1. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-1 ENTREPRENEURIAL FINANCE Fourth Edition Chapter 1 Financial and Economic Concepts

2. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-2 Learning Objectives  Understand the basic concepts and importance of finance as it relates to individuals and business.  Understand the basic economic concepts of finance.  Distinguish between marginal revenue and marginal cost.  Distinguish between economic capital and financial capital.  Determine the opportunity cost of making decisions.  Identify the relationship that exists between savings, income, expenditures, and taxes.

3. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-3 Learning Objectives (continued)  Identify those factors that affect interest rates.  Understand the relationships that exist between supply and demand for money and prevailing market interest rates.  Describe the role of the Federal Reserve and those tools used to achieve the goals of economic growth, price stability, and full employment.  Understand the relationship that exists between risk and return on investment.  Compare systematic risk to unsystematic risk and their impact on business.

4. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-4 Opportunity Costs  The highest value that is surrendered when a decision to invest funds is made.

5. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-5 Choices Available for Funds Table 1-1 Expected Financial Returns of Investment Opportunity Investment OpportunityExpected Annual Return (%) Purchase stock11 Purchase home9 Purchase bonds6 Place money in bank savings account2 Purchase new car-15

6. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-6 Examples of Opportunity Cost  Decide to purchase car  Opportunity cost = Stock

7. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-7  However, if you decided to purchase stock rather than the car  Opportunity cost = Home

8. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-8 Income, Expenditures, and Taxes  Gross income is all of the money received from all sources during the year. › Wages › Tips › Interest earned on savings and bonds › Income from rental property › Profits to entrepreneurs

9. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-9 Basic Income Calculations  Gross income - taxes = Disposable income › For most of us, disposable income is take-home pay.  Disposable income - Fixed expenses = Discretionary income › Fixed expenses are contractual obligations like rent, utilities, insurance, and car payments. › Discretionary income is that we can spend or save.

10. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-10 Table 1-3 Income and Expenses of Variable Households Household NameGross Income ($) Income, SS, & Medicare Taxes ($) Federal Taxes Paid as a % of Gross Income Disposable Income ($) Fixed Expenses ($) Discretionary Income ($) Jones 30,0005,22817.43%24,77319,6735,100 Roberts 50,0009,75819.52%40,24332,6837,560 Smith 70,00016,50223.57%53,49940,17913,320 Brown 90,00023,43226.04%66,56941,36925,200 Meeks 110,00028,81426.19%81,18642,30638,880 Adams 130,00035,10427.00%94,89648,09646,800 Charles 150,00041,39427.60%108,60650,71857,888 Source for taxes: Department of the Treasury, Internal Revenue Service, Publication 15 (Rev. January 2002)

11. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-11 Taxes  Progressive taxes: larger percentage of tax paid as income increases.  Regressive taxes: larger percentage of tax paid as income decreases.  Proportional taxes: percentage of tax paid remains the same at all levels of income.

12. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-12 Example of Progressive Tax  Formula for tax percentage paid:  Income tax is progressive:

13. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-13 Example of Regressive Tax  Sales tax is regressive: › Income = $20,000; savings = 0; sales tax = 5% › Sales tax paid = $20,000 x 0.05 = 1,000 › Income = $60,000; savings = $10,000; sales tax = 5% › Sales tax paid = $50,000 x 0.05 = $2,500

14. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-14 Example of Proportional Tax  Formula for tax percentage paid: › Medicare tax is 1.45% › Annual income $30,000 › Medicare tax = $30,000 x 0.0145 = $435 › Annual income $500,000 › Medicare tax=$500,000 x 0.0145 = $7,250

15. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-15 Flat Tax Proposal

16. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-16 Factors Affecting Interest Rates  The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds.  The demand for borrowed funds is all of the money that is demanded in our economy at a given price.

17. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-17  Federal Reserve Policy › The Federal Reserve is the central bank of the United States.  Risk › Systematic Risk: Risk associated with economic, political, and sociological changes that affect all participants on an equal basis. › Unsystematic Risk: Risk unique to an individual, firm, or industry. Factors Affecting Interest Rates (continued)

18. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-18

19. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-19

20. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-20

21. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-21

22. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-22

23. $$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 1-23 Table 1-6 Money Rates, as of August 5, 2005 Type of RateDefinitionRate (%) Discount The charge on loans to depository institutions by the New York Federal Reserve Bank4.25 Federal Funds The rate banks charge each other for overnight loans in minimum amounts of $1 million3.44 T-bill, three months The rate on government treasury bills sold at a discount of face value in units of $10,0003.47 Prime The interest rate that banks charge their most creditworthy customers6.25 Source: Federal Reserve Statistical Release H.15 – August 5, 2005