is there a reason for this?

Do you allow customers to connect with you via social media? If so, how quickly
do you respond to those customers?

Finally, how do you respond to online reviews? Do you ignore them and hope they
will go away, or do you reach out to dissatisfy customers to learn how you can
improve your product or service?

7. Pay attention to your company’s culture

Happy employees work harder. They are more loyal, and they tell others about it.
Harder working employees result in an improved return on investments.

Think about the expense of finding, onboarding, and training a new employee. You
might not have needed to go through the cost and time to find a new employee if
you had used those resources to treat your previous employee well. A high ROI
isn’t the only reason you should focus on the happiness of your employees. It’s
also the right thing to do.

8. The Bottom Line

Maximizing your return on investment is more than just the latest buzz word. It
should be an integral part of your business’s daily strategy.
 Understanding the Risk-Return tradeoff and how it can help you
invest wisely
Rahul had been pleading with his father for over a month to revise his pocket
money. Finally, his father decided to use this as an opportunity to teach him an
important investing lesson. He called Rahul and told him that he was ready to
reconsider his pocket money. He gave him 2 options to choose from:

Option A: I will increase your pocket money by 20% if you score above 90% in
your upcoming exams. However, if you score below 90%, you pocket money will
be reduced by 15%.

Option B: Your pocket money will be increased by 5% effective immediately and

will not depend on how you score in your exams.

While it took some time for Rahul to figure out which option was suitable for him,
he did learn an important investing lesson that day – there is always a risk-return
tradeoff in investments. Higher the expected returns (note the word expected) form
an investment option, the higher are the risks associated with it (more like Option
A in this case). While investment options with lower risks will also have lower
expected returns.

But what exactly is Risk?

Investments generally entail different types of risk driven by various factors (read
What are the various types of risk associated with my investment). However, all of
it boils down to one simple definition of risk – the chance that the actual return on
your investment will vary from the expected return.

For example, say you purchase mutual fund units worth Rs 10,000 today and plan
to withdraw your money in 3 years. Historically, mutual fund units have yielded
12% annual return and hence you expect your investment to grow to approx. Rs
14,050 in 3 years’ time.

Your risk here is the chance that your units will be worth less than Rs 14,050
(downside risk) in 3 years from today or the chance that your units will be worth
more (Yes! Even this is called a risk – upside ris Concept of Risk-Return in
Portfolio Context (With Formula
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So far our analysis of risk-return was confined to single assets held in isolation. In
real world, we rarely find investors putting their entire wealth into single asset or
investment. Instead they build portfolio of investments and hence risk-return
analysis is extended in context of portfolio.

A portfolio is composed of two or more securities. Each portfolio has risk-return

characteristics of its own. A portfolio comprising securities that yield a maximum
return for given level of risk or minimum risk for given level of return is termed as
‘efficient portfolio’. In their Endeavour to strike a golden mean between risk and
return the traditional portfolio managers diversified funds over securities of large
number of companies of different industry groups.

However, this was done on intuitive basis with no knowledge of the magnitude of
risk reduction gained. Since the 1950s, however, a systematic body of knowledge
has been built up which quantifies the expected return and riskiness of the
portfolio. These studies have collectively come to be known as ‘portfolio theory’.

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A portfolio theory provides a normative approach to investors to make decisions to

invest their wealth in assets or securities under risk. The theory is based on the
assumption that investors are risk averse. Portfolio theory originally developed by
Harry Markowitz states that portfolio risk, unlike portfolio return, is more than a
simple aggregation of the risk, unlike portfolio return, is more than a simple
aggregation of the risks of individual assets.

This is dependent upon the interplay between the returns on assets comprising the
portfolio. Another assumption of the portfolio theory is that the returns of assets
are normally distributed which means that the mean (expected value) and variance
analysis is the foundation of the portfolio.

i. Portfolio Return:
The expected return of a portfolio represents weighted average of the expected
returns on the securities comprising that portfolio with weights being the
proportion of total funds invested in each security (the total of weights must be
100).

ii. Portfolio Risk:

Unlike the expected return on a portfolio which is simply the weighted average of
the expected returns on the individual assets in the portfolio, the portfolio risk, σp
is not the simple, weighted average of the standard deviations of the individual
assets in the portfolios.

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It is for this fact that consideration of a weighted average of individual security

deviations amounts to ignoring the relationship, or covariance that exists between
the returns on securities. In fact, the overall risk of the portfolio includes the
interactive risk of asset in relation to the others, measured by the covariance of
returns. Covariance is a statistical measure of the degree to which two variables
(securities’ returns) move together. Thus, covariance depends on the correlation
between returns on the securities in the portfolio.

The End!

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