Summary - Business Finance - ثاني ثانوي

SUMMARY Every decision has an opportunity cost, which is what a person gives up by making a choice. Personal opportunity costs include your time and health, Financial opportunity costs can be measured in terms of monetary gains based on the time value of money, The increased value of money involves two types. of calculations: tuture value and present value. The amount available at a later date is called the future volue. In contrast, the current value of an amount in the future is the present value. Future value and present value calculations commonly involve two types of cash flows - a single amount and an annuity, which is a series of equal amounts. The annuity involves both a series of equal deposits or payments each year along with a constant rate of return. As shown in the table below, four basic variations of the time value of money exist. Timy Value of Money Summary Single Amount Future value of Future Value a single amount Present value of Present Value Series of Equal Amounts (anmulty) Future value of a series of amounts Present value of a series of amounts a single amount Other time value of money situations that vary from these four basic situations include uneven amounts each year, time periods of less than a year, and non-annual compounding. Finally, using a time value of money adaptation, present value calculations may be used to determine monthly loan payments when an amount is borrowed for a certain number of years at a certain rate. PROBLEMS 1. Describe opportunity costs, or the value of what was lost when choosing between two or more options, you have encountered in your life. وزارة التعليم CHAPTER 5 Opportunity Costs and the Time Value of Moneys 211

LI 212, Business Finance 2. Explain the difference between future value and present value. 3. Explain how the frequency of compounding affects the growth of a person's money. 4. Describe a situation for which a person might use the future value of a series of amounts calculation. 5. In which situations would a present value calculation be used?

6. For these situations, decide it the event is an example of a future value calculation or a present value calculation: a. calculating the amount to deposit today to achieve an amount in the future; b. determining the value of an investment that will grow over the next ten years, c. investing SAR 50 a month for six years. EXERCISES 1. Fatemah has invested SAR 6,000 with an annual rate of 2.5%. What would be the earnings on this amount? 2. Nora has invested SAR 850. What would be the future value in six years at an interest rate of 7%6? 3. Saad plans to invest SAR 6,400 a year for the next six years, earning 4% interest. What would be the future value of this savings amount? حرارة التعليم CHAPTER 5 Opportunity Costs and the Time Value of Moneys (213)

p214 Susiness Finance 4. Ibrahim invests SAR 6,000 a year into a retirement account. If these funds have an average earning of 9% over the 40 years until retirement, what will be the value of the retirement account? 5. If Layla hopes to have SAR 60,000 for a down payment for a house in five years, what amount would she need to Invest today? Assume that the money will earn 5% interest. 6. Abdullah is planning to go to graduate school in a program of study that will take three years. He wants to have SAR 12,000 available each year for various school and living expenses. If he earns 4% interest on his money, how much must he deposit at the start of his studies to be able to withdraw SAR 12,000 a year for three years? 7. What amount would Manam have to invest today to be able to take out SAR 800 a year for 10 years from an account earning 8% interest?

8. What amount would Tala have to invest today at a 6% rate of interest to have SAR 1,000 five years from now? ASSESSMENT QUESTIONS Choose the correct answer. 1. Time used for recreation is considered to be a financial resource. True/False 2. Interest is calculated by multiplying an amount of money umes a rate times a length of time. True/False 3. Future value is the amount to which current savings will grow based on a certain rate and a certain time period True/False 4. Earning interest on interest is called compounding. True/False 5. When using a financial calculator, the rate is indicated by: a. N b. PMT c. 1 d. FV 6. The future value of a series of amounts would best be used for determining the value of: a. an account with annual deposits. b. loan payments. c. an amount set aside for employee benefits d. changing foreign currency rates. حرارة العليم CHAPTER 5 Opportunity Costs and the Time Value of Moneys 215)

p216Business Finance 7. A present value of a savings account would be larger than the future value of that account True/False 8. To determine the growth of an amount you would use the: a. present value of a series b. future value of a series. c. future value of a single amount. d. present value of a single amount. 9. Time value of money calculations may be used to determine the amount of a loan payment. True/False 10. Compounding can only occur on an annual basis. True/False 11. If a person deposits SAR 150 in year 1, SAR 250 in year 2, and SAR 200 in year 3. this is referred to as: a. uneven amounts. b. time periods of less than a year. c. non-annual compounding. d. annual discounting.

