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BWFF 2023 FINANCIAL

MANAGEMENT II
Kharul Azhar Bin Ramli
Room : 022 (COB Main Building)
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OBJECTIVES :
Upon completion of the course, students are
expected to :
understand the foundation of key concepts

and theories of financial management as a


whole.
acquire knowledge and skills necessary to
solve different types of problems in finance.
develop investment or financing analysis,
planning and forecasting on business and
non-business organization.
2

FM I
Introductory course to
financial management, it
focuses on short term
financial management.
Financial Statement
Forecasting & Planning
Risk & return
Time value of money
Short term financing
Management of cash ,

AR & inventory

FM II
Follow-up course of FM1,
focuses on investment
decision making process
& long term financing.
Time value of money review
Bond & stock valuation
Cost of capital
Capital Budgeting

Techniques
Cash Flows in Cap
Budgeting
Leverage & Cap Structure
Dividend policy
3

RM1

today is worth more


than a RM1 tomorrow
Would you rather receive RM1,000 today or a year from now?

You should prefer to receive the RM1,000 today because you


can invest the RM1,000 and earn interest on it. As a result,
you will have more than RM1,000 a year from now.

The amount of interest involved in any financing transaction is

based on three elements:

1.Principal (p): The original amount borrowed or invested.


2.Interest Rate (i): An annual percentage of the principal.
3.Time (n): The number of years that the principal is borrowed

or invested.

Simple interest
is computed on the principal amount only. It is the return on the principal
for one period.
Compound interest is computed on principal and on any interest earned
that has not been paid or withdrawn. Compounding computes interest not
only on the principal but also on the interest earned to date on that
principal, assuming the interest is left on deposit.

What is Compounding and


Discounting??
Translate $1 today into its equivalent

in the future (compounding).


Today

Future

?
Translate $1 in the future into its

equivalent today (discounting).


Today

Future

Steps in solving a
problems:
Read the question carefully.
Underline clue words.
What did you need to do?
What facts are you given?
What do you need to find out?

Compound Interest and Future


Value
Formula:
FV = PV (1 + i)n
(FVIF i, n )

or

FV = PV

PV Present value
i - interest rate
n - number of compounding period

10

Future Value - single sums


1.

If you deposit $1000 in an account earning 8%, how


much would you have in the account after 5 years?

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Future Value - single sums


1.

If you deposit $1000 in an account earning 8%, how


much would you have in the account after 5 years?

PV = 1000
= ??

FV

12

Future Value - single sums


1.

If you deposit $1000 in an account earning 8%, how


much would you have in the account after 5 years?

PV = 1000
= ??

FV

FV = PV (1+ i)5n
= 1000 (1+ .08)5
= 1469.33

13

Future Value - single sums


Try this
2.

Suppose that you invest $500 today at an interest


rate of 5% per year and expect to hold the
investment for ten years. How much will the
investment be worth at the end of this period?

14

Discounting and Present Value


Formula:
PV = FV / (1 + i)n
(PVIF i, n )

or

PV = FV

FV Future value
i - interest rate
n - number of compounding period

15

Present Value - single sums


1. If you receive $1000 two years from now,

what is the PV of that $1000 if your


opportunity cost is 10%?

16

Present Value - single sums


1. If you receive $1000 two years from now,

what is the PV of that $1000 if your


opportunity cost is 10%?

PV = ??
1000

FV =

17

Present Value - single sums


1. If you receive $1000 two years from now,

what is the PV of that $1000 if your


opportunity cost is 10%?

PV = ??
1000

FV =

PV = FV / (1+ i)n
= 1000 / (1+ .1)2
= 826.45

18

Present Value - single sums


Try this.
2. What is the present value of $500 to be

received 10 years from today if the


discount rate is 8%?

19

Dealing with Non-Annual Periods and Rates


In the above examples the interest rates were annual

and the number of periods were measured in years.


Very often, however, that is not the case. (e.g :
semiannually, quarterly, monthly, weekly, daily)

Rule of thumb:

Interest rates and the number of


periods must always agree as to the
length of a time period.

20

Non annual periods & rates


Try this
1. You just purchased a parcel of land for $10,000.

