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Business Activities

Investing. Financing. Planning. Operating. Business Activities. Financing Activities. Why do we need this activity? Two main sources of business financing: equity investors(owners,shareholders) and creditors(lenders). Cash. Financial Institution. Surplus Spending unit.

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Business Activities

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  1. Investing Financing Planning Operating Business Activities

  2. Financing Activities • Why do we need this activity? • Two main sources of business financing: equity investors(owners,shareholders) and creditors(lenders).

  3. Cash Financial Institution Surplus Spending unit Deficit Spending unit Financial instruments Government Financial Structures

  4. The Players • Firms - net borrowers(deficit spending unit) • Households - net savers(surplus spending unit) • Govt.– regulator, borrower, investor • Financial intermediaries • Banks, insurance companies, credit unions, etc. • Connect borrowers and lenders as brokers or as dealers • Are they needed? Why do they exist?

  5. The Players (continued) • Investment companies • Pool and manage money of many investors • Mutual funds, pension funds, etc. • Why can’t individuals do just as well (or can they)? • Investment bankers • Specialize in sale of new securities • Do firms need them? Can’t they issue securities on their own?

  6. Investment and Financial Assets • Categories of Assets • Real assets determine the productive capacity of the economy • tangible assets and intangible assets • Financial assets are simply claims on real assets or the income generated by them • Success or failure of financial assets ultimately relies on real assets.

  7. Trends • Globalization: international and global markets continue developing • Securitization: Brady bonds, MBS, REITs • Credit enhancement • Financial engineering: repackaging services/products of financial intermediaries • Bundling & unbundling

  8. Cash Flow Diagram Deterministic Cash flow assumed

  9. Revenue vs Profit ?

  10. Example: Different Points of View Consider the 10-year, 6% annual interest bank loan example…

  11. Important Concepts for Cash Flow Analysis • Opportunity cost • Time Value of Money • Discounting rate vs interest rate • MARR(Minimum Attractive Rate of Return): opportunity cost of capital

  12. Review Section Financial statements

  13. 회계원칙 • 수익의 원칙: 현금주의가 아닌 발생주의 • 비용의 원칙: 수익비용대응의 원칙 • 회계기간의 원칙 • 화폐측정의 원칙

  14. 5년동안 1000만원을 받는 프로젝트를 수주했다. 돈을 만약 지금 모두 받았다면 이것을 모두 당기의 이익으로 할 것인가? • 현금주의: 모두 당기이익으로 하는 것 • 발생주의: 5년 동안에 나누어서(회계기간의 원칙) 하는 계상하는 것, 즉 매년 200만원씩만 이익으로 치는 것 • 수익대비비용의 원칙: 주는 입장에서도 1000만원을 한꺼번에 비용으로 계상하는 것이 아니라 나누어 계상하는 것 • 화폐측정의 원칙: 만일 어떤 서비스를 하긴 했는데, 화폐로의 가치를 합리적으로 하지 못한다면 이는 수익이나 비용으로 계상할 수 없다. 그것이 합리적으로 쌍방이 용인될 때 계상하게 된다.

  15. Value of Money • Quantity • Time • Risk • Equivalence = f(Quantity,Time,Risk) Discounting rate

  16. Equivalence • Two cash flow sequences are said to be equivalent at a given interest rate, if and only if, they have the same worth at that interest rate. • The worths must be calculated for the same time (the present is most often used, but any point in time may be used) • Equivalence depends on a given interest rate (the cash flows will not be equivalent at a different interest rate). • The equivalence of cash flows doesn’t necessarily mean that we are indifferent to them. There may be other reasons for us to prefer one cash flow over another.

  17. Example: Equivalence What is the present worth of a $3,000 payment that you will receive in 5 years, if you can invest your money at 8% compounded annually?

  18. Nominal and Effective interest rates • The nominal interest rate (or APR – Annual Percentage Rate) is the annual rate that is often quoted, as follows: This loan is at an interest rate of 12% per year, compounded monthly. • Notice that this is not the period interest rate. • The effective interest rate is the annual rate calculated using the period rate derived from the nominal rate.

  19. Let r = nominal interest rate (APR) per year (this is always per year) M = number of compounding periods in a year i = effective interest rate per year (again, always per year) Then the period rate(effective interest rate per period)is r / M the effective annual rateis (1 + i) = (1 + r/M)M or i = (1 + r/M)M – 1

  20. Example: Credit cards For many years, credit cards typically charged 18% on outstanding charges. i = (1 + 0.18/12)12 – 1 i = 0.1926 or 19.26%

  21. Example: effective rate If the effective yearly rate is quoted at 12% with interest compounded monthly, what is the effective monthly rate?