KEY TERMS Match the terms listed with their definitions Write the letters of the correct definitions. Term 1. Annuity 2. Compounding 3. Discounting 4. Future value 5. Non-annual compounding 6. Opportunity cost 7. Present value 8. Time value of money Your choice Definition a. The process by which earnings are based on the original amount as well as previous amounts earned b. What a person gives up by making a choice c. The payment of interest more frequently than once a year d. The current value of a future sum of money given a specified rate of return e. Increases in an amount of money as a result of its earnings over time f. A series of equal, annual payments with a constant rate of return g. The amount by which savings will increase based on a certain rate and over a certain time penod h. The process of determining the present value of a payment that is to be received in the future KEY FORMULAS Simple interest calculation Future value of a single amount Simple interest - Principal x Rate of interest (annual) x Time (years) FV=PV (1+0) Future value of a series of amounts (annuity) 11+00-1 FV (annuity) PMT X- Present value of a single amount PV= FV 0+0 1 (1+0 Present value of a series of amounts (annuity) PV (annuity) - PMT x وزارة التعليم CHAPTER 5 Opportunity Costs and the Time Value of Moneys 217)

pul218 Business Finance M MINI CASE 5.1 Time Value of Money for Investment Calculations Asma is planning an investment program for her long-term saving. She plans to select various investments, including stocks, mutual funds, and real estate. Asma plans to deposit SAR 12,000 per year. She estimates an average annual return of 9% for the next 20 years. Asmo will use time value of money calculations to determine the growth of her investment portfolio. Task 1. What would be the future value of Asma's investment after 20 years? 2. Would you advise Asma to deposit the 12,000 once as a single amount at the beginning of the investment program or as an annuity at the end of each year? Explain your answer.

MINI CASE 5.2 Time Value of Money and Personal Financial Decisions Personal financial security is vital for the personal welfare and economic satisfaction of individuals and their families, Younis and his wife Ayesha have two children, ages six and eight. Their current home is too small for their growing children. They also want to save for their children's future education costs and their retirement. Personal financial goals can be measured with the use of time value of money (future value and present value). Task 1. What financial goals do Younis and Ayesha need to set? 2. What do Younis and Ayesha need to start planning for from today, and how? حرارة التعليم CHAPTER 5 Opportunity Costs and the Time Value of Moneys 219

p220Business Finance M CASE STUDY: SELECTING A CAPITAL PROJECT Should our company open a branch office in another country, or take a new product to market? This type of busmess decision is part of Saudi Vision 2030 to diversify the economy. Every organization is dependent on capital assets for current operations and long-term success, Purchasing new equipment, constructing additional buildings and obtaining updated technology are examples of capital spending activities. The decision to purchase long-term assets such as machinery, computers, trucks, and machine tools can use a five-step process; 1. Set Capital Spending Goals: The capital projects of a company should be based on the organizational goals, which may include expanding sales, reducing costs, and increasing profits. 2. Determine Potential Capital Projects: After setting clear capital spending goals, different projects will be considered. For example, if providing customer service is a priority, spending for upgraded technology to answer customer questions may be appropriate: If improving distribution is a necessity, a new warehouse or additional delivery trucks might be considered. 3. Forecast Cash Flows: Next, managers must identify amounts of expected cash flows for the project. The two main sources of cash inflows are: (1) additional sales revenue, and (2) reduced operating expenses. Lower expenses create a positive cash flow since money not going out is like money coming in. 4. Identify Rate and Risks: Financing the capital project is the next step. A discount rate is used to calculate the present value of the future cash flows. Managers also assess potential risks, such as inflation, lower consumer spending, new government regulations and natural disasters. Risk is usually considered by using a higher discount rate to reflect potential risk. 5. Select and Implement Project: Finally, managers must decide which capital projects will be selected and how to put the projects into operation. So, if a manager evaluated the two options (opening a branch office in another country, or taking a new product to market), here are example calculations they would use: A. Opening a branch office in another country. Cost SAR 10,000,000 Average expected annual cash flows for the following 10 years =SAR 2,100,000 Discount rate=8%

B. Taking a new product to market Cost - SAR 9,000,000 Average expected annual cash flows for the following 10 years = SAR 1,900,000 Discount rate = 7% As companies implement plans for Saudi Vision 2030, capital projects will be vital for business growth and expansion. Planning new products and services, selling in new markets, and updating technology for production and distribution are some of the capital spending decisions that will result in a more diverse economy. Study Questions 1. What are the present values of the two options? 2. Comparing the present value of the two projects with their costs, which project will the company choose? 3. Which other factors should the company consider when deciding which project to select? Online Activity Several online calculators are available for computing time value of money. Locate an online present value calculator and complete the following tasks: 1. Describe the format and process presented for the online calculator. 2. Calculate the present value for the following situation: a six-year project with anexpected annual cash flow of SAR 44,000 using a discount rate of 5%. وزارة التعليم CHAPTER 5 Opportunity Costs and the Time Value of Moneys 221