If you expect a 12% rate of return (compound


semiannually) on your investment, how much
will you sell the land for in 10 years?
2. If you want to have $1,800 in seven years, how

much money must you put in a savings account


today? Assume that the savings account pays
8% and it is compounded quarterly .

21

Hint for single sum


problems:
In every single sum present value and
future value problem, there are four
variables:

FV, PV, i and n.


When doing problems, you will be given

three variables and you will solve for the


fourth variable.
Keeping this in mind makes solving time
value problems much easier!

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Example 1:
If you sold land for $11,933 that you
bought 5 years ago for $5,000, what
is your annual rate of return?
PV = 5000

FV = 11,933

5
i= ?
23

Mathematical Solution:
PV = FV (PVIF i, n )
5,000 = 11,933 (PVIF

?, 5

PV = FV / (1 + i)n
5,000 = 11,933 / (1+ i)5
i = [FV/PV] 1/n - 1
= [11,933/5000] 1/5 1
= (2.3866)1/5 1
i = .19 or 19%

24

Example 2:
Suppose you placed $100 in an
account that pays 9.6% interest,
compounded monthly. How long will
it take for your account to grow to
$500?

PV = 100

FV = 500

?
n= ?
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Mathematical Solution:
PV = FV / (1 + i)n
100 = 500 / (1+ .008)n
5 = (1.008)n
ln 5 = ln (1.008)n
ln 5 = n ln (1.008)
1.60944 = .007968 n
n = 202 months

26

Solving for i & n


Try this
1. You lend a friend $10,000 for which your

friend will repay you $27,027 at the end of


five years. What rate are you charging your
friend?
2. About how many years would it take for

$1000 investment to grow sevenfold if it


were invested at 10% compounded
semiannually?
27

28

Annuities
Annuity: a sequence of equal cash

flows, occurring at the end of each


period.

29

Examples of annuities:
If you buy a bond, you will

receive equal semi-annual


coupon interest payments over
the life of the bond.
If you borrow money to buy a

house or a car, you will pay a


stream of equal payments.
30

Future Value Annuity


Formula:
FVA = PMT

(1 + i)n - 1
i

FVA = PMT (FVIFA

i, n

PMT equal payment


i - interest rate
n - number of compounding period
31

Future Value - Annuity


If you invest $1000 each year at 5%,
how much would you have after 3
years?

1000

1000
1

1000
2

3
??
?

32

Solution
FVA = PMT (FVIFA i, n )
=1,000 (FVIFA .05, 3 )
=1,000 (3.1525) = $3152.5
FVA = PMT

(1 + i)n - 1
i

FVA =
33

Present Value Annuity


Formula:
PVA = PMT

1
1- (1 + i)n
i

PVA = PMT (PVIFA

i, n

PMT equal payment


i - interest rate
n - number of compounding period
34

Present Value - Annuity


2

What is the PV of a 3-year $2000


annuity discounted back to the
present at 6%?

2000
0

2000

2000
2

?
??
35

Solution
PVA = PMT (PVIFA i, n )
= 2,000 (PVIFA .06, 3 )
= 2,000 (2.673) = $ 5346 (use
PVIFA table)
PVA = PMT
PVA =

1
1 - (1 + i)n

36

Ordinary Annuity
Try this ..
1. What is the present value of an annuity of

$15 received at the end of each year for five


years? Assume a discount rate of 8%. The
first payment will be received one year from
today .
2. How much must you deposit at the end of

each of the next 5 years in a savings


account paying 5% annually in order to have
$5,000 saved by the end of the 5th year?
FV = PMT {(1+i)5/i} - 1
37

38

Perpetuities
Suppose you will receive a fixed

payment every period (month,


year, etc.) forever. This is an
example of a perpetuity.
Perpetuity is an annuity that

goes on forever.

39

Present Value of a Perpetuity


When we find the PV of an

annuity, we think of the


following relationship:

PV = PMT (PVIFA i, n )

40

Mathematically,
(PVIFA i, n ) =

We know that a perpetuity


is an annuity where n =
infinity. What happens to
this formula when n gets
very, very large?

41

When n gets very large,

1-

1
n
(1 + i)

this becomes zero.

So were left with PVIFA =

i
42

Present Value of a Perpetuity


So, the PV of a perpetuity

is very simple to find:

43

Present Value of a Perpetuity


What should you be willing to pay in order
to receive $10,000 annually forever, if you
require 8% per year on the investment?

