ECO218: PRINCIPLES OF FINANCE
Course Introduction
ECO218: PRINCIPLES OF FINANCE
Course Introduction
• Firms are required to keep detailed financial
records so that organized reports can be
distributed to managers, shareholders, and
government regulators.
• Principles of Finance focus on what these
managers, investors, and government
agencies do with this information. It ca also
be label as "corporate finance" or "financial
management".
ECO218: PRINCIPLES OF FINANCE
Course Introduction
• Finance is a broad term; you will
find that both managers that
compile the financial reports and
stockbrokers working on the
Stock Exchange Markets will
claim that they work in finance.
ECO218: PRINCIPLES OF FINANCE
Course Introduction
•So
what
exactly
is
finance?
ECO218: PRINCIPLES OF FINANCE
Course Introduction
• Finance is the
management.
science
of
fund
• It is distinct from accounting in that,
whereas accounting aims at organizing
and compiling past information, finance
is geared towards deciding what to do
with that information.
ECO218: PRINCIPLES OF FINANCE
Course Introduction
• In Finance we learn how to determine
which projects have the best potential
payoff.
• How to manage investments.
• How to value stocks.
ECO218: PRINCIPLES OF FINANCE
Course Introduction
• In the end, you will discover that all
finance boils down to one concept:
return.
• In essence, finance asks: "If I give you
money today, how much money will I get
back in the future?“
ECO218: PRINCIPLES OF FINANCE
Course Introduction
• Financial concepts:– Time value of money
– Management financial statements
– Ratio analysis
– Capital budgeting
ECO218: PRINCIPLES OF FINANCE
Course Introduction
• Financial concepts:– Capital structure
– cost of capital
– Bonds
– Stocks
ECO218: PRINCIPLES OF FINANCE
Course Introduction
• In summary
– Principles of Finance will show us how to use
financial concepts such as the time value of
money, financial statements, financial ratio
analysis, capital budgeting analysis, capital
structure, the cost of capital, bonds and stocks.
– It will also provide an understanding of cash flow
and long term financing, and how to apply these
concepts and skills in business decisions.
ECO218: PRINCIPLES OF FINANCE
Time value of money;Introduction to Interest
ECO218: PRINCIPLES OF FINANCE
Time value of money
• Suppose you have the option of receiving
100,000naira today vs. 200,000naira in five
years. Which option would you choose?
• How would you determine which is the better
deal?
• Some of us would rather have less money
today vs. wait for more money tomorrow.
ECO218: PRINCIPLES OF FINANCE
Time value of money
• However, sometimes it pays to wait.
• Time value of money explains how to
determine the value of money today vs.
tomorrow by using finance tools to determine
present and future values.
• Also, Time value of money exposes the
concept of interest rates and how to apply
them when multiple periods are considered.
ECO218: PRINCIPLES OF FINANCE
Time value of money
• Let take a look at the difference between
present value and future value.
– The concept called the "time value of money"
assumes that individuals face either an increase in
prices in the economy as time passes in the form
of an inflation rate, such as a 4% annual inflation
rate, or
– an opportunity to put their savings in an
investment account offering an interest rate, such
as 5% per year.
ECO218: PRINCIPLES OF FINANCE
Time value of money
• Therefore, under the "time value of money"
concept, you can see that 1,000naira that you
can receive in two years from today does not
have the same value as 1,000naira today.
• In fact, it will have a lesser value today.
ECO218: PRINCIPLES OF FINANCE
Time value of money
• Likewise, if you receive 1,000naira today and
have the opportunity to put this money in an
investment account earning 5% per year, in
two years you will have more than 1,000naira.
ECO218: PRINCIPLES OF FINANCE
Time value of money
Assume: 10% risk free interest
Now
100,000
1 year
109,000
2year
120,000
100,000 + 10,000 = 110,000 +11,000 = 121,000
ECO218: PRINCIPLES OF FINANCE
Time value of money
Future(FV) vs Present(PV) Value
Assume: 10% risk free interest
FV
1 year
2year
100,000
110,000
121,000
ECO218: PRINCIPLES OF FINANCE
Time value of money
Future(FV) vs Present(PV) Value
Assume: 10% risk free interest
What is the PV of 65,000 in one year
let x be the PV
this mean that
1x + 10%x = 65,000
1x + 0.10x = 65,000
1.10x = 65,000
x = 65,000 / 1.10
x = 59,090.90909
ECO218: PRINCIPLES OF FINANCE
Time value of money
Future(FV) vs Present(PV) Value
Assume: 10% risk free interest
The PV of 65,000 in one year
will be 59,090.90909
It then mean that
The FV of 59,090.90909 in one year
will be 65,000
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
•What
Interest?
is
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
• Interest is what you Paid for keeping an
Amount of Money over a Period of Time.
• It could also be regarded as Rent Paid for
the Usage of Money over a specific Time
Period.
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
• Interest can either be a Simple or
Compound Interest.
• In Reality Only Compound Interest are
used in modern Economics
• But we shall start our discussion with a
Simple Interest.
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
Simple Interest
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
Simple Interest
Assume: 10% per Year risk free
Simple interest
Principal is 100,000naira
How much do I Own at the end of
Ten years from Today
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
Simple Interest
Assume: 10% per Year risk free Simple interest
Principal is 100,000naira
Maturity Date is 10years
let x be the Value I Own at the end of each Year Ti.
this mean that at end of each Year:T0: x = 100,000naira
T1: x = 100,000 + (100,000)(0.10) = 100,000 + 10,000
= 110,000
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
Simple Interest
Assume: 10% per Year risk free Simple interest
Principal is 100,000naira
Maturity Date is 10years
T2: x = 100,000 + (100,000)(0.10)(2)
= 100,000 + 20,000
= 120,000
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
Simple Interest
Assume: 10% per Year risk free Simple interest
Principal is 100,000naira
Maturity Date is 10years
T3: x = 100,000 + (100,000)(0.10)(3)
= 100,000 + 30,000
= 130,000
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
Simple Interest
Assume: 10% per Year risk free Simple interest
Principal is 100,000naira
Maturity Date is 10years
T10: x = 100,000 + (100,000)(0.10)(10)
= 100,000 + 100,000
= 200,000
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
Simple Interest
In summary
Assume: r% per Year risk free Simple interest
P is the initial Principal Amount
let x be the Value Owned at the end of each Year Ti.
this mean that at end of each:-
Ti: x = P + (P)(r)(i)
ECO218: PRINCIPLES OF FINANCE
Introduction to Interest
Simple Interest
So if;
r = 10% (Simple Interest rate)
P = 100,000 (Initial Principal Amount)
I = 10 (Years of Maturity)
let x be the Value Owned at the end of Ti Years.
this mean that at end of i years:T10: x = 100,000 + (100,000)(0.10)(10)
= 100,000 + 100,000
= 200,000