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Introduction to Corporate
Finance & Time Value of
Money
Module-1
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Module 1 Outline
• Understand the concept of Finance &
Financial Management
• Need for Finance
• Financial Decisions involved in a business
• Objectives of Financial Management
• Finance Function
• Time Value of Money
• Reasons behind time value of money
• Types of Time Value of Money
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What is Finance?
•The concept of finance includes capital, funds,

money, and amount.

•Finance is the art and science of managing money.

•Finance is ensuring the supply of money when it is

required to the organisation.

•Finance refers to the management of flow of money

through an organization
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Introduction to Financial
Mgmt
• “Financial management is the operational
activity of a business that is responsible
for obtaining and effectively utilizing
the funds necessary for efficient business
operations”

• Hence Financial management talks about


▫ Acquisition of Funds
▫ Utilization of Funds Acquired
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Need for Finance


• Establishment of Business /To Start a
Business
▫ To invest on Land, Labour,Technology
• Survival of Business/To Run a
Business
▫ To Compete by spending on publicity,
marketing, Promotions, Branding
• To Expand/Modernize /Diversify/Grow
• To buy Assets
• To run day to day business
To Procure Raw Materials, Pay salaries
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Evolution of Financial
Management
• The Traditional phase
• The Modern phase
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The Traditional phase


• The role of Financial Management was much narrow
• It was limited to raising of funds and
administration to meet the financial requirements
• Finance Mgr used to arrange funds for major events
such as Mergers, Expansion, Diversification
• The preparation of Financial statements and
managing cash level
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Drawbacks of The Traditional


approach
• It only concentrated on financial problems arising
from non-recurring events such as mergers ,
reorganizations etc
• It ignored routine and day today problems
• It only concentrated on long term financing
• It ignored the working capital financing
• It ignored the utilization of capital and
allocation of capital
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Modern Approach
• Modern Approach concentrates on both
procurement of funds as well as their
utilization of funds.
• It started focusing on effective & efficient
utilization of funds
• The main content of this approach
▫ What specific assets should a firm
acquire(How should the funds be employed)?
▫ What is the total amount of funds required by
a firm to invest and raise?
▫ How should the funds be financed?
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Major Financial Decisions of a Firm


• Investment Decision: It is concerned with the
selection of long term assets in which funds
will be invested by a firm.
• Financing Decision: The financing decision is
concerned with capital – mix or capital
structure of a firm
• Dividend Decision: It is concerned with the
distribution of profits of a firm to the
shareholders.
• Working Capital Decision: It is concerned with
the selection of short term/current assets in
which funds will be invested by a firm.
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Objectives of Financial Management


 Maintenance of Adequate Liquid
Assets
 Investment in liquid Assets should be
neither too low nor too high
 Manager has to maintain proper balance
between Liquidity & Profitability
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Objectives of Financial Management


 Profit Maximization
• Profit maximization is the traditional and narrow
approach, which aims at, maximizes the profit of
the concern.
• A Manager should only take those actions or
decisions that lead to increase of company profits and
other decisions should get rejected
• All decision should be evaluated & taken on the basis
of the contribution to be made to the company profits
• It aims at Increasing EPS
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Justifications of Profit Maximization


1.A firm being an economic entity its basic objective should be too

earn profits

2.Profits are the main sources of finance for the growth of business

3.Profit acts as instrument which determines the success of failure

of a firm

4.It is possible to attract the investors to make investments.

5.It ensures prompt payment to the creditors

6.Better wages/ working conditions to the employees


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Measures to increase the profits of the


firm
1. By Increasing the sales of the firm and there by

increasing the revenues by setting the products

price & output high

2. By reducing the cost of production through

efficient use of resources/assets

3. By reducing the cost of capital for raising the funds

4. By minimizing the risks


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Draw backs of Profit Maximization


Objective
• Profit Maximization is a vague objective
• It ignores the time value of money
• It ignores the factors of risks and uncertainty
• Profit maximization gives room for unethical
trade practices or corrupt practices
• Higher profit involve higher risks; hence Business
would like to have normal profit with less risk
rather than higher profits with higher risks
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Objectives of Financial
Management
Wealth Maximization
It means maximizing the wealth of the company and
the market value of the share
Shareholders' wealth can be defined as the total
market value of all the equity shares of the
company.
In order to maximize the wealth of the firm or the
market value of the share, a proper balance has to
be maintained between risk & return
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How the Wealth can be maximized?