  22. Inflation • A decrease in the value of the dollar (or other monetary unit); or • equivalently, the increase in the general level of prices of purchased items. • Inflation is interesting to us because it leads to “distortions” that influence behaviour, costs and decisions.

  23. Nominal vs. Real interest rate • Nominal interest rate = u (growth of money) • Inflation rate : f (growth of CPI) • Real interest rate: r (growth of purchasing power) Called Fisher equation

  24. Inflation rate is a effective rate Because inflation is measured as the percentage rise in a market basket of goods and service at the end of the year, it is an effective annual rate. Must be a effective annual rates

  25. Example: nominal and effective rates related to inflation Jaehyun invests in a savings and loan association that guarantees a nominal 12% return, compounded monthly. Inflation is projected at 6% annually. What is their true(deflated) rate of return on this use of their money? Effective annual monthly rate: 1% u : effective annual rate

  26. Present Worth Analysis • Present Worth (PW) is the equivalent value at time 0 (the present) of a set of cash flows. • PW is often preferred to other possible measures* of a “project’s worth” because it is usually relatively easy to use, and it is intuitively meaningful. * Some of the other measures we’ll be looking at: EAW - Equivalent Annual Worth IRR - Internal Rate of Return B/C – Benefit/Cost Ratio

  27. Example: Valuing an Investment Opportunity A condo unit can be rented for $12,000 per year, net of taxes and expenses. It can be resold in 5 years for $200,000. The investor requires 10% per annum on her investment. What is the maximum amount that she should be willing to pay for this condo unit? PW (receipts) = 12,000 (P/A, 0.10, 5) + 200,000 (P/F, 0.10, 5) = 12,000 ( 3.791) + 200,000 ( 0.6209) = $169,672

  28. When to Use Present Worth 1. When setting a price to buy or sell an economic alternative (Pricing or Valuation, PW) 2. When evaluating an economic alternative (deciding whether it’s good or bad) for which the price is known (Evaluation, NPW) 3. When calculating an equivalent value for a cash flow sequence (PW).

  29. Present Worth Measure • 단일 대안의 선택시 Is PW > 0 ? The standard for a desirable project is PW > 0 PW = 0 à economic indifference PW < 0 à try to avoid the project • 여러 대안중에서 선택할 때는?

  30. Shortcomings of PW measure • Investment scale problem • Different time horizon? • Liquidity problem: 회수되는 기간이 길 경우에 발생payback period measure

  31. Investment scale problem Discounting rate: 8% Which alternative is preferred?  수익율의 개념이 필요!

  32. 30 20 Example: Different Time Horizon MARR=12% A1 100 NPV(A1)=-100+30(P/A,12,20)=124.082 EAW(A1)=-100(A/P,12,20)+30=16.61 34 A2 40 150 NPV(A2)=-150+34(P/A,12,40)=130.29 EAW(A2)=-150 (A/P,12,40)+34=15.80

  33. Different time horizon 문제의 해결 • LCM(least common multiplier)법 • Equivalent Annual Worth measure • Time horizon이 짧은 대안에 대해 MARR(?)로 재투자 • Time horizon이 짧은 대안의 끝으로 CF를 조정해 주는 방법

  34. 30 20 LCM(least common multiplier)법 MARR=12% 30 A1 40 100 100 NPV(A1)=124.082+124.082(P/F,12,20)=136.95 34 A2 40 NPV(A2)=130.29 150 반복해서 투자할 수 있다는 가정이 타당한가?

  35. 30 30 20 20 100 Equivalent Annual Worth 이용 • 기본적으로 LCM방법에 기초한 것임. EAW방법을 사용할 경우 계산적인 우위를 갖을 수 있음. WHY? 16.61 20 EAW(A1)=-100(A/P,12,20)+30=16.61 30 20 100 100

  36. MARR로 재투자 30 A1 40 100 20 긴 horizon에 맞추기 FW(A1)=NPV(A1)*(F/P,12,20)=124.082*9.6463=1196.93 이 값을 40년 후의 값으로 다시 바꾸면…. 1196.93(F/P,12,20)=11546 34 A2 40 150 FW(A2)=NPV(A2)*(F/P,12,40)=130.29*93.0510=12123.61

  37. 30 20 짧은 horizon에 맞추기 A1 100 30 A2 40 150 Salvage value를 예상하여야 한다.

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