PV = PMT
i
=
44

$1000

$1000

$1000

8
45

Ordinary Annuity
- annuity payments are made at the end
of each period
1000
1000
1000
1000

P
V
0

Annuity Due

F
4
V

- annuity payments occurs at the


beginning of each
period 1000
1000
1000
1000

P
0
V

F
4
V

46

Future Value of Annuity Due


If you invest $1,000 at the beginning of each
period of the next 4 years at 5%, how much
would you have at the end of year 4?
1000
0

1000
1

FORMULA:

1000

1000

FVAD = PMT (FVIFA i, n


(1 +i)
FVAD = PMT ( 1 + i)n
1 (1 +i)

)
47

Solution
FVAD = PV (FVIFA

i, n

)(1 + i)

= 1000 (FVIFA

.05, 4

)(1 + .05)

= 1000 (4.3101)(1.05)
= 4525.6 (use FVIFA table)
FVAD = PMT

(1 + i)n 1
I

(1 + i)

FVAD =
48

Present Value of Annuity Due


What is the PV of $1,000 at the beginning of
each of the next 3 years, if your opportunity
cost is 9%?
1000
1000
1000
0

FORMULA:
PVAD

= PMT (PVIFA
(1 +i)1

PVAD = PMT
(1

i, n

1 - ( 1 + i)n
+i)
49

Solution
PVAD = PV (PVIFA

i, n

= 1000 (PVIFA

)(1 + i)
.09, 3

)(1 + .09)

= 1000 (2.5313)(1.09)
= 2759.12 (use PVIFA table)
1
1 - (1 + i)n

PVAD = PMT

(1 + i)

i
PVAD=
50

Annuity Due
Try this
1. How much money must you pay into an

account at the beginning of each of five


years in order to have $6,000 at the end of
the fifth year? Assume that the account pays
10% per year.
2. What is the present value of $100 received

at the beginning of each year for 10 years?


The first payment is received today. Use a
discount rate of 6%,
51

$500

$800

$1500

$1000

8
52

Uneven Cash Flows

2,000

4,000

6,000
3

Is this an annuity?
How do we find the PV of a

cash flow stream when all of


the cash flows are different?
(Use a 10% discount rate.)
53

Uneven Cash Flows

2,000

4,000

6,000
3

Theres no short cut way. We have to discount


each cash flow back separately.

54

Uneven Cash Flows


2,000
0

4,000

6,000

PV1 = 2,000 / (1 + 0.1)1


PV2 = 4,000 / (1 + 0.1)2
PV3 = 6,000 / (1 + 0.1)3

Calculate the individual PV and then total up all


the PV.
55

Uneven Cash Flows


2,000
0

4,000

6,000
3

PV1 =
PV2 =
PV3 =

PV of Cash Flow Stream:


9,631.85

$
56

Annual Percentage Yield (APY)


Which is the better loan:
8% compounded annually, or
7.85% compounded quarterly?
We cant compare these nominal (quoted)

interest rates, because they dont include the


same number of compounding periods per
year!
We need to calculate the APY.
57

Annual Percentage Yield (APY)


APY =

(1+

quoted rate
m

- 1

Find the APY for the quarterly loan:

APY =

.0785
1+
4

- 1

APY = .0808, or 8.08%


The quarterly loan is more expensive than the 8%
loan with annual compounding!
58

Annual Percentage Yield (APY)


Try this
Which of the following provides the greatest
annual interest?
a.
8% compounded annually
b. 7.5% compounded monthly
c.
6.9% compounded quarterly
d. 6% compounded daily

59

Exercises - TVM
1. You have just borrowed $100,000 and you

agree to pay it back over the next 25 years in


25 equal end-of year annual payment. The
bank charge 10% compound interest on the
loan. How much you should pay annually?
2. You are offered $1000 today, $10,000 in 12

years , or $25,000 in 25 years. Assuming that


you can earn 11% on your money, which option
should you choose? Why
60

Uneven Cash Flows


Exercise :
0
9

300

200

400

500

500

500

500
7

500

500

PV1
PV2
PV3

PVA
6

PV3

Try to calculate the of the above uneven cash


flows. (use 10% discount rate)
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