NAME: GRADE & STRAND:

Business Finance

Lesson 4: Basic Long-Term Financial Concepts

WHAT I NEED TO KNOW?

At the end of this lesson, you will able to:

1. distinguish simple and compound interest;
2. solve exercises and problems in computing for time value of money with the aid of present and
future value tables;

WHAT I KNOW?
For your pre – test turn on page 5.

WHAT’S IN?

“A peso today is worth more than a peso

tomorrow”. The time value of money would tell
us that a peso today is not equal to a peso in the
future.
The most basic finance-related formula is the
computation of interest. It is computed as
follows:
where:

𝐈 = P× Rt (Equation 4.1)
I = interest P = Principal
R = Interest rate T = Time period
Figure 1 [Link]
[Link]

As a review, try this exercise by identifying the a) principal, b) interest rate, and time period in the
examples below.
1. Your mother invested P 18 000 in government securities that yields 6% annually for two
years.
2. Your father obtained a car loan for P 800 000 with an annual rate of 15% for 5 years.

Long Term Finance

Long-term finance can be defined as any financial instrument with maturity exceeding one
year (such as bank loans, bonds, leasing and other forms of debt finance), and public and private
equity instruments. Maturity refers to the length of time between origination of a financial claim
(loan, bond, or other financial instrument) and the final payment date, at which point the remaining
principal and interest are due to be paid. Equity, which has no final repayment date of a principal,
can be seen as an instrument with nonfinite maturity. The one year cut-off maturity corresponds to
the definition of fixed investment in national accounts. The Group of 20, by comparison, uses a
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maturity of five years more adapted to investment horizons in financial markets (G-20 2013).
Depending on data availability and the focus, the report uses one of these two definitions to
characterize the extent of long-term finance. Moreover, because there is no consensus on the
precise definition of long-term finance, wherever possible, rather than use a specific definition of
long-term finance, the report provides granular data showing as many maturity buckets and
comparisons as possible.

Long-term financing means financing by loan or borrowing for more than one year by
issuing equity shares, a form of debt financing, long-term loans, leases, or bonds. It is usually done
for big projects, financing, and company expansion. Such long-term financing is generally of high
amount.

The fundamental principle of long-term finances is to finance the strategic capital projects of
the company or to expand the company’s business operations.
These funds are normally used for investing in projects that will generate synergies for the
company in the future years.
E.g.: – A 10-year mortgage or a 20-year lease

Advantages of Long-Term Financing

 Align specifically to the long-term capital objectives of the company
 Effectively manages the asset-liability position of the organization
 Provides long-term support to the investor and the company for building synergies
 Opportunity for equity investors to take controlling ownership in the company
 Flexible repayment mechanism
 Debt diversification
 Growth and expansion

Limitations of Long-Term Financing

 The regulators lay down strict regulations for the repayment of interest and principal
amounts.
 High gearing on the company may affect the valuations and future fundraising.
 High gearing on the company may affect the valuations and future fundraising.
 Stringent provisions under the IBC Code for non-repayment of the debt obligations may
lead to bankruptcy
 Monitoring the financial covenants in the term sheet is very difficult.

WHAT’S NEW?

For the introduction of our lesson turn on page 5.

WHAT IS IT?

In general business terms, interest is defined as the cost of using money over time. This
definition is in close agreement with the definition used by economists, who prefer to say that
interest represents the time value of money.
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Interest is the excess of resources (usually cash) received or paid over the amount of resources
loaned or borrowed which is called the principal.

If you decided to invest your

money in a bank, you will ask the banker
how much interest you will get. The
banker will explain that there are two
types of interest that would be used to
determine the amount of interest that you
are going to receive. Remember that
interest is beneficial for you when you are
receiving it but not when you are paying it.
So, it is important to know which type of
interest when deciding where to put your
money and where to get the money.

SIMPLE INTEREST
Simple interest is the product of the
principal amount multiplied by the period’s
interest rate (a one-year rate in standard).
Example 1: You invested P 10 000 for 3
years at 9% and the proceeds from the Figure 2
investment will be collected at the end of [Link] 3
years. Using a simple interest interest
assumption, the calculation will be as follows:

Year Principal Interest Cumulativ

1 P 10 000 10 000 x 0.09 = P 900 P9

2 P 10 000 10 000 x 0.09 = P 900 P1

3 P 10 000 10 000 x 0.09 = P 900 P2

Using the formula in Equation 4.1, simple interest can

be computed.