• By avoiding projects which involve high profits with
high risks, as such projects may prove terrible for firm
if the project goes wrong
• By paying regular dividends to shareholders, as it
increases the reputation of the firm and finally
raises the value of firm
• By maintaining growth in sales. The sales should be
stable, large and diversified
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Benefits of Wealth
Maximization
• It considers the time value of money

• It takes into account the risk and uncertainty

factors

• This concept takes dividend policy into account

• It leads to the economic welfare of the

shareholders of the firm


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India's Top 10 Wealth


Creators
Company Total Market Cap(Rs. Cr)

Reliance 7,88,530.05
TCS 7,50,458.18
HDFC Bank 5,71,037.42
HUL 3,71,670.22
ITC 3,50,374.30
HDFC 3,21,654.19
Infosys 3,20,222.22
SBI 2,50,335.35
ICICI Bank 2,39,366.23
Kotak Mahindra 2,37,254.49
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World’s Top 10 Wealth


Creators Company
Apple Inc
Google
Microsoft
Amazon
Berkshire Hathaway
Facebook
JPMorgan Chase
Bank of America
Johnson & Johnson
Exxon Mobil Corp
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Finance Function
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Organization of Finance
Function
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CFO Role
• The chief financial officer (CFO) primary
responsibilities
▫ Managing the processes for financial
forecasting and budgets, and overseeing
the preparation of all financial reporting
▫ Provide leadership, direction and
management of the finance and accounting
team
▫ Providing strategic recommendations to
the CEO/president, BOD & Executive Mgmt
Team
▫ Advising on long-term business and
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Functions of Treasurer and Controller


Treasurer Controller
Obtaining Finances Financial Accounting

Banking Relationship Internal Auditing

Cash Management Taxation

Credit Administration Management Accounting


& Control
Capital Budgeting
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Emerging Role of Financial Manager


in India
• He is no longer referred to as my accountant.
• The finance manager is now a part of the top
management.
• He is also responsible for formulation and
implementation of policies and decision making.
• Earlier it was a support function now it is
mainline.
•  Survival of a firm depends largely on an Mgmt’s
capabilities to anticipate and prepare for change
rather than just react to it. Finance Mgr plays a
crucial role in this
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Top CFO’s of India

V
Mr. Alok Kumar Mr Srinivas
Ramakrishnan-
Agarwal-RIL Phatak -HUL
TCS
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Introduction to Time Value of Money


• A rupee receivable today is more valuable than a
rupee receivable in future.

• Put in simple words, to days money is more valuable was


future money.

• The amount that is received today can be


reinvested and it can earn an additional amount
in the form of interest or any other form

• Rupee to be received later in future cannot be


reinvested
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Rational behind Time value of Money


• Uncertainty: An individual is not certain about
future cash receipts, he prefers receiving cash now.

• Current Consumption

• Inflation: In an inflationary period, a rupee today


has higher purchasing power than a rupee in the
future.

• Possibility of Investment Opportunity: It is the


possibility of investment opportunity through which
they can earn additional cash
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Time Lines & Notation


• A Time Line shows both the timing and
the amount of each cash flow in a Cash
flow stream
10 10 10 10 10
K K K K K

12 12 12 12 12
0 % 1 % 2 % 3 % 4 % 5

10 10 10 10 10
K K K K K

12 12 12 12 12
0 % 1 % 2 % 3 % 4 % 5
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Time Lines & Notation


