MONASH

BUSINESS
SCHOOL

BFC2140
CORPORATE FINANCE I

EMMA ZHANG
What is Corporate Finance

The Financial Management function is centered around

corporate finance, which attempts to find the answers to
the following questions:

 Capital budgeting
THE INVESTMENT DECISION
 How can cash be raised for the required investments?
THE FINANCE DECISION
 How should wealth be redistributed to shareholders?
THE DIVIDEND DECISION
The Corporate Objective

 Primary goal is to maximise the value of the firm, which is

same as maximising shareholder wealth.

 Every decision that we make as financial managers needs to

come back and answer this question

“Have we added value?”

If the answer is “yes” the we should undertake the decision

If the answer is “no” then we should not!
It’s all about the Cash!

 A firm can generate cash flow by selling goods and services

produced by productive assets or generated via human capital

 The firm can then opt to; 1) pay remaining cash (residual cash
flow) to the owners (or shareholders); or 2) reinvest back into the
company for growth.

 Accounting profits are not the same as cash flow, leave

accounting to the accountants!
 Why?Profit maximisation ignores size; timing and risk associated with
receipt of cash
Cash Flow
 MONASH
BUSINESS
SCHOOL

Unit Details
What I need to know
- Refer to the unit guide for more information
TEACHING STAFF (CLAYTON)

In addition to attending your allocated lectures and tutorials you are also encouraged to
attend and obtain assistance when required with our teaching staff. The benefit of these
consultations sessions is to provide yourself with an informal opportunity to raise
content specific questions with qualified staff who will assist you.

Up-to-date contact details will be available in the BFC2140 Moodle site by the end of
teaching week one

Staff will be available for consultation during these stipulated hours commencing in
teaching week two
 IMPORTANT NOTE

• It is policy within the department of Banking and

Finance to respond only to any electronic enquiries
(e-mail) that have been received from an authorised
student e-mail address.

• It is important that you read the Unit Guide. If you

have any questions regarding the Unit details, they
are possibly answered in the Unit Guide.

• Check BFC2140 Moodle site at least twice a week

Tutorials

• Tutorials are held reinforcing materials discussed in the previous

weeks lectures. Tutorials have already commenced and in theory
you have already met your tutor.

• Get to know your tutor. KNOW THEIR NAME!

• Questions for each tutorial can be downloaded from Moodle.

• Solutions will be made available on Moodle on Friday evening

following the completion of all classes.
 ASSESSMENT – BFC2140

ASSESSMENT TASK DUE DATE VALUE

Mid Semester Test Week 6 (in scheduled allocated lecture) 25%

Weeks 2; 3; 4; 5; 6; 8; 9; 10; 11; 12 (Friday 9pm

On Line Post Lecture Exercises 20%
each week)

Tutorial Engagement and

Continuous 5%
Participation
Final Examination Official Examination Period 50%

TOTAL 100%
Workload

• 3 hrs per week in class

• 9 hrs per week outside of class

• Read the lecture notes AND the relevant section of

the textbook BEFORE lectures
• Attend lectures and review materials after class
• Listening to lecture recordings cannot replace attending
lectures.

• Attempt tutorial questions before class

• Attend ALL tutorials
• Review tutorial answers after class
• Keep up with the material and you will do well!
 MONASH
BUSINESS
SCHOOL

Teaching Week One

Introduction to Corporate Finance
and Financial Mathematics

Readings
Chapter 1, pp. 1-24; Chapter 3, pp. 63-87; and Chapter 4, pp. 88-94
 MONASH
BUSINESS
SCHOOL

Learning Objectives

• Understand the notion of time value of money.

• Calculate FV and PV of a single amount.

• Discuss compounding frequency.

• Compute effective annual interest rates (EAR).

Time Value of Money
(Financial Mathematics)

“ A dollar today is worth more

than a dollar tomorrow. ”
Computational Aids

 Non Programmable Financial Calculators

=> HP10bII+
 Computer Software (e.g. Microsoft Excel)
 Time Lines
 Financial Tables
 Time Lines

Tick marks at ends of periods – time, n= 0 is today,

n = 1 is the end of period 1 (or the beginning of period 2)
Compounding techniques - FV

Discounting techniques - PV
Four Important Cash Flow Patterns

1) Single Sum or Lump Sum Cash Flow

2) Mixed Stream or Multiple Cash Flow
3) Annuities
4) Perpetuities

Financial Mathematics requires work (practice).

