Using a financial calculator

Using a financial calculator is a skill, similar to typing. You just need to know which steps to take and then you need to practice to the point when you feel comfortable with using a calculator.

In all explanations with a financial calculator we will be using an HP 10bll. Other financial calculators are similar, yet we find it easier to work with the HP. Most text books use HP calculators when providing guidance on using a financial calculator, so if you have a different calculator you may need to spend more time learning slightly different calculation steps. Before investing further time, it may be wise to get a universally used calculator.

Before using a financial calculator to make specific calculations such as calculating NPV or IRR, it is important to make sure that you:

1 – Clear the calculator – by pressing second function followed by “C All”

2 – Set calculator for the “END” by pressing second function followed by “BEG/END” and ensuring that the word “BEGIN” is not displayed. Exceptions to this rule occur when it is specifically stated in the problem that cash flows occur at the beginning of the period (for example, at the beginning of the year).

Again, if no sign appears on the display then you do not need to reset it as it is set for “END” by default. If it says “BEGIN” on the display, you need to press second function followed by “beg/end.”

When you set the calculator for the “END” of the period you do that because in the problem you are working with, cash inflow or outflow occurs at the end of the period. If the problem does not state when cash flows occur, you need to assume that it occurs at the “END” of the period.

The majority of calculations will require the “END” setting. If it is by mistake set for “BEGIN” but cash flows occur at the end of the period, then incorrect answers will be generated.

Therefore, it is advisable to keep it set for the “END” at all times as a default and only reset it for “BEGIN” when a calculation requires that to be done. Right after a calculation is completed that requires the “BEGIN” setting, it is important to develop a habit to reset it to the “END”.

In the explanations using a financial calculator, for convenience and clarity purposes, we will generally display explanations of calculations as presented in the example below:

PV: -900 I: 7 N: 5 FV: 1,262.3

When using a HP 10bll financial calculator, or using any financial calculator, you need to first insert the number (number, e.g. -900) and then insert the purpose of the number (e.g. PV).

For example, as per above, you need to press:

900 followed by the minus sign followed by PV

7 followed by I

5 followed by N

Than press FV, and the calculator will display the correct answer

Financial calculators sometimes give false answers. It is advisable to check each calculation 3-4 times to make sure that the same answer is given consistently.

Throughout the site, if you ever struggle with a calculation, always come back to this page for some simple tips on using a financial calculator.

Test yourself


ABC Corporation plans to invest in project C which has an initial investmentof $500,000. ABC’s cost of capital is 8%. The operating cash flows to be generated from the project will be as follows:

End of 1st year: $100,000 End of 2nd year: $300,000 End of 3rd year $250,000

1 – What is the Profitability Index (PI) for project C?

2 – What is the NPV for project C?

3 – Taking the NPV found in the previous step into account, is the project acceptable according to the NPV technique?

4 – Based on the Profitability Index (PI), is project C acceptable?

SOLUTION:

1 – First we need to find present values of the mixed stream of operating cash inflows. Using a financial calculator, we need to take the following steps:

End of 1st year:

FV: $100,000

N: 1

I: 10

Calculate PV: $90,909.09

End of 2nd year:

FV: $300,000 N: 2

I: 10

Calculate PV: $247,933.88

End of 3rd year:

FV: $250,000

N: 3

I: 10

Calculate PV: $187,828.7

Next we need to add up all present values from operating cash inflows to obtain the total PV of operating cash inflows:

= $90,909.09 + $247,933.88 + $187,828.7

Total PV of operating cash inflows = $526,671.67

Next we will follow the equation for Profitability Index (PI):

PI = Total present value of cash inflows/Initial investment

PI=$526,671.67/$500,000

PI=1.05

Therefore, the profitability index (PI) for project C is 1.05.

