Finance for HR

Pitabas Mohanty

Introduction to the Course

Course Content
Finance Accounting

Level of Difficulty Pedagogy Evaluation

Two Quizzes (40%) Class Attendance (10%) End term Examination (50%)

Website for the Course

https://www.sites.google.com/a/xlri.ac.in/profmohanty

Imagine a few situations

You got two job offers and want to know which one to accept:
Job 1: Monthly salary Rs.75,000 Job 2: Monthly Salary Rs.50,000 and 100 employee stock options (can be exercised after 2 years)

You want to buy a house:

Bank A says: Take a mortgage loan at a floating interest of 9% pa Bank B says, Take a mortgage loan at a fixed interest of 8.75%, but with 2% processing fee

You want to invest your surplus money

Choice 1: Invest in bank fixed deposits Choice 2: Invest in ULIPs Choice 3: Invest in Mutual Funds Choice 4: Some combination of the above

Situations Contd.
You have a credit card outstanding of Rs.35,000. the bank says, pay at least Rs.700 now and the balance can be paid later.
You get tempted.

Your company has made Rs.500 crores profit. It however says it cannot increase your salary because there is no cash. You want to know why the stock market increases one day and falls the next day. By the end of this course, you should know how to analyze situations like this and how to make an informed judgment. You will also know what questions to ask your bank or insurance agent or broker.

Wife, Mother-in-Law and You

Wife and MIL are the only two owners of a company. You manage the company. Each of them has Rs.5000 with them. They will each get another Rs.5000 after one year. Assumptions made Lending and borrowing rates are equal to 10%. Assumptions made Wife wants to spend Rs.6000 today. MIL wants to spend Rs.4000 today.

Wife, M-i-L, You and a Land

Will you buy a land that is available at Rs.11000 now which you can sell at Rs.15000 after one year?
Assumptions made

Wife borrows Rs.7818.18. MIL borrows Rs.5818.18.

What happens if...

The resale value of the land is Rs.12,000 Wife borrows: Rs.6454.54 MIL borrows: Rs.4454.54 Loss in consumption today: Rs.45.45
That is Rs.45.45 for each one of them

Moral of the Story

Both wife and MIL accepted (rejected) the proposal despite having different preferences for consumption.
In fact any investor would accept any investment proposal having positive NPV.

The management of a company therefore does not need to consult the shareholders every time a decision is to be made.

Moral of the Story contd.

If NPV is positive, all shareholders accept the project. If NPV is negative, all shareholders reject the project. This result facilitated separation of management from ownership. So what is the basic objective of a finance manager?

Net Present Value

Why investing in the land is profitable for both the ladies? Meaning of Net Present Value

Moral of the Story

Invest in any Project with Positive NPV. All shareholders will accept it. Have a negative NPV project? Rest assured that all shareholders will reject it. Separation theorem
Also known as Unanimity Principle

This facilitates separation of management from ownership

Summary of the Results

A good project is a good project irrespective of who invests in that.
A bad project is a bad project

Always invest in positive NPV projects.

Time Value of Money

Creating a Pension Fund: Our Objective

Today (30) Monthly Spending: Rs.50,000 Inflation Rate: 6% Interest rate: 7.75% Expected return from stock market: 15%

Retirement (60)

Signing Off (80)

Basic Objective Create a pension fund today (30) and invest some Rs. X each month so that you have enough money at the time of retirement (60) to take care of your life after retirement (till 80)

Finding the Future Value of a Cash Flow

You invest Rs.100 in SBI at an interest rate of 10% per annum. How much will you get after one year? How much will you get after 2 years? How much after 5 years?
F P 1 r
n

Finding Monthly Pension Requirement

You spend Rs.50,000 per month today. You plan to retire after 30 years. The yearly inflation rate is 8% now. What should be your monthly pension? You believe that you will live for another 50 years. What is the last monthly pension you would require?

