ENTREPRENEURIAL FINANCEFIFTH EDITION
Chapter 1Financial and Economic Concepts
1
Chapter One Objectives
2
Opportunity Costs
The highest value that is surrendered when a decision to invest funds is made.
3
Choices Available for Funds
Table 1-1 Expected Financial Returns of Investment Opportunity
Investment Opportunity Expected Annual Return (%)
Purchase stock 11
Purchase home 9
Purchase bonds 6
Place money in bank savings account 2
Purchase new car -15
Examples of Opportunity Cost
Decide to purchase car
Opportunity cost = Stock
However, if you decided to purchase stock rather than the car
Opportunity cost = Home
Income, Expenditures, and Taxes Gross income is all of the money
received from all sources during the year.WagesTipsInterest earned on savings and bondsIncome from rental propertyProfits to entrepreneurs
7
Basic Income Calculations Gross income - taxes = Disposable income
For most of us, disposable income is take-home pay.
Disposable income - Fixed expenses = Discretionary incomeFixed expenses are contractual obligations like
rent, utilities, insurance, and car payments.Discretionary income is that we can spend or
save.
8
Household Name
Gross Income ($)
Income, SS, & Medicare Taxes ($)
Federal Taxes Paid
as a % of Gross
IncomeDisposable Income ($)
Fixed Expenses ($)
Discretionary Income ($)
Jones 30,000 5,228 17.43% 24,773 19,673 5,100Roberts 50,000 9,758 19.52% 40,243 32,683 7,560Smith 70,000 16,502 23.57% 53,499 40,179 13,320Brown 90,000 23,432 26.04% 66,569 41,369 25,200Meeks 110,000 29,912 27.19% 80,088 41,208 38,880Adams 130,000 36,202 27.85% 93,798 46,998 46,800Charles 150,000 42,492 28.33% 107,508 49,620 57,888
Department of the Treasury, Internal Revenue Service, Publication 15 (Rev. January 2008).
9
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.
10
Example of Progressive Tax
Formula for tax percentage paid:
100 x dollarsin Income
dollarsin payment Tax PercentageTax
15% 100 x $20,000
$3,000 percentageTax
28% 100 x $60,000
$16,000 percentageTax
Income tax is progressive:
11
Example of Regressive Tax
5% 100x $20,000
$1,000 percentageTax
4.17% 100x $60,000
$2,500 percentageTax
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
12
Example of Proportional Tax
Formula for tax percentage paid:Medicare tax is 1.45%Annual income $30,000Medicare tax = $30,000 x 0.0145 = $435Annual income $500,000Medicare tax=$500,000 x 0.0145 = $7,250
13
Flat Tax Proposal
Gross Income ($)
Taxes Paid ($)
Percentage of Income Paid in Taxes %
30,000 - 0.0040,000 1,700 4.2550,000 3,400 6.8060,000 5,100 8.5070,000 6,800 9.7180,000 8,500 10.6390,000 10,200 11.33
100,000 11,900 11.90110,000 13,600 12.36120,000 15,300 12.75130,000 17,000 13.08140,000 18,700 13.36
Table 1-2 Flat Tax Proposal
14
Factors Affecting Interest Rates
The supply of money saved is primarily the total money that is placed in demand deposit (checking) accounts, savings accounts, and money market mutual funds.
The demand for borrowed funds is all of the money that is demanded in our economy at a given price.
15
Factors Affecting Interest Rates (continued) Federal Reserve Policy
The Federal Reserve is the central bank of the United States.
RiskSystematic Risk: Risk associated with economic,
political, and sociological changes that affect all participants on an equal basis.
Unsystematic Risk: Risk unique to an individual, firm, or industry.
16
Table 1-4 Supply Table: Money Saved for Seven Sample Families
Annual Interest Rate (%) Jones Roberts Smith Brown Meeks Adams Charles Total
0 -$ -$ -$ -$ -$ -$ -$ -$ 2 - - - - - - - - 4 - - - 500 780 1,940 5,790 9,010 6 - - 670 1,250 1,940 2,720 7,530 14,110 8 100 200 930 1,760 2,020 3,890 12,000 20,900 10 200 500 1,500 3,000 3,500 7,000 16,000 31,700 12 250 750 2,500 5,000 6,000 10,000 20,000 44,500 14 300 1,000 3,250 9,000 12,000 15,000 25,000 65,550 16 400 1,200 4,500 12,000 18,000 23,000 31,000 90,100 18 500 1,500 6,000 15,000 25,000 28,000 38,000 114,000 20 500 1,700 8,000 18,000 30,000 32,000 40,000 130,200 22 500 1,700 8,000 18,000 30,000 33,000 41,000 132,200 24 500 1,700 8,000 18,000 30,000 33,000 41,200 132,400
Annual Savings ($000)
17
18
Interest Rate (%)
Amount Financed ($)
Interest Paid ($)
0 180,000 01 155,454 24,5462 135,274 44,7263 118,595 61,4054 104,731 75,2695 93,141 86,8596 83,396 96,6047 75,154 104,8468 68,142 111,8589 62,141 117,85910 56,975 123,02511 52,503 127,49712 48,609 131,39113 45,200 134,80014 42,199 137,80115 39,543 140,45716 37,181 142,81917 35,071 144,92918 33,177 146,82319 31,468 148,53220 29,922 150,07821 28,516 151,48422 27,233 152,76723 26,059 153,94124 24,980 155,020
Table 1-5 Ann Smith's Demand for Money
19
20
21
22
Type of Rate Definition Rate (%)
Discount The charge on loans to depository institutions by the New York Federal Reserve Bank 2.50
Federal Funds The rate banks charge each other for overnight loans in minimum amounts of $1 million 2.23
T-bill, three months The rate on government treasury bills sold at a discount of face value in units of $10,000 1.33
Prime The interest rate that banks charge their most creditworthy customers 5.25
Source: Federal Reserve Statistical Release H.15 - April 7, 2008
Table 1-6 Money Rates, as of April 7, 2008
Top Related