1. CDAE 266 - Class 04 Sept. 6 Last class: 1.Introduction 2.Review of economic and business concepts Today: 2. Review of economic and business concepts Class exercise 1 and class exercise 2 Next class: 2. Review of economic and business concepts Quiz 1 Important date: Problem set 1: due Tuesday, Sept. 18

2. 1. Introduction 1.1. Small businesses in the U.S. economy 1.2. A global perspective of entrepreneurship 1.3. Quantitative methods for business decision making 1.4. Decision making process 1.5. Applications of quantitative methods 1.6. Decision making for community entrepreneurs

3. 2. Review of Economics Concepts 2.1. Overview of an economy 2.2. Ten principles of economics 2.3. Theory of the firm 2.4. Time value of money 2.5. Marginal analysis 2.6. Break-even analysis

4. 2.1. Overview of an economic system 2.1.1. Who are the major players? 2.1.2. What are their relations?

5. 2.2. Ten principles of economics How people make decisions: (1) People face tradeoffs (2) The cost of something is what you give up to get it (3) Rational people think at the margin (4) People respond to incentives How people interact: (5) Trade can benefit both sides (6) Markets are usually a good way to organize …. (7) Government can sometimes improve market …

6. 2.2. Ten principles of economics How the economy as a whole work: (8) A country’s standard of living depends on … (9) Prices rise when the government prints too much $ (10) Short-run tradeoff between inflation and unemployment

7. 2.3. Theory of the firm 2.3.1. Definition of a firm or business: An organization that combines and organizes resources for the purpose of producing goods and/or services for sale.

8. 2.3. Theory of the firm 2.3.2. Theory of the firm -- Profit maximization -- Expected value maximization -- Management utility maximization -- Sales maximization 2.3.3. Market structures -- Perfectly competitive market -- Monopoly -- Oligopoly

9. 2.4. Time value of money 2.4.1. What is the time value of money? 2.4.2. How to calculate the TVM? 2.4.3. Future value and compounding 2.4.4. Present value and discounting 2.4.5. Future value of an annuity 2.4.6. Present value of an annuity 2.4.7. Compounding & discounting periods 2.4.8. Perpetuities 2.4.9. How to calculate the TVM using Excel?

10. 2.4.1. What is the time value of money (TVM)? 2.4.2. How to calculate the TVM? -- Formulas -- Tables -- Computer program in Excel 2.4.3. Future value and compounding -- Formula: FV n = PV (1 + r) n -- Table A -- Practice question: What is the future value of $4000 in 5 years from today if the annual interest rate is 6%?

11. Class Exercise 1 ( Thursday, Sept. 6 ) 1. What is the future value of $3000 in 6 years from today if the annual interest rate is 6%? 2. Mr. Smith deposited $3000 into a saving account five years ago and the current balance is $4615.8. What was the annual interest rate of his saving account (assume the interest rate was fixed in the past two years and interest was paid only once a year)?

12. 2.4.4. Present value and discounting -- Formula: PV = FV n / (1 + r) n -- Table B: PV = FV n * Factor B -- Example question: What is the present value of $4000 due in 5 years from today if the annual discount rate is 7%?

13. 2.4.5. Future value of an annuity -- What is an annuity? -- Formula -- Table C: FVA n = A * Factor C -- Example question: Mr. Smith has just opened an education account for his 10-year-old son. If Smith deposits $2,000 in the end of each year over the next 8 years and the account has a fixed annual interest rate of 9%, how much money will be available in the account when his son is 18 (i.e., 8 years from today)?

14. 2.3.6. Present value of an annuity -- Formula -- Table D: PVA n = A * Factor D -- Example question: Suppose that you are the winner of a lottery ticket and you will receive $5,000 in the end of each year over the next 3 years. What is the present value of the ticket if the annual interest (discount) rate will be fixed at 6% in the next 3 years.

15. More annuity examples: Example 1: Mr. Johnson has just borrowed $3,000 to buy a new computer and will pay back the money by 6 equal end-of-year payments in the next 6 years. If the fixed interest rate is 5%, how much does he need to pay in the end of each year? Example 2: Mortgage problems

16. Class Exercise 2 (Thursday, Sept. 6) Mrs. Sullivan would like to save money to replace her car in 5 years from today by depositing the same amount of money in the end of each year over the next 5 years. If the estimated cost for a new car in 5 years from today is $25,000 and the interest rate is 6% per year, how much does she need to deposit each year?