Lecture_Week_02_3slides

# Lecture_Week_02_3slides - FINS1613 Business Finance...

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7/25/2011 1 Australian School of Business FINS1613 Business Finance Lecturer: Anh Tu Le FINS1613 – Semester 2, 2011 2 Lectures so far…Week 1 b Business finance decisions: s The Investment Decision s The Financing Decision s The Dividend Decision b Firm’s objective = Maximise firm value How do we measure value? Lecture 2: Introduction to Financial Mathematics Lecturer: Anh Tu Le Readings: RTBWJ Chapters 4 & 5

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7/25/2011 2 FINS1613 – Semester 2, 2011 4 Lecture 2: Learning Objectives b Recognise how to measure value b Distinguish between different types of cash flows b Calculate future and present values for different types of cash flows b Understand and solve problems involving simple and compound interest, including compounding, discounting and making comparisons using the effective interest rate FINS1613 – Semester 2, 2011 5 Measuring Value b What you need to know: s Cash flow amount b Inflows b Outflows s Timing of Cash flow s Riskiness of Cash flow b Interest rate FINS1613 – Semester 2, 2011 6 Basic Tool: Time Lines b Time 0 is today, Time 1 is one period from today or the end of the first period (year, month, etc), or the beginning of the second period, and so on. 0 1 2 3 4 5 Today End of period 1, start of Period 2 Time
7/25/2011 3 FINS1613 – Semester 2, 2011 7 Basic Tool: Time Lines (cont.) b Information on a time line is usually written as: s Cash flows are written immediately below the tick marks. s Unknown cash flows are denoted with a question mark. s Interest rates are written above the line and between the tick marks. FINS1613 – Semester 2, 2011 8 Basic Tool: Time Lines (cont. .) b Assume a cash outflow of \$100 at time 0 (hence the minus sign), an interest rate of 10% and an unknown cash flow at Time 3 b The information would appear on the timeline as: 0 1 2 3 -100 ? Time Cash flows 10% FINS1613 – Semester 2, 2011 9 Basic Tool: Time Lines (cont. .) b If interest rates alter, the new interest rate is shown above the time line. Here the interest rate changes from 5% in Period 1 to 10% in the second period Time 0 5% 3 2 1 Cash flows -100 ? 10%

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7/25/2011 4 FINS1613 – Semester 2, 2011 10 Time Value of Money: Concept b A dollar received today is worth more than a dollar received in the future. s Why? s If you invest the dollar you receive today, it would generate a return so you would have more than a dollar in the future. FINS1613 – Semester 2, 2011 11 Time Value of Money: Example b You have been given \$100 today and you decide to deposit it in a savings account offering a yearly rate of 10%. b How much will you have in 1 year s time? s \$100 + (100*10%) = \$110 b So \$100 today is worth \$110 in a year s time. FINS1613 – Semester 2, 2011 12 Time Value of Money : Definitions b Present Value ( PV ) s The amount you have today, or earlier money on a time line = \$100 b Future Value ( FV ) s The amount you will have in the future, or later money on a time line = \$110 b Interest rate ( r ) s The rate amount the bank pays on money invested each
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