RELATIONSHIP (Part 1 of 3)
MONEY
Medium of Exchange -Means of payment for goods or services;
What sellers accept and buyers pay ;
CAPITAL
Wealth in the form of money or property that
can be used to produce more wealth.
Interest
the cost of money often expressed as a
percentage that is periodically applied and
added to an amount (or varying amounts) of
money over a specified length of time
the return obtainable from the productive
investment and efficient use of money resources
during a specific time period
it is the profit from lending money, or the
earning power of money
the amount paid for the use of borrowed
money, the cost of borrowing money
Simple Interest
when total interest earned or charged is linearly
proportional to the initial amount of the loan
(principal - or the amount of money borrowed)
General Formula:
I = Pin
where: I = total interest earned by the principal
P = principal amount lent or borrowed
n = number of interest period (e.g. years)
i = interest rate per interest period
Sample Problems:
1) Php400 is loaned for 5 quarters at a simple interest
rate of 3% per quarter.
a. What is the total amount of interest to be repaid?
b. What is the total amount owed after 5 quarters?
2) A man borrows Php10,000 from a loan firm. The rate
of simple interest is 15%, but the interest is to be
deducted from the loan at the time the money is
borrowed. At the end of one year he has to pay back
Php 10,000. What is the actual rate of interest?
Compound Interest
it is based on the total amount owed at the end of
the previous period which consists of the original
principal loaned plus the accumulated interests
which had not been paid when due
It means interest on top of interest.
It is much more common in practice than simple
interest.
Sample Problems:
1) If Php400 is loaned for 5 quarters at a compound
interest of 3% per quarter compounded quarterly, find
the total amount owed at the end of the last quarter.
2) At a certain interest rate compounded quarterly,
Php1000 will amount to Php4500 in 15 years. What is
the amount at the end of 10 years?
ieff = (1+r/n)n-1
where:
ieff = is the effective interest rate
r is the nominal rate of interest
n is the number of compounding
period per year
Sample Problems:
1) Calculate the effective rate corresponding to each of
the following rates:
(a) 9% compounded semi-annually;
(b) 9% compounded quarterly;
(c) 9% compounded monthly.
2) If you are investing your money which is better: 12%
compounded monthly or 12.5% compounded
annually?
3) Find the nominal rate compounded monthly which is
equivalent to 12% compounded quarterly. What is the
corresponding effective rate?
Cash Flows
These are inflows and outflows of money
Net cash flow = receipts disbursements
= cash inflows cash outflows
Since cash flows normally take place at frequent
and varying time intervals within an interest period,
a simplifying assumption is made that all cash flow
occurs at the end of an interest period
End-of-Period convention
Cash Inflows
Revenues
Operating cost reductions
Asset salvage value
Receipt of loan principal
Income-tax savings
Receipts from stock and bond sales
Construction and facility cost savings
Savings or return of corporate capital funds
Cash Outflows
First cost of assets
Operating costs
Periodic maintenance and rebuild costs
Loan interest and principal payments
Major, expected upgrade costs
Income taxes
Bond dividends and bond payment
Expenditure of corporate capital funds
Year 1
Year 4
2
Time scale
(EOY)
Cash Flow,
$
2
1
Sample Problem
Mrs Green has just purchased a new car for
Php12,000,000. She makes a down payment of
30% of the negotiated price and then makes
payments for Php303,680 per month thereafter
for 36 months. Furthermore, she believes the car
can be sold for Php3,500,000 at the end of three
years. Draw a cash flow diagram of this situation
from Mrs Greens viewpoint.