Finance for HR-Intro

7/31/2019 Finance for HR-Intro

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Finance for HR

Pitabas Mohanty


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


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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


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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.


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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.


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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.


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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


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Moral of the Story

Both wife and MIL accepted (rejected) theproposal despite having different preferencesfor consumption.

In fact any investor would accept any investmentproposal having positive NPV.

The management of a company thereforedoes not need to consult the shareholdersevery time a decision is to be made.


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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?


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Net Present Value

Why investing in the land is profitable for both

the ladies?

Meaning of Net Present Value


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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


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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.


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Time Value of Money


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Creating a Pension Fund: Our

Objective

Today

(30)

Retirement

(60)

Signing Off

(80)

Monthly Spending:

Rs.50,000

Inflation Rate: 6%

Interest rate: 7.75%

Expected return from stockmarket: 15%

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)


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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?

nrPF 1


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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?


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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 tripleyour money?

Rule of 72

Rule of 114


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Annual Percentage Rate and Effective

Rate

ICICI Bank currently charges 12.75% interest onits 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 compoundstwice 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.


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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 paymentsof 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 startingfrom 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.


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Future Value of an Annuity

Future Value of a Normal Annuity

Today 1 2 3 n

A A A

A

r

rAFVA

n1)1(

)1(

1)1(r

r

rAFVAD

n


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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 normalannuity?

What if it is an ordinary annuity?


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Jack and Jill go to the bankbut on

different dates

Jack and Jill are both 20 years old and plan toretire 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?


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Finding Present Value of a Single Cash

Flow

You need

Rs.2,000,000 after

10 years. How

much should youdeposit in the bank

today if the bank

gives 7% interest?

nr

FP

)1(


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Getting a Loan from a Bank

TDH Bank charges 10% interest on all personalloans.

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 youcan pay Rs.110 next year and Rs.121 two yearsfrom today?


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Getting a Loan from a Bank

TDH Bank charges 12% interest on all housingloans.

You can pay Rs1 every month to the Bank for

the next 60 months. How much loan will theBank give you today?

What if you can pay Rs.1,000 a month?

You want a loan of Rs.500,000. How muchshould you pay every month to the Bankagainst these 60 payments?


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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 estimatedvalue of Rs.60 lakhs. The bank will give you monthlypension for the next 15 years. The rate of interest is12% on this reverse mortgage. What is the monthlyinterest?

After 5 years, suppose the value of the house isrevalued at Rs.2 crores. What will be the new monthlypension if the rate of interest remains unchanged?


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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 yearsInterest rate is 10%.

What should you do?


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Practice Problem

Julie Miller is borrowing $10,000 at a

compound annual interest rate of12%.

Amortize the loan ifannual payments are made

for 5 years.End ofYear

Payment Interest Principal EndingBalance

0 --- --- --- $10,000

1 $2,774 $1,200 $1,574 8,426

2 2,774 1,011 1,763 6,6633 2,774 800 1,974 4,689

4 2,774 563 2,211 2,478

5 2,775 297 2,478 0

$13,871 $3,871 $10,000


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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?

Documents

Finance for HR-Intro