TYPES OF BUSINESS

1.  Proprietorship
2.  Partnership
3.  Corporation
1. PROPRIETORSHIP
-Business owned by one individual. This person is
responsible for the firm’s policies, owns all its assets,
and personally liable for its debts
-ADVANTAGES
*formed easily and inexpensively, no organizational
requirements, lower tax rates (compared to corporate)
-DISADVANTAGES
*personal liabilities, difficult to raise capital (inability to
issue bonds and stocks)
INTRODUCTION
TYPES OF BUSINESS

1.  Proprietorship
2.  Partnership
3.  Corporation
2. PARTNERSHIP
-Similar characteristics as proprietorship except that it has
multiple owners
- Established by written contracts specifying salaries,
contributions to capital, distribution of profits and losses
-Additional DISADVANTAGE
*Partners risk all their personal assets, even those not
invested in the business
TYPES OF BUSINESS

1.  Proprietorship
2.  Partnership
3.  Corporation
3. CORPORATION
-Legal entity, which is separate from owners and
managers, created under the provincial/federal law.
-MAJOR ADVANTAGES
*can raise capital from large numbers of investors by
issuing stocks and bonds
*permits easy transfer of ownership interest by trading
shared of stock
TYPES OF BUSINESS

1.  Proprietorship
2.  Partnership
3.  Corporation
3. CORPORATION
MAJOR ADVANTAGES
*It allows limited liability – personal liability is limited to
the amount of the individual’s investment in the business
*It is taxed differently

DISADVANTAGES
*Difficult and expensive to establish
*Subject to numerous governmental requirements and
regulations
Time Value of Money
Objectives

n  To describe the return to capital in the form of

interest (or profit)
n  To relate equivalence calculations and time
value of capital
Capital

n  Wealth in the form of money or property

that can be used to produce more wealth.
n  Debt capital (borrowed capital) is obtained
from lenders (e.g., through loans, sale of
bonds) for investment.
n  Equity capital is capital owned by individuals
who have invested their money or property in
a business project or venture in the hope of
receiving a profit.
Types of Capital

Financing Definition Instrument Description

• Debt • Borrow • Bond • Promise to

financing money pay
principle &
interest;

• Equity • Sell partial • Stock • Exchange

financing ownership of shares of
company; stock for
ownership of
company;
QUIZ:
Which would you prefer?
1. Which do you prefer? Why?
A. 100 Million pesos today
B. 50 Million today and 50 Million pesos
next year

2. If you invest your 1 Million pesos today in some

business and it will gain 10,000 pesos (1 %) next
year, will you pursue this business? Why?
Time Value of Money
q  earning power
(interest)
q  Purchase power
(inflation)
q  Time value of money
is measured in terms
of interest rate.
q  Interest is the cost of
money—a cost to the
borrower and an
This a two-edged sword whereby earning
earning to the lender grows, but purchasing power decreases
(due to inflation), as time goes by.
The Interest Rate
The Interest Rate
The Interest Rate
Elements of transactions involving Interest

n  1. An initial amount of money in transactions

involving debt or in investments is called the
principal

n  2. The interest rate measures the cost or price

of money and is expressed as percentage per
period of time
Elements of transactions involving Interest

n  3. A period of time called interest period, which

determines how frequently interest is calculated

n  4. A specified length of time marks the duration

of the transaction and thereby establishes a
certain number of interest periods.
Elements of transactions involving Interest

n  5. A plan for receipts or disbursements that

yields a particular cash flow pattern over a
specified length of time.

n  6. A future amount of money results from the

cumulative effects of the interest rate over a
number of interest periods.
CASH FLOW DIAGRAM

