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ENTREPRENEURIAL FINANCE Fourth Edition

ENTREPRENEURIAL FINANCE Fourth Edition. Chapter 1 Financial and Economic Concepts. Learning Objectives. Understand the basic concepts and importance of finance as it relates to individuals and business. Understand the basic economic concepts of finance.

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ENTREPRENEURIAL FINANCE Fourth Edition

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  1. ENTREPRENEURIAL FINANCEFourth Edition Chapter 1 Financial and Economic Concepts

  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. 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. Opportunity Costs • The highest value that is surrendered when a decision to invest funds is made.

  5. Choices Available for Funds

  6. Examples of Opportunity Cost • Decide to purchase car • Opportunity cost = Stock

  7. However, if you decided to purchase stock rather than the car • Opportunity cost = Home

  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. 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. 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.

  11. Example of Progressive Tax • Formula for tax percentage paid: • Income tax is progressive:

  12. 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

  13. 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

  14. Flat Tax Proposal

  15. 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.

  16. Factors Affecting Interest Rates (continued) • 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.

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