Doubling and Tripling your Money

You have Rs.100 with you and Corporation Bank gives 6% interest on its Fixed Deposits. How long should invest to double your money? How long should you invest to triple your money?
Rule of 72 Rule of 114

Annual Percentage Rate and Effective Rate

ICICI Bank currently charges 12.75% interest on its housing loans. What exactly does this mean? A Small Example:
You create a fixed deposit with SBI for 1 year. The bank gives you 10% interest per annum, but compounds twice a year. How much will you get after one year?
How much will you get after 2 years?

Effective Rates in case of

Credit card Delayed Payments In 2008, the Credit Card Industry got $55bn in credit card fees and $90bn in finance charges.

Finding Future Value of an Annuity

What is an annuity?
Same cash flow Same timing (frequency)
Examples: 60 monthly payments of Rs.5,000 each, 20 quarterly payments of Rs.25,000 each, 10 annual payments of Rs.50,000 each

Two types of annuities

Normal or Ordinary Annuity (cash flow starts one period from today)
Example: You take a loan and repay the bank in 60 EMIs starting from next month

Annuity Due (Cash flow starts today itself)

Example: You create a recurring deposit (like making 30 monthly deposits) with a bank and start depositing today itself.

Future Value of an Annuity

Future Value of a Normal Annuity
Today 1 2 3

(1 r ) FVA A
r

(1 r ) FVAD A
r

(1 r )

Maturity Value of a RD Account

You create a recurring deposit account with a bank. The bank gives you 6% interest per annum. You make 60 monthly deposits. How much will you get back if it is a normal annuity?
What if it is an ordinary annuity?

Jack and Jill go to the bankbut on different dates

Jack and Jill are both 20 years old and plan to retire at the age of 60. Jack decides to deposit Rs.5000 every year in a bank account for the next ten years Jill decides to deposit Rs.5000 every year after ten years (when she is 30) and continue to do so till she is 59. Rate of interest is 8% pa. Who will earn more at the time of retirement?

Finding Present Value of a Single Cash Flow

You need Rs.2,000,000 after 10 years. How much should you deposit in the bank today if the bank gives 7% interest?
F P n (1 r )

Getting a Loan from a Bank

TDH Bank charges 10% interest on all personal loans. You can pay Rs.110 next year to the Bank. How much loan will the Bank give you today? You can Rs.121 to the Bank after 2 years. How much loan will the Bank give you today? How much loan will the Bank give you if you can pay Rs.110 next year and Rs.121 two years from today?

Getting a Loan from a Bank

TDH Bank charges 12% interest on all housing loans. You can pay Rs1 every month to the Bank for the next 60 months. How much loan will the Bank give you today? What if you can pay Rs.1,000 a month? You want a loan of Rs.500,000. How much should you pay every month to the Bank against these 60 payments?

Reverse Mortgage
What is that? An Example:
You have a house valued at Rs.1 crores. The bank is willing to take the house from you at an estimated value of Rs.60 lakhs. The bank will give you monthly pension for the next 15 years. The rate of interest is 12% on this reverse mortgage. What is the monthly interest? After 5 years, suppose the value of the house is revalued at Rs.2 crores. What will be the new monthly pension if the rate of interest remains unchanged?

Few Practice Problems

You have the following two choices: Invest Rs.1000 today and receive Rs.200, Rs.300, Rs.400, and Rs.500 respectively in the next four years Invest Rs. 1000 today and receive Rs.250, Rs.350, Rs.350, and Rs.450 respectively in the next four years Interest rate is 10%. What should you do?

Practice Problem
Julie Miller is borrowing $10,000 at a compound annual interest rate of 12%. Amortize the loan if annual payments are made for 5 years.
End of Payment Interest Principal Ending Year Balance 0 ------$10,000 1 2 3 4 5 $2,774 2,774 2,774 2,774 2,775 $13,871 $1,200 1,011 800 563 297 $3,871 $1,574 1,763 1,974 2,211 2,478 $10,000 8,426 6,663 4,689 2,478 0

Practice Problem: Add-On Interest

You buy a Home Theatre system costing Rs.25,000 from a dealer. The dealer offers you a five year loan at an interest of 10 percent. His calculations: Annual interest = Rs.2500 Total interest = Rs.12500 Total payments = Rs.37500 Annual Payment = Rs.7500 What is the effective rate he is charging?