COMPOUND INTEREST

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 Compound interest is the interest paid on both the principal and the amount of interest
accumulated in prior periods.
Example 2: Using example 1 where you invested P 10 000 for 3 years at 9% and the proceeds
from the investment will be collected at the end of 3 years, compound interest will be computed as
follows:

Figure 3
[Link]
cartoon-systematic-investment-plan-money-

Year Principal Interest Cumulative Interest Total

1 P 10 000 10 000 x 0.09 = P 900 P 900 P 10 900

2 P 10 900 10 900 x 0.09 = P 981 P 1 881 P 11 881

3 P 11 881 11 881 x 0.09 = P 1 069.29 P 2 950.29 P 12 950.29

FV = (𝟏 + 𝒊)𝒏
For compound interest, use the formula

where:
FV = Future Value
P = Principal
i = Interest rate per compound interest period or periodic rate
n = Time period or number of compound interest periods

Subtract the principal from the future value to get the compound interest. Hence, I c= FV – P.

In order to gain a better undrstanding of what goes exactly in simple and compound
interest, a step by step approach will be used using the given example in the time line disccusion.

Problem: Pretend you are able to save P500 with a annual interest of 5%, every year from the
allowance that you receive from your parents. If you are to draw a time line for one school year,
how would it look like? How do you intend to use the money have saved after the school year?

0 1 2 3

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Amount in the P500 P525 P551.25 P578.81
Beginning of the period

 at the beginning of Period 1, the amount of money is P500. It is invested at an interest

compunded for three years.
 By the end of perdio 1 (year 1), you earned P500 (.05) = P25.00; hence, your total money
becomes P525. That you will be your beginning for the beginning of Period 2 (year 2).
 By the beginning of period 2, you will already have a higher balance of P525. Repeating the
process: P525 (0.05) = P26.25. by the end of period 2, you will have earned P26.25 in
interest. Your total balance by the end of period 2 will be P551.25
 By the end of period 3 (year 3), the balance would be P578.81
 If you noticed, the interest in the previous was added to the balance. In effect, the interest
also earned interest in the next period. This is called compound interest.

Figure 4 [Link] Time

value of money is the idea that money available now is worth more than the same amount that will
be available in the some future date. The worth is founded on the principle that money has earning
capacity. The same principle also states that unless the present value is outweighed by the amount
of interest it would earn, money is worth more if it is made available to you the soonest.

Time value of money is an important concept applied in financial and investment decisions,
the two prime consideration are interest compounding and discounting. Interest compounding and
used appropriately – come up with cash flow estimates.

Time line, in business, is a graphical representation of the timing of cash flows. It is

important tool in analyzing that time value of money.

FUTURE VALUE OF MONEY

To account for time value for single lump-sum payment, we use the same formula provided
for under compound interest rates.
FV = (𝟏 + 𝒊)𝒏
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Where, PV = Present Value
(𝟏 + 𝒊)𝒏 = Future value interest factor (FVIF)*
The future value is the value of the present value after n time periods.

Example 3: Using the formula, find the future values of P 1 000 compounded at a 10%
annual interest at the end of one year, two years and five years.

Solution: PV = P 1 000 and i = 0.10

Year 1 FV = P 1 000 (1 + 0.10)1 = P 1 100*
Year 2 FV = P 1 000 (1 + 0.10)2 = P 1 210*
Year 5 FV = P 1 000 (1 + 0.10)5 = P 1 610.50*

Example 4: Determine the compound amount on an investment at the end of 2 years if P 20 000 is
deposited at 4% compounded a) semi-annually and b) quarterly.

a) Given: PV = P 20 000,
i = 0.04/2,
n=2x2=4

( )
4
0.04
FV =20,000 1+ =P 21,648
2
b) Given: PV = P 20 000
i = 0.04/4
n=4x2=8

( )
8
0.08
FV =20,000 1+ =P 21,658
4

PRESENT VALUE OF MONEY

To get the present value of a lump-sum amount, we rearrange Equation 4.2:

PV = 𝐅𝐕 (𝟏 + 𝒊)−𝒏

where, (𝟏 + 𝒊)−𝒏 = Present value interest factor (PVIF)* or discount factor

Example 5: Jack would like to buy a car two years from now using the proceeds of a 20%
investment that is compounded semi-annually. If the projected price of the car is P 1 400
000, how much money must be invested today to earn the price of the car?

