Finance Tuition Topics
Time Value of money
The phrase ‘A Bird in the Hand is Worth Two in the Bush’ is used for saying that it’s better to hold onto something one has already than to risk losing it by trying to attain something better.
Similarly, that is the concept for time value of money. Having that $1 now (Present Value) is worth so much more than that $1 in the future (Future Value). Present value and Future value of money are calculated based on discounting and compounding factors. Below are the formulas for the Future and Present value of money.
Annuities and Perpetuity
An annuity is a series of payments made at equal intervals. There are 2 forms of annuities – ordinary annuities and annuities due. The payments in an ordinary annuity occur at the end of each period. In contrast, an annuity due features payments occurring at the beginning of each period.
Think about insurance premiums or car installments. They are a form of annuities.
A perpetuity is an annuity that has no end, or a stream of cash payments that continues forever.
Net Present Value (NPV) and irr
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.
It is just a form of calculating total returns by discounting all future cashflows and assessing if profits or losses will be made. The NPV formula is as follows :
Internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
Simply, it is the rate of return an investment can earn for you.
Payback period refers to how long you take to recover the initial investment you made. For example, you invested in shares worth $100,000. Every year, you are able to get dividends of $20,000. It takes you 5 years to recover the initial investment.
Therefore, the payback period is 5 years. Naturally, it will mean that the shorter the payback period, the more attractive the investment will be.
In doing equity valuation, present value discounting is applied to dividends and share price in order to derive the theoretical share price.
The Net Present Value (NPV) model is modified to account for dividends as cash flow and share price as the final value.
In a nutshell, just discount all the dividends and future share price that you will be selling the shares for. Add up the total and that is your theoretical share price.
A bond is a interest paying financial investment that will pay your initial investment when it is due.
Think of a fixed deposit but only that bonds can be sold anytime to another investor if you do not want to own it before due date.
Bond valuation is similar to equity valuation. The value of the bond is derive from the present value of future interest payment and the initial investment you will get in future.
Capital asset pricing model (CAPM)
Capital asset pricing model is a model that describes the relationship between the expected return. It is based on the concept of risk free rate, market returns and Beta.
What is Beta? Beta refers to the relationship measured by correlation between the investment and the market.
In other words, it is to calculate the returns that you expect from an investment based on its relationship with the market. The CAPM model is as follows :
weighted average cost of capital (wacc)
Weighted average cost of capital is the measurement of the cost that the company will pay to its creditor and shareholders.
It is used as the basis to assess investment or projects to be undertaken. For example, if a company’s WACC is 10%, it will not accept any form of investment that earns less than 10% as this is the company’s cost.
The formula for WACC is as follows :
How are you going to deliver Finance content to me when it sound so technical?
I recalled once my ex trainee who was a working as a Director for one of the aviation service industry. He did not had an accounting or finance background and thus, it was not easy for him to understand what these finance jargons were all about. What is even a bond to start off with and how does bond works.
It was only then that i realised working adults might had years of experience in their own field but they might not know the very basics of finance world.
I took on a different approach to coaching working adults and thus never assume that years of working = years of finance knowledge.
I started making jargons layman form and simple to understand for the working adults and soon enough, they are able to comprehend it well enough. Finance is always making simple things harder to understand with their own form of language.
How about full time students? will we find it hard to understand finance?
It will not be hard for full time students to learn about finance even though they had no working experience. As mentioned, even working adults who were not from the finance industry had some difficult understanding it.
The key is for me to deliver the content via a simplistic manner to the student. It is simple. Finance, is something the student is practicing every single day. From the simple budget for a graduation holiday to getting the monthly allowance and planning how to save it for his or her next hobby purchase. These are all basic finance. So, what’s so hard to understand?