MGM230H5 Lecture Notes - Lecture 1: Corporate Finance, Capital Budgeting, Investment

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Published on 23 Apr 2017
School
Department
Course
Professor
MGM230 January 4, 2017
Chapter 5
Finance science that describes the management, creation, and study of
money, banking, credit, investments, assets & liabilities
Finance manager goal: to value assets/analyze decisions based on their risk
level and expected rate of return in order to maximize shareholder value
Revolves around 6 main principles
1. Time value of money
2. Risk vs. reward
3. Diversification
4. Efficient financial markets
5. Management vs. owner
6. Greed
Important questions using finance:
1. Capital budgeting what long term investments should we invest in or avoid?
2. Capital structure how do we pay for our assets?
3. Working capital management how do we manage daily finances?
Time value of money a dollar today is worth more than a dollar in the future
o Risk vs. reward:
o Risk - the greater uncertainty of receiving dollar at a later date vs.
receiving it right away
o Reward - could reinvest the dollar today to earn interest earlier vs. waiting
to reinvest that dollar later
Recall to value assets/analyze decisions based on their risk level and their
expected rate of return in order to maximize shareholder value
o Ex. What are they worth in today’s time period?
Present value (PV) - current value of future sum of money or stream of cash
flows given (FC) measures the future sum of value that a given sum of money is
“worth” at a specified time in the future assuming a certain interest later
Interest rate (r) - exchange rate between earlier money and later money
Term (t) number of periods
2 Methods of Which Interest Can Be Earned
Simple interest earn interest (return) on principal only
Suppose you invest 1000 for one year at 5% per year. What is the future value in 1
year?
Interest: 1000(0.5) = 50
FV in 1 year = principal + interest = 1000 + 50 = 1050
Suppose you invest 1000 for 2 years at 5% per year. What is the FV with simple interest
after 2 years?
Interest: 1000(0.5) = 50 + 1000(0.5) = 50
FV in 2 years = principal + interest = 1050 + 1050 =
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Document Summary

Revolves around 6 main principles: time value of money, risk vs. reward, diversification, efficient financial markets, management vs. owner, greed. Worth at a specified time in the future assuming a certain interest later. Interest rate (r) - exchange rate between earlier money and later money: term (t) number of periods. 2 methods of which interest can be earned: simple interest earn interest (return) on principal only. Suppose you invest 1000 for one year at 5% per year. Fv in 1 year = principal + interest = 1000 + 50 = 1050. Interest: 1000(0. 5) = 50 + 1000(0. 5) = 50. Fv in 2 years = principal + interest = 1050 + 1050 = January 4, 2017: compounded interest earn interest on principal and reinvested interest. Suppose you invest 1000 for 2 years at 5% per year. The extra 2. 50 comes from interest from the interest of (0. 5)50. Loan payments for an automobile, mortgage, earnings from lottery winnings, etc.

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