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

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

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

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

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

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

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

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

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

$$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 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, %24,77319,6735,100 Roberts 50,0009, %40,24332,6837,560 Smith 70,00016, %53,49940,17913,320 Brown 90,00023, %66,56941,36925,200 Meeks 110,00028, %81,18642,30638,880 Adams 130,00035, %94,89648,09646,800 Charles 150,00041, %108,60650,71857,888 Source for taxes: Department of the Treasury, Internal Revenue Service, Publication 15 (Rev. January 2002)

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

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

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

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

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

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

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

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

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

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

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

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

$$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 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, Prime The interest rate that banks charge their most creditworthy customers6.25 Source: Federal Reserve Statistical Release H.15 – August 5, 2005