finacial management lecture notes (2)

8/2/2019 Finacial Management Lecture Notes (2)

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OVER VIEW OF

FINANCIALMANAGEMENT

Patel MahendraSigma Institute Of Mana ement Studies


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Mana ement Studies

Meaning and Definition

of Finance Business Finance defined, asthat administrative area or set of administrative function in anorganization which relate with thearrangement of cash and credit sothat the organization may have the

means to carry out its objectives assatisfactorily as possible In simple terms finance is defined as

the activity concerned with theplanning, raising, controlling andPatel MahendraSigma Institute Of Mana ement Studies


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Financial Management

Financial management is managerialactivity which is concerned with theplanning and controlling of the firmsfinancial resources.

Howard and Uptron define financialmanagement as an application of

general managerial principles to thearea of financial decision-making. Financial management is the

operational activity of a businessthat is responsible for obtaining andPatel MahendraSigma Institute Of Mana ement Studies


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Nature of Financial

Management The nature of financial managementrefers to its relationship with relateddisciplines like economics andaccounting and other subjectmatters.

The area of financial managementhas undergone tremendous changesover time as regards its scope andfunctions. The finance functionassumes a lot of significance in thePatel MahendraSigma Institute Of Mana ement Studies


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Finance and Related

Disciplines Economics Accounting Production Marketing Quantitative Methods Costing

Law Taxation Treasury Management Banking Insurance Patel MahendraSigma Institute Of Mana ement Studies


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Objective & Scope of FinancialManagement

Objective of Financial Management

Scope of Financial Management

Role of Financial Management

Functions



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Objective of FinancialManagement

It deals with planning and mobilization of

funds required by the firm objective of profit maximization to maximize the wealth of the shareholders to trade off between risk and return

Scope of Financial Management Role of Financial Management Functions



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Scope of Financial Management Estimating the total requirements of funds for a

given period. Raising funds through various sources, Investing the funds in both long term as well as

short term capital needs;

Funding day-to-day working capital requirementsof business; Managing funds and treasury operations; Ensuring a satisfactory return to all the stake

holders; Paying interest on borrowings & Repaying lendersPatel MahendraSigma Institute Of

Mana ement Studies


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Role of Financial Management Liquidity Forecasting cash flows, Raising funds

Managing the flow of internal funds, Profitability Cost control Pricing Forecasting Future ProfitsPatel MahendraSigma Institute Of Mana ement Studies


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Role of Financial Management Functions Investment decisions Capital Budgeting

Working Capital Management Financing decisions Cost of Capital Capital Structure Decisions LeveragesPatel MahendraSigma Institute Of

Mana ement Studies


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Functional areas of financialmanagement

Determining the source of Funds Financial Analysis Optimum Capital Structure C V P Analysis

Profit Planning and Control Fixed Assets Management Project Planning and evaluation Capital Budgeting

Working Capital Dividend Policies Acquisitions and Mergers Corporate taxation



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Emerging Role of FinanceManager1. Investment Decisions for obtainingmaximum profitability2. Financing decisions through a

balanced capital structure3. Dividend decisions, issue of Bonus

Shares and retention of profits4. Best utilization of fixed assets.5. Efficient working capital

management6. Taking the cost of capital, risk,

return and control aspects7. Tax administration and tax lannin .Patel MahendraSigma Institute Of

Mana ement Studies


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Sources of Finance

Long Term Source

Equity Share Capital

Preference Share Capital

DebenturesLease and Hire Purchase

Term Loans

Short Term Source

International Sources



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Sources of Finance Long Term Source

Short Term Source Trade Credit Accrued Expenses Commercial Papers

Short-term Unsecured Debentures Bank Credit Overdraft Cash Credit

Bills Purchased and Bills Discounting Letter of Credit Working Capital Term Loan

Funded Interest Term LoanPatel MahendraSigma Institute Of Mana ement Studies


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Sources of Finance

Long Term Source

Short Term Source

International Sources

Depository Receipts (DR)Foreign Currency Convertible Bonds(FCCBs)

External Commercial Borrowings (ECB)



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Concept of time value of money The price of 10 grams of gold in 1970

was Rs. 430. The price of the same isRs. 9000 in 2006. If we deposit Rs.1000 in a savings bank account, @ 4%

return, we would get Rs. 1020 at theend of six months. The relationship of the relative values

of money over a period of time isknown as time value of money. Thevalue of money over a period isaffected by various factors like

inflation, rate of interest and thePatel MahendraSigma Institute Of Mana ement Studies


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Compound Interest and futurevalues

The term compounding implies thatinterest payable on a loan orinvestment is not paid at the end of the interest payment term but isadded on to the principal andinterest is calculated on the total

sum in future. This in effect meansthat interest is paid on interest.

A= P0 (1+ r)^nA = the end value after adding thePatel MahendraSigma Institute Of Mana ement Studies


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Interest compounding atintervals more than once a year

A= P0 (1+ r/m)^n*m WhereA = the end value after adding theinterestP0= Principal or original investment at

timer = Rate of interest in decimalsn = Number of years of investmentm= Number of times interest is paid ina year. Patel MahendraSigma Institute Of Mana ement Studies


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Some points to remember aboutcompounding interestcalculations

For the same rate of interest, if more number of times interest is paid during

the year, greater will be the future value atthe end of the given year

Greater the number of years, greater thedifference will be in future values, if computedusing different methods compounding likeyearly and semi annually.

When compounding is continuous the future

value can be computed by A= P0*(FuturePatel MahendraSigma Institute Of Mana ement Studies


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Patel Mahendra

Time Preference for Money

Time preference for money is anindividuals preference for possession of agiven amount of money now , rather thanthe same amount at some future time.