The main goal is to ensure we have time comparability.

Single Sum or Lump Sum Cash flows
(Lump Sum Cash Flow Pattern)
Interest is ted:
 Simple Interest

 Simple Interest is determined by multiplying the interest rate

by the principal by the number of periods.

Interest = Principal x periods x interest rate

Example 1: Assume you borrows $50,000 today and promise to repay

a lump sum in 90 days time. How much do you need to repay if the
market interest rate is 7% p.a.
 Future Value
(Compounding Techniques)
The total amount due at the end of the investment is
called the Future Value (FV) and involves compounding interest.

Interest is received on accumulated interest from previous periods as

well as on the principal; that is, interest generates further interest.
 Future Value Formula

• The general formula for the future value of an

investment over many periods can be written as:

FVn = C×(1 + r)n

Where
(C) is the cash flow at date 0,
(r) is the appropriate interest rate, and
(n) is the number of periods over which the cash is invested.
Example 2: Future Value Lump Sum

Suppose that you invested $1,000.00 in CBA today. Assume

also that you invest at a guaranteed fixed rate of 6.00% per
annum after tax for a period of 5 years. How much will this
amount grow to by the time the investment account matures.

FVn = C×(1 + r)n

FV5 = $1000×(1.06)5 = $1,338.23
Example 2: Future Value Lump Sum
continued demonstrating compounding

$1000  (1.06) 5
$1000  (1.06) 4
$1000  (1.06) 3

$1000  (1.06) 2
$1000  (1.06 )

$ 1000 .00 $ 1060 .00 $ 1123 .60 $ 1191 .02 $ 1262 .48 $ 1338 .23

0 1 2 3 4 5
Example 2: Future Value Lump Sum
– Continued (using HP10II+ calculator )
ASIDE: Future Value Interest Factor
FVIF Determination
(1 + r)n is also called the future value interest factor

• FVIF is the FV of 1 dollar at r% per annum after n

periods

• Future value is due to the number of periods in which

interest can be compounded. The larger the number of
periods, the greater the future value.

• Future value also depends critically on the interest rate

- the higher the interest rate, the greater the future
value.
Example 2 – Continued (FVIF)
Tables

FV6%,5yrs = $1000.00(1.338) = $1,338.00

There will often be rounding errors when using tables!
 Present Value
(Discounting Techniques)
The use of discounting techniques aids in finding the
current dollar amount of a given future value.

n
 Present Value Formula

The general formula for the present value of a multi period case for a single cash
flow can be written as:

C
PV 
n
(1  r)
where
( PV ) is the cash flow at date n=0,
( r ) is the appropriate interest rate per period,
( n ) is the number of periods over which the cash is invested.
Example 3: Present Value Lump Sum

How much would you have to set aside today in order to have
$20,000 five years from now assuming the current interest rate is
7.00%?
Example 3: Present Value Lump Sum
– Continued (using HP10II+ calculator )
ASIDE: Present Value Interest Factor
PVIF Determination
1/(1 + r)n is also called the present value interest factor

• PVIF is the PV of 1 dollar at r% per annum after n

periods
• Present value is due to the number of periods in
which interest can be discounted. The larger the
number of periods, the smaller the present value.
• Present value also depends critically on the
assumed interest rate (discount rate) - the higher
the interest rate, the smaller the present value.
Example 3 – Continued (PVIF)
Tables

PV7%,5yrs = $20,000(0.713) = $14,260.00

• There will often be rounding errors when using tables!
Example 4: How Long is the Wait?

If you deposit $5,000 today in an account paying

10%, how long does it take to grow to $10,000?

FVn = C(1 + r)n

$10,000 = $5,000(1.10)n
(1.10)n = $10,000/$5,000
ln(1.10)n = ln(2)
n×ln(1.10) = ln(2)
n = ln(2)/ln(1.10)
n = 0.6931/0.0953
n = 7.27 years
Example 4 –
Continued (using HP10II+ calculator )

Convert to 7 years and 99 days (assuming 365 day year)

 The Rule of 72

• The ‘Rule of 72’ (This rule is only an approximation)

If you earn r% per year, your money will

double in about 72 / r years.