2 – To find NPV, we follow the formula for NPV:

NPV=Present value of cash inflows – Initial investment

Therefore, NPV for project C = $526,671.67 – $500,000

NPV for project C = $26,671.67

3 – Since NPV is more than zero ($26,671.67), project C is acceptable according to NPV technique.

4 – Since Profitability Index (PI) is greater than 1 (1.05), the project may be considered to be acceptable.

Blogbschool.com is powered by www.firmsconsulting.com. Firmsconsulting is a training company that finds and nurtures tomorrow’s leaders in business, government and academia via bespoke online training to develop one’s executive presence, critical thinking abilities, high performance skill-set, and strategy, operations and implementation capabilities. Learn more at www.firmsconsulting.com.

Sign up to receive a 3-part FREE strategy video training series here.

Capital Budgeting Techniques

The Capital budgeting techniques discussed here focus on financial considerations, although, there are financial and non-financial considerations that should be taken into account when selecting a project for capital expenditure.

There are unsophisticated (simple) and sophisticated (advanced) techniques.

1 – Unsophisticated techniques include payback period (PB, also called payback method) and average rate of return(ARR).

2 – Sophisticated techniques include net present value (NPV), internal rate of return (IRR), equivalent annual annuity (AEE) and profitability index (PI).

Out of this range of techniques, payback period is the most popular unsophisticated technique. From the sophisticated techniques, the most popular methods are net present value (NPV) and internal rate of return (IRR).

Capital budgeting techniques used to select most profitable projects for capital expenditure, which is aligned with enterprise’s objective of maximizing shareholder’s wealth. Sophisticated techniques are considered to be the most effective means of selecting the most appropriate projects for capital expenditures. Such techniques take into account risk, the time value of money and focus on cash flows rather than on accounting profits.

The result of educated usage of capital budgeting techniques knowledge generated on which projects and in which order should be accepted based on the available funds for investment.

Debt-equity ratio analysis

Debt-equity ratio analysis is one of several debt ratio analyses. Debt ratios measure the degree or financial leverage of the firm. The more debt the firm uses, the higher its financial leverage, the higher its financial risk (the risk of bankruptcy) and the higher the potential returns.

It measures the degree of indebtedness of the enterprise. It measures how much of equity and how much of debt a company uses to finance its assets. It is also referred to as leverage or gearing.

The formula is as follows:

Debt-equity ratio = Total liabilities/Shareholders equity

This formula is sometimes presented simply as:

Debt-equity ratio = Debt/Equity

Example of a debt-equity ratio analysis


Assume Gold Co. currently has total debt of $1,000,000 and shareholders equity of $1,800,000. The debt-equity ratio for the Gold Company is conducted as follows:

$1,000,000/$1,800,000=0.56

The result is less than 1 and indicates that business uses mainly equity to finance its operations. The financial risk of Gold Company seems to be under control. However, it is possible that company may have lower than possible returns due to being too careful with using debt financing. However, a closer investigation is required before any conclusions can be made.

Things to note about this ratio


If the debt-equity ratio shows a result of less than one, then it means that equity is mainly used to finance operations. However, if the debt-equity ratio is more than one, then it means that the debt is mainly used for financing of operations. If the result of debt-equity ratio analysis is equal to one, then it means that a half of financing comes from debt and a half comes from equity.

The more debt compared to equity the firm uses in financing its assets, the higher the financial risk and the higher the potential return. Financial risk refers to the risk of the firm being forced into bankruptcy if the firm does not meet its debt obligations as they come due.

The results should be compared to industry averages, to the firm’s past ratio trends and to a similar analysis of leading competitors within the industry.

Blogbschool.com is powered by www.firmsconsulting.com. Firmsconsulting is a training company that finds and nurtures tomorrow’s leaders in business, government and academia via bespoke online training to develop one’s executive presence, critical thinking abilities, high performance skill-set, and strategy, operations and implementation capabilities. Learn more at www.firmsconsulting.com.

Sign up to receive a 3-part FREE strategy video training series here.