The estimated inflows (revenues) and outflows (costs) of

money

(+) Inflows – Revenue, tax savings, salvage value

(-) Outflow – operating costs, initial investment, tax
 End-Of-Period Convention
n  To simplify the effects of interest within an interest
period, it assumed that all cash flow transactions
occurs at the end of an interest period
 Cash Flow Transactions for Two Types of
Loan Repayment
Electronics manufacturing company borrows 20,000 from a bank at a 9%
annual interest rate. In addition, the company pays a 200 loan origination
fee. The bank offers 2 repayment plans
1) With equal payments made at the end of every year for the next five
years
2) single payment made after the loan period of five years
End of Year Receipts Payments
Plan 1 Plan 2
Year 0 $20,000.00 $200.00 $200.00
Year 1 5,141.85 0
Year 2 5,141.85 0
Year 3 5,141.85 0
Year 4 5,141.85 0
Year 5 5,141.85 30,772.48
Cash Flow Diagram for Plan 1
Methods of Calculating Interest

n  Simple interest: the practice of charging an

interest rate only to an initial sum (principal
amount).
n  Compound interest: the practice of
charging an interest rate to an initial sum
and to any previously accumulated interest
that has not been withdrawn.
 Simple Interest
n  P = Principal amount
n  I = Interest earned End of Beginning Interest Ending
Year Balance earned Balance
n  i = Interest rate
0 $1,000
n  N = Number of period
1 $1,000 $100 $1,100
n  Example:
q  P = $1,000 2 $1,100 $100 $1,200
q  i = 10%
3 $1,200 $100 $1,300
q  N = 3 years
Simple Interest Formula
F = P + (iP ) N
where
P = Principal amount
i = simple interest rate
N = number of interest periods
F = total amount accumulated at the end of period N

F = $1, 000 + (0.10)($1, 000)(3)

= $1,300
Compound Interest
n  P = Principal amount
n  i = Interest rate
End Beginning Interest Ending
n  N = Number of
of Balance earned Balance
interest periods Year
n  Example: 0 $1,000
q  P = $1,000
q  i = 10% 1 $1,000 $100 $1,100
q  N = 3 years 2 $1,100 $110 $1,210

3 $1,210 $121 $1,331

Compound Interest Formula

n = 0: P
n = 1: F1 = P(1 + i )
2
n = 2 : F2 = F1 (1 + i ) = P(1 + i )
M
N
n = N : F = P(1 + i )
Cash Flow Diagram
$1,331

0 1 2

F = $1, 000(1 + 0.10)3

$1,000
= $1,331
Some Fundamental Laws
F = m a
V = iR
2
E = m c

The Fundamental Law of Engineering Economy

N
F = P(1 + i)
 Practice Problem: Warren Buffett’s
Berkshire Hathaway
n  Went public in 1965: $18 per share
n  Worth as of 2006: $91,980
n  Annual compound growth: 23.15%
n  Current market value: $115.802 B
n  If his company continues to grow at
the current pace, what will be his
company’s total market value
when he reaches 100? ( lives till
100 (76 years as of 2006)
Market Value

n  Assume that the company’s stock will continue

to appreciate at an annual rate of 23.15% for the
next 24 years.

24
F = $115.802M
B (1 + 0.2315)
= $17.145 trillions
Example
n  Problem Statement
Consider the following sequence of deposits
and withdrawals over a period of 4 years. If
you earn a 10% interest, what would be the
balance at the end of 4 years?

0 1
$1,210

4
?
2 3

$1,000 $1,000 $1,500

 i = 10 %

$1,210 ?
0 1 3
2 4

$1,000 $1,000
$1,500
$1,100
$1,000
$1,210 $2,981
$2,100 $2,310
-$1,210 + $1,500

$1,100 $2,710
Solution
End of Beginning Deposit Withdraw Ending
Period balance made balance
n=0 0 $1,000 0 $1,000

n=1 $1,000(1 + 0.10) = $1,000 0 $2,100

$1,100

n=2 $2,100(1 + 0.10) = 0 $1,210 $1,100

$2,310

n=3 $1,100(1 + 0.10) = $1,500 0 $2,710

$1,210

n=4 $2,710(1 + 0.10) = 0 0 $2,981

$2,981
Seatwork
On the first day of the year, a man deposits $1000 in a
bank at 8% per year, compounded annually. He withdraws
$80 at the end of the first year, $90 at the end of the
second year, and the remaining balance at the end of the
third year.
a) Draw the cash flow diagram.

b) How much does he withdraw at the end of the third

year?

c) How much better off, in terms of net cash flow, would he

have been if he had not made the withdrawals at the ends
of years one and two?
THANK YOU!

- Lea Diola