Point in time

CF1

CF2

CF3

i%
End of
period 1

Financial Management I

Period

For an Individual
Interest Rate

10%
100

FV = ?

Finding FVs (moving to the right on a time line) is

called compounding.

Financial Management I

For a Company
Cost of Capital

+40

+80

10%
-100

+10

Cash Flows

Financial Management I

FV = PV (1 + R)
^N
FV -> Future Value
PV -> Present Value
R -> Interest Rate/ Cost of
N - > Number of periods
Financial Management I

capital
5

 Individual
Cost of foregoing consumption today

Company
Needs money today (cash outflow)
2 sources of funds
Debt
Equity

Kd

Cost of
Kd
Debt
Cost of
Ke
Equity
borrowing
funds from

-> cost of
Bank
(e.g. 10%)
Ke -> cost of transferring ownership
Financial Management I

Debt + Equity

Debt + Equity

Money
Borrowed
10,000$

Debt
Debt
5,000$
2,000$
Kd = 10%
Kd

Equity
Equity
5,000$
8,000$
Ke
Ke = 20%

Total Cost = 0.5 * Kd + 0.5 * Ke

Total Cost = 0.2 * Kd + 0.8 * Ke

2,000/10,000
5,000/10,000

Financial Management I

8,000/
10,000
7

D/(D+E)* Kd + E/
(D+E)*Ke

Financial Management I

2 kinds
Systematic Risk
From the system
Cant diversify
E.g. rupee appreciation

Unsystematic Risk
Unique
Diversifiable
E.g. high debt on balance sheet

Market Only rewards the systematic risk

Financial Management I

 Measure

of systematic risk known as

Beta ()
Movement with the market
= 1.1
Nifty moves by 100 points, stock moves

by 110Kepoints
=

Rf

(Rm Rf)

Capital Asset Pricing Model (CAPM)

Financial Management I

10

PHEW!
Financial Management I

11