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1.financial management
- 1. Financial Management An Introduction Lecture >>> 01 Parus Khuwaja, Lecturer, IBA, UOS
- 2. Approach To Teaching – Theory followed by practice – Maximize understanding not memorizing – Interactive class
- 8. What will the goal of this class? – Financial principles as it affects firm value.
- 19. Measuring Value: The Time Value Of Money Lecture 2A
Editor's Notes
- What do you think of finance? May be you import a car and specially a new car? How did you pay for it? You might answer I financed it…. Basically the finance means is to raise money. When you buy the car you borrowed money to buy the car… and financing means to raise money…
- In the same context what are the two major decisions that a company makes? You may essentially think the left side and right side of balance sheet… Left side which I refer to it is asset investment decision ( you will find in your book as CB decision) becz at what the company is spending money on? Example>>>>what if a company buys land? Would that be an asset investment decision? It would. Cause company is investing money on. What about apple investing in the iphone? They have to hire scientist, invest in R&D an infrastructure and so on…. It is What about hiring a CEO? Would that be an asset investment decision? You will say NO you cannot put Steve job on balance sheet… ye its right from accounting perspective But from finance perspective what we care about is at what you are spending money on will create value
- Now what the another big picture decision you see? Basically the right hand side
- What you think which decision is more important? Both or any one of them?
- I my view I think asset investment decision is more important. Because its your business plan--- you might have best capital structure but if your business plan is not good or bad then you may go for bankrupt. What will be the goal of this class?
- That will be my light house means every single topic has to relate to firm value and I will justify why it relates to firm value? Example>>>> what is the really useful tool to have to create a Jigsaw puzzle? Its picture of the puzzle… actually I want to tell that every topic will create be like a piece of puzzle and at the end we get value.
- So here is the road map.. For the theory part of asset investment decision This is the logic that why I go in this pattern?
- The very first topic….. Oh my look at the time>>>>>> the time value of money The question backed from why we have a model to measure value? Becz of our class goal… the finance principles as it affects firm value Does it is necessary to measure value? Ye if we want to manage then we definitely have to manage value… Example… if you want to go for diet what instrument do u really need? The scale…. Which will tell you whether u are loosing weight or gaining weight… Its very much logical to start with measuring inorder to measure the impact on our decision. Obviously we get into detail this is our first topic.
- While it turs our cash flows and discount rate.
- We will discuss it in detail meanwhile the reason for showing this problem at this stage to make you know that discount rate and cash flows are two main things to measure value. Let me ask one thing what will can be the other names of discount rate?.... Means if I hold coffee in one hand and water in other hand what they are? They both are liquid. Similarly discount rate is liquid and it has various types..
- In this class we use the letter r for discount rate with subscript which refer the appropriate word for which we are using
- A bottom line analysis with an asset investment decision is NPV even +NPV
- Define this slide by your self
- The right hand side of the balance sheet Now we say why the debt have worth 400 and why the equity has worth 600? What will be the discount rate for financial securities?its very much important to determine becz
- Do you remember the goal of this class? Financial principles as it affects firm value…. If you ae going to manage value you have to measure value. I can see you are really a very nice person I wanna give you thousand $$$??? Would it be happy face or sad face? Happy face but its not enough to just talk about.. We have to define when?
- Basically move that $ amount into different time periods.. Things in the bottom represents time period On the top is $ amount 1 year from today…. I will get $10 What this time value of money diagram will do? Will move this $10 on time value of money diagram…. What will be the worth at period 3? This is what we do in single cashflow formula.. What is effective period rate? The interest which your $ earn after one period?
- So I made 5 cents of the $ and so its communicated on % basis it would be 5% effective 6 month rate. Nominal interest rate?
- (1+0.1) (1+0.1)(1+0.1) or (1+0.1)^2
- This 12% is effective rate? Or its annual or advertised ate? What is the only first step which I can take? Divide 12 by 4 Once I divided it what that 3% mean? Effective quarterly rate
- This is basically a fv problem How long does the period? Its quarter n two periods
- What can be the only first step? Divide 12% by 4
- I will draw a cashflow timeline diagram What aout my periods have to be? When did some kind of action happened with cashflows? Primary thing is that iam getting the stuff in months. If I draw a cashflow diagram…and I called 0 today then 10,000 would be showup in 6 months…. The question is if it is time period today then what is its worth in 3 months? And what its worth in one year from today? So what kind of rate do we need? The effective monthly rate and the question says the 12% compounded monthly>>>> what the only first thing you do with 12%? Is it already an effective rate? NO its an APR Divided by 12 12%/12 = 1%
- Lets start with discussing>>>> what is the value of 10,000 at time 12 ?>>> what is my fv? What is my pv? Its 10,000? What is my r? its monthly so its better to work with effective monthly rate…>>>what would be my t?>>> how many periods iam moving this 10,000? 6 it would be my t.
- Now the question is what is the worth of 10,000 in 3m? Now we gonna bring back in time.
- Log is nothing its just a mathematical function. Which convert power into multiplication Natural logarithms are different than common logarithms. While the base of a common logarithm is 10, the base of a natural logarithm is the special number e. Although this looks like a variable, it represents a fixed irrational number approximately equal to 2.718281828459.
- Whats the first step you will do? I will draw a cashflow diagram? What about the time period? Its semi-annual every 6 months What should be the future value?...>>> the triple of 100 $ that would be 300 What kind of rate should we use?>>> the effective six months rate>>> 12%/2= 6%
- Does it takes 19 periods to triple? No 19 periods… how long does it one period? 6 months So how many years is that? 18.85/2=9.5