Three reasons may be attributed to theindividuals time preference for money:risk

preference for consumptioninvestment opportunities

Sigma Institute Of Mana ement Studies


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Patel Mahendra

Required Rate of

Return The time preference for money is generallyexpressed by an interest rate. This rate will bepositive even in the absence of any risk. It maybe therefore called the risk-free rate.

An investor requires compensation for assumingrisk, which is called risk premium .

The investors required rate of return is:

Risk-free rate + Risk premium.



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Future Value

Compounding is the process of finding thefuture values of cash flows by applying theconcept of compound interest.

Compound interest is the interest that isreceived on the original amount (principal)as well as on any interest earned but notwithdrawn during earlier periods.

Simple interest is the interest that iscalculated only on the original amount(principal), and thus, no compounding of interest takes place.



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Patel Mahendra

Future Value

The general form of equation forcalculating the future value of a lump sumafter n periods may, therefore, be writtenas follows:

The term (1 + i)n is the compound valuefactor (CVF ) of a lump sum of Re 1, and italways has a value greater than 1 forpositive i, indicating that CVF increases as i and n increase. = CVFn n,i F P



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Patel Mahendra

Example

If you deposited Rs 55,650 in a bank, whichwas paying a 15 per cent rate of interest ona ten-year time deposit, how much wouldthe deposit grow at the end of ten years?



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Patel Mahendra

Example

If you deposited Rs 55,650 in a bank, whichwas paying a 15 per cent rate of interest ona ten-year time deposit, how much wouldthe deposit grow at the end of ten years?

We will first find out the compound valuefactor at 15 per cent for 10 years which is4.046. Multiplying 4.046 by Rs 55,650, weget Rs 225,159.90 as the compound value:

10, 0.12FV 55,650 CVF 55,650 4.046 Rs 225,1= = =



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Patel Mahendra

Future Value of an Annuity

Annuity is a fixed payment (or receipt)each year for a specified number of years.If you rent a flat and promise to make aseries of payments over an agreed period,

you have created an annuity.

The term within brackets is the compoundvalue factor for an annuity of Re 1,which we shall refer as CVFA .

(1 ) 1nn

i F Ai

+ =

= CVFAn n, i F A


l


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Patel Mahendra

Example

Suppose that a firm deposits Rs 5,000 atthe end of each year for four years at 6 percent rate of interest. How much would thisannuity accumulate at the end of the fourthyear?


l


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Patel Mahendra

Example

Suppose that a firm deposits Rs 5,000 atthe end of each year for four years at 6 percent rate of interest. How much would thisannuity accumulate at the end of the fourthyear? We first find CVFA which is 4.3746. If we multiply 4.375 by Rs 5,000, we obtain a

compound value of Rs 21,875:4 4, 0.065,000(CVFA ) 5,000 4.3746 Rs 2F = = =


Si ki d


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Patel Mahendra

Sinking Fund

Sinking fund is a fund, which is createdout of fixed payments each period toaccumulate to a future sum after aspecified period. For example, companies

generally create sinking funds to retirebonds (debentures) on maturity.The factor used to calculate the annuity for

a given future sum is called the sinkingfund factor (SFF ).=

(1 ) 1n n

i A F

i+



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P V l f Si l C h


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Patel Mahendra

Present Value of a Single CashFlowThe following general formula can be employed

to calculate the present value of a lump sum tobe received after some future periods:

The term in parentheses is the discount factoror present value factor (PVF ), and it is alwaysless than 1.0 for positive i, indicating that a futureamount has a smaller present value.

(1 )(1 )

nnnn

F P F i

i = = +

+

,PVFn n i PV F =



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Patel Mahendra

Example

Suppose that an investor wants to find outthe present value of Rs 50,000 to bereceived after 15 years. Her interest rate i9 per cent. First, we will find out thepresent value factor, which is 0.275.Multiplying 0.275 by Rs 50,000, we obtain

Rs 13,750 as the present value:15, 0.09PV = 50,000 PVF = 50,000 0.275 = Rs 13,7



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C it l R d L


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Patel Mahendra

Capital Recovery and LoanAmortisation

Capital recovery is the annuity of aninvestment made today for a specified periodof time at a given rate of interest. Capitalrecovery factor helps in the preparation of aloan amortisation (loan repayment ) schedule .

The reciprocal of the present value annuityfactor is called the capital recovery factor (CRF ).

,

1=

PVAF ni A P


P t V l f U


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Patel Mahendra

Present Value of an UnevenPeriodic Sum

Investments made by of a firm do notfrequently yield constant periodic cashflows (annuity). In most instances the

firm receives a stream of uneven cashflows. Thus the present value factorsfor an annuity cannot be used. Theprocedure is to calculate the presentvalue of each cash flow and aggregateall present values.



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Patel Mahendra

Present Value of Perpetuity

Perpetuity is an annuity thatoccurs indefinitely . Perpetuities arenot very common in financialdecision-making:

PerpetuityPresent value of a perpetuity

Interest rate=



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Present Value of GrowingAnnuities

The present value of a constantlygrowing annuity is given below:

Present value of a constantly

growing perpetuity is given by asimple formula as follows:

1= 1 1

n A g

P i g i

+ +

= A

P i g



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Patel Mahendra

Value of an Annuity Due

Annuity due is a series of fixedreceipts or payments starting at thebeginning of each period for aspecified number of periods.Future Value of an Annuity Due

Present Value of an Annuity Due

,= CVFA (1 )n n i F A i +

= P V F A (1n , i P ASigma Institute Of

Mana ement Studies


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Multi-Period

CompoundingIf compounding is done more thanonce a year, the actual annualisedrate of interest would be higher thanthe nominal interest rate and it iscalled the effective interest rate.

= EIR 1 1n m

im

+

finacial management lecture notes (2)

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