Finance notes

Fundamentals of financial decisionmaking

The first step to any decisionmaking is identifying costs and benefits.Clearly articulating how the costs and benefits are determined, example using the market, historical data or forecast based on some mathemathical model.

Once this is done converting costs and benefits to a common denominator and then comparing provides a solid basis for decisionmaking. For financial purposes and to begin with we consider time as thedifferenciating factor. TO compare costs and benefits that coudl be spread across time, we have to convert both to a single point for comparison. Interest rates are typically used as the exchange rate across time.

When the costs and benefits of any investment is calculated in terms of cash today we term the value as Present value (PV).

We Define Net Present Value NPV = PV(benefits)-PV(costs).

alternatively NPV = PV(all cash flows)

NPV decision rule states that when comparing projects or investments choose the project withthe highest and positive NPV. ( no exceptions)

Law of one price:

If equivalent goods or services trade simultaneously in different competitive markets, then they will trade for the same price in both markets.


Three rules of time travel

1. Only values at the same point in time can be compared or combined.
2. To move cash forward in time you must compound it FV = C * (1+r)^n
3. To move cash backward in time you must discount it PV = C/(1+r)^n


This pretty much summarizes the basic transformation. using timelines and the above formulae, we can compute, compare and contrast complex real live situations.

THats all for now :-)