• For example, if property sales grow at 10% per year, it

takes about 7.20 (=72/10) years to double your
investment.
Example 5: What Rate Is Enough?

Assume the total cost of a 3-year commerce university

education will be $100,000 when your child (hopefully yet to
be conceived) enters university in 20 years. Assume you have
$5,000 to invest today. What rate of interest must you earn on
your investment to cover the cost of your future child’s
education?

FVn  C  (1  r ) n
$100,000
$100,000  $5,000  (1  r ) 20 (1  r ) 20   20
$5,000
(1  r )  201 20

r  201 20  1  1.1616  1  0.1616 or 16.16%

Example 5 –
Continued (using HP10II+ calculator )
 Nominal Interest Rates

• The nominal interest rate (NIR) is known is also

known as the annual percentage rate (APR) and is
simply the stated, or quoted, rate (e.g., 10% pa
compounded annually)

• The NIR is simply equal to the interest rate

charged per period (i.e., periodic rate) multiplied
by the number of periods per anum.

• For example, if a bank charges 1% per month on

a car loan, the NIR is 1% x 12 = 12%
 Compounding Frequency

• So far, compounding frequency has been assumed

to be annual. In reality compounding frequency is
greater than one in any given period.
m n
 r
FVn  C  1  
 m

• m is the frequency of compounding in a period

• r is the stated/quoted annual interest rate, and is
commonly called the nominal interest rate.
 Compounding Periods

Compounding an investment m times a year for

n years provides for future value of wealth:
m n
 r
FVn  C  1  
 m

For example, if you invest $50 for 3 years at 12% compounded semi-annually, your
investment will grow to

23
 0.12 
FV  $50   1    $50  (1.06) 6  $70.93
 2 
Example 6: Compounding Frequency

A bank is offering 12 percent interest compounded quarterly, if you put $200 in an

account, how much will you have at the end of year 2?

• Given PV = $200, m = 4, n = 2, i = 0.12,

42
 0.12 
FV 2  $200  1    $253.35
 4 
 Effective Annual Interest Rates

• The EAR (or effective annual yield) is the true interest

rate expressed as if it were compounded once per year:

m
 r
EAR  1    1
 m

where r = the quoted annual interest rate (i.e., APR),

m = the number of compounding periods in a year,
Example 7:
EFFECTIVE ANNUAL RATE
You have $10,000 to invest for one year and the
following choices are offered by the banks in
your area:

(a) 6% p.a., compounded annually;

(b) 5.95% p.a., compounded daily;

Which of the alternatives would you choose?

Example 7 - Solution

Work out the EARs

m 1
 r  0.06 
a) EAR  1    1  1    1  6.00%
 m  1 
m 365
 r  0.0595 
b) EAR  1    1  1    1  6.13%
 m  365 

Work out what you would get at the end of a

year, you would also choose (b)
Example 7 –
Continued (using HP10II+ calculator )
Aside: Continuous Compounding

• Frequency of compounding (or discounting) within a period

of time approaches infinity (i.e., interest is charged so
frequently that the time between two periods approaches
zero)

• Interest is compounded instantaneously

 Continuous Compounding (continued)

r n
FV  C  e
C
PV 
r n
e
Where
C = the cash flow
n = the number of periods
r = the one-period interest rate
e = 2.71828182846, a constant (base of natural logarithms – also
known as Euler’s constant)
Example 8:
FV Continuous Compounding

You invest $1,000 in an account today. The interest is

10% p.a., compounded continuously. What will the
balance be in the account at the end of five years?

FV5  C  e r  n  $1,000  e 0.10(5)

 $1,000(1.64872)  $1,648.72
Example 9:
PV Continuous Compounding
Suppose you want a balance of $1,000 at the end of five years. If interest on
the account is 10% p.a., compounded continuously, how much must you
deposit today?

C
PV 
rn
e
$1,000

e0.105
 $1,000 / 1.64872  $606.53
Today we have been talking about single lump sum cash flows.

Next week we will turn our attention to the remaining cash flow
patterns we need to be familiar with, namely;
Mixed Stream
mixed or multiple cash flow stream
The perpetuity, and
(or Multiple Cash Flow)
The annuity
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