FinanceGreg Stone

Finance?• What is Finance?

• Decisions about Money• Who needs to know about Finance?

• Everyone!! Actually, only people who work for Corporations or Businesses and those who want to be wealthy and those who already are Wealthy Dudes!

• What types of decisions are made by people in Finance? • Investing in projects, investing in the stock market, investing

money into a marketing plan, planning for retirement, buying a new car/house/timeshare/lottery ticket, replacing a machine, buying a business, starting a business

Project Decisions

• Where should we build these iPods?

• How can we make money from Facebook?

• How did Google go from being a private company to a public company?

• Should we build a hotel or a parking lot on this property or should we sell it?

• Should we mine for gold at a given site knowing what we know from the geologists?

People Who Manage Money Well

• Warren Buffett, CEO Berkshire Hathaway

• 3rd Wealthiest Man in the World

• By the time he was 35, amassed $7 million fortune? At 50, he had over $200 million. 

• Worth estimated at $50 Billion

People Who Manage Money Well

• “The Donald”

• CEO Trump Organization

• Companies file for bankruptcy 3 times yet still a rich man.

• Forbes estimates he’s worth $1.6 Billion

People Who Manage Money Well

• Carlos Slim Helu

• Richest Man World

• Telecom Tycoon

• Forbes estimates he’s worth

• $74 Billion

People Who Manage Money Well

• Abigail Johnson • Runs Fidelity Investments

together with her father Edward Johnson

• Worth: $12 Billion

People Who Do Not Manage Money Well

Mike Tyson• Undisputed Heavyweight

Champion• First heavyweight boxer to hold

the WBA, WBC and IBF titles simultaneously.

• At his peak earned $30 million per fight

• Wealth:

• $300 million to broke

People Who Do Not Manage Money Well

Dr. John McAfee• Founder McAfee Antivirus• NASA computer programmer• "Money does a really strange

thing. It gives you this sense of omnipotence. But eventually you're just one person, you look around at all this stuff you've acquired and you wonder how you're ever going to use it."

• Wealth: • $100 million to $4 million

People Who Do Not Manage Money Well

MC Hammer• Can't Touch This

• $46 million to broke

People Who Do Not Manage Money Well

Thomas Jefferson• President of the United States• Principal author of the

Declaration of Independence• Louisiana Purchase• Founded University of Virginia

• When he died, his assets had to be sold to cover his debts. His net worth was equivalent to about $143,000 today

People Who Do Not Manage Money Well

Within two years of retirement, 78 percent of NFL players are bankrupt or in severe financial distress.

-Yahoo Sports

Sixty per cent of retired NBA players go broke five years after their NBA paychecks stop arriving

-NBA Players' Association

Requirements

• Fin 301-required for all business majors• FIN 307, FIN 308, FIN 404-required for Finance Majors• Plus 5 electives such as:

• Derivatives, real estate, valuation, portfolio management

Time Value of Money• The value of any asset is the sum of the

discounted future cash flows from that asset.

• Future value• Present value• Rates of return• Amortization

• Amount of expected cash flows (bigger is better)• Timing of the cash flow stream (sooner is better)• Risk of the cash flows (less risk is better)

What three aspects of cash flows affect an investment’s value?

What’s the FV of an initial $100 after 3 years if i = 10%?

FV = ?

0 1 2 310%

Finding FVs (moving to the righton a time line) is called compounding.

100

After 1 year:

FV1 = PV + INT1 = PV + PV (i)= PV(1 + i)= $100(1.10)= $110.00.

After 2 years:

FV2 = FV1(1+i) = PV(1 + i)(1+i)= PV(1+i)2

= $100(1.10)2

= $121.00.

FV3 = FV2(1+i)=PV(1 + i)2(1+i)= PV(1+i)3

= $100(1.10)3

= $133.10.

After 3 years:

In general,

FVn = PV(1 + i)n.

What if it were for 30 years?• FV1= 100(1.10)^30 =

$1,744.94

$0.00

$200.00

$400.00

$600.00

$800.00

$1,000.00

$1,200.00

$1,400.00

$1,600.00

$1,800.00

$2,000.00

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31

So, you want to have some fun when you retire……….

• You decide that you need 1.5 million dollars to retire. How much do you need to save, and for how long do you need to save, to reach your goal?

• If you are 20 now and decide you want to retire at the age of 65. You think you can earn an average of 10% per year on your money. If you save $2,086 per year you will reach your goal.

• If you are 20 and you decide you want to retire when you are 35. You think you can earn an average of 10% per year on your money. You need to save $47,210 per year to reach your goal.

10%

What’s the PV of $100 due in 3 years if i = 10%?

Finding PVs is discounting and it’s the reverse of compounding.

100

0 1 2 3

PV = ?

Solve FVn = PV(1 + i )n for PV:

PV =

FV

1+ i = FV

11+ i

nn n

n

PV = $100

11.10

= $100 0.7513 = $75.13.

3

Example• What if you won the Megabucks lottery and you were

offered $5 million but you had to receive that $5 million over 20 years ($250,000 per year).

• Would you rather take the 20 $250,000 payments or $2.13 million today?

• It depends on what rate of interest you can get. At 10% you would be indifferent between the two. Less than 10% take the 20 $250,000 payments. More than 10% take the $2.13 million.

Starbucks!• Imagine you buy a Starbucks coffee for $4, 5 days a

week ($20 per week). What if you had the choice of taking that money and investing it at 8% interest compounded weekly (0.15% per week). If you chose to save it how much money would you have at the end of 40 years??

$305,139

Another Problem• You decide you want to run your own hotel business. You

think that you can generate cash flows from your business of $50,000 per year for 30 years. After that time, your hotel will be worthless. The bank would charge you 10% (per ear) to borrow the money.

• The Present Value of those Cash Flows is $471,345 so if you could buy/build the hotel for less than $471,345 it would be a good deal.

Rule of 72s• 72/percent return=time to double• i.e. 10%• 72/10=7.2 years• If you are making 1% interest per year it will take 72/1 or

72 years for your money to double. • $10,000=$20,000 in 72 years.• If you are making 10% interest per year, it will take

72/10=7.2 years to double.• $10,000=$5,120,000 in 72 years.• If you are making 20% interest per year, it will take

72/20=3.6 years to double.• $10,000=$ 5,242,880,000 in 72 years.

What determines a firm’s value?

• A firm’s value is the sum of all the future expected free cash flows when converted into today’s dollars:

)WACC1(

FCF....

)WACC1(

FCF

)WACC1(

FCFValue

22

11

Amortization

Construct an amortization schedulefor a $1,000, 10% annual rate loanwith 3 equal payments.

Step 1: Find the required payments.

PMT PMTPMT

0 1 2 310%

-1,000

3 10 -1000 0

INPUTS

OUTPUT

N I/YR PV FVPMT

402.11

Interest declines. Tax implications.

BEG PRIN ENDYR BAL PMT INT PMT BAL

1 $1,000 $402 $100 $302 $698

2 698 402 70 332 366

3 366 402 37 366 0

TOT 1,206.34 206.34 1,000

$

0 1 2 3

402.11Interest

302.11

Level payments. Interest declines because outstanding balance declines. Lender earns10% on loan outstanding, which is falling.

Principal Payments