Solution:
Given: FV = P 1 400 000,
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 i = 0.20/2,
n = 2 x 2 years = 4

( )
−4
0.20
PV =1,400,000 1+ =P 956,200
2

WHAT’S MORE?

For your activity turn on page 9.

WHAT I CAN DO?

For the application for this module turn on page 9.

WHAT I HAVE LEARNED?

Time value of money is the idea that money available now is worth more than the same
amount but will not be available until some future date. The principle behind has nothing to do with
inflation or the possibility that the buying power of the money will diminish over time. The principle
is based on the earning capacity of money – which money will received now can be reinvested and
will gain earning after a certain amount of time.

The principle of compounding is important to investors. In compounding, the interest that

was earned from the previous period is added to the principal. Then additional interest is earned on
the interest.
ASSESSMENT

Solve each problem. You can attached a short bond paper for your answer and
computation.
1. Lisa receives an amount of P 20 000 deposited in her account on her 18th birthday. If the
bank pays 6% interest monthly and no withdrawals are made, how much should be credited in her
account on his 21st birthday?

2. James borrows P 5 000 with interest at 15% quarterly. How much should he pay at the end
of 2 years and 6 months to settle her debt?

3. Mr. Santos invested P 15 000 in an account for each of his children. The accounts paid 8%
compounded semi-annually. Determine the balance of each account for the following:
a. The youngest child withdrew the balance after 5 years for college
b. The second child withdrew the balance after 8 years to buy a car
c. The third child withdrew the balance after 10 years to travel

References

Book;
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Albert N. Gamatero, Business Finance, Diwa Learning Systems Inc. 2017

Unpublished References;
Monina C. Raagas, Business Finance Alternative Delivery Mode, Module 4 - Quarter 1: Basic
Long-Term Financial Concepts First Edition, 2020

NAME: GRADE & STRAND:

Business Finance
Lesson 4 ANSWER SHEETS

General Instructions: This answer sheet is use for the answer and solutions purposes only.
If the answer sheet is not enough you can use another separate sheet (short bond paper) and
please attached it in this answer sheet.

WHAT I KNOW?

A. TRUE OR FALSE. On the space provided, write TRUE if the idea being expressed is
correct and FALSE if otherwise.
_________ 1. Interest represents the time value of money.
_________ 2. Compound interest is the product of the principal amount multiplied by the period’s
interest rate.
_________ 3. Simple interest is the interest paid on both the principal and the amount of interest
accumulated in prior periods.
_________ 4. Present value is the current value of a future amount of money, or series of
payments, evaluated at an appropriate discount rate.

WHAT’S NEW?

Fill in the blanks of the table involving a simple interest.

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Principal Rate Time Interest

P 8 000 1) 7 months P 210

P 15 000 4.8% 2) P 300

3) 4.5% 4 months P 500

P 1 000 4) 1 yr & 3 months P 70

P 4 500 0.25% 5 and a half years 5)

WHAT’S MORE

Complete the table for a compound interest involving P 40 000 loaned for a period of 5 years with
6% interest compounded annually.
Principal Interest Amount (at the
at the end of the
start of
the year year)

1st year P 40 000 40 000 x 0.06 x 1 = P 2 400.00 P 40 000 +P 2

400 =
P 42 400.00
2nd year
3rd year
4th year
5th year

WHAT I CAN DO?

[Link]: Complete the table to find the compound amount of P 50 000.00 invested at 10%
interest. Show your solutions.
In 1 year In 5 years In 10 years
1. Compounded annually
2. Compounded semi-annually
3. Compounded quarterly
4. Compounded monthly
5. compounded daily

ASSESSMENT
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