• A cash flow that occurs at time 0 is
therefore already in present value terms
and does not need to be adjusted for time
value.
• 12% is the discount rate. Discount rate
can be different for different years
• Cash flows can be either positive or
negative
• Positive cash flows are called cash inflows
and Negative cash flows are called cash
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Notations Used in Time Value of


Money
Notations Stands for
PV Present value
FV Future value
CFt Cash flow at the end of
period t
A Annuity: constant cash
flows over several periods
i Discount rate
g Expected growth rate in
cash flows
n Number of years over
which cash flows are
received or paid
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Methods of Time Value of


Money
1. Future value of a single Cash Flow
2. Present value of a single Cash Flow
3. Future value of an annuity Cash Flow
4. Present value of an annuity Cash Flow
5. Present Value of a Perpetuity
6. Growing annuity
7. Growing perpetuity
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Time Value of Money


• Time value of money concept is grouped
into following two areas:
1. Future Value: Future value describes the
process of finding what an investment
today will grow to in the future.

2. Present Value: The present value


describes the process of determining
what a cash flow to be received in the
future is worth in today’s rupees.
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Future value of a Cash Flow


• The customer who deposits money today
with a bank will get the principal amount
and interest on maturity/at the end of the
period of deposit.
• Two components are involved in Future
Value
▫ Principal
▫ Interest
• Principal and Interest added together is
called ‘future value’.
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Future value of a Cash Flow


Compounded Annually
• It is the process to determine the future
value of a single lump sum amount
invested at one point of time.
• FVn = PV (1+i)^n
▫ Where,
 FVn = Future value of initial cash outflow after
n years
 PV = Initial cash outflow
 i = Rate of Interest p.a.
 n = Life of the Investment
 and (1+i)n = Future Value of Interest Factor
(FVIF)
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Future value of a Cash Flow for multiple


compounding periods
• It is the process to determine the future value of a single
lump sum amount invested at one point of time but the
interest rate is compounded Yearly, semi- annually, quarterly,
monthly or daily

• The process of investing money and reinvesting the interest


earned there on is compounding

• FVn = PV (1+i/m)^m*n
▫ Where,
 FVn = Future value of initial cash outflow after n years
 PV = Initial cash outflow
 i = Rate of Interest p.a.
 n = Life of the Investment
 and (1+i)n = Future Value of Interest Factor (FVIF)
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Problems on Future value of Single


Cash Flow
1. Calculate the future values at the end of
4 years of Rs.10,000 invested today at
an interest rate of 10% p.a.

2. Calculate the future values at the end of


4 years of Rs.10,000 invested today at
an interest rate of 10% p.a.
compounded Semi Annually
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Present value of a single Cash


Flow
• The process of finding present value of a
future cash flow is called ‘discounting’

• The interest rate used to calculate


present values is called the discount
rate.
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Present value of a single Cash


Flow
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Problems on Present value of Single


Cash Flow
1. Find the present value of Rs.1,000 to be
received 3 years from today if the
interest rate is 10% p.a.

2. What is the present value of Rs.10,000


receivable 10 years hence if the interest
rate is 8% p.a.?
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Future Value of an Annuity


• An annuity is a series of periodic cash flows of equal amounts.

• It is a stream of constant cash flow (payment or receipt) occurring at


regular intervals of time.

• Ex The recurring deposits made by a depositor in a bank and the


premium payments of a life insurance policy.

• The payment is made either in the beginning of the period or at the


end of the period.

• When the cash flow (receipt or payment) occur at the end of each
period, the annuity is called an ordinary annuity

• When cash flow occurs at the beginning of each period, the annuity is
called an annuity due.
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Future Value of an Ordinary Annuity


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Future Value of an Ordinary Annuity


• FVA n= A[(1+i)^n-1]
i
Where A= Annual Cash Flow
i= Rate of Interest or Return
n= Number of years or duration of the
annuity

The term [(1+i) n -1/i] is referred to as the


future value interest factor for an annuity
(FVIFA r.n).
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Future Value of an Annuity Due


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Future Value of an Annuity Due


• FVA n= A[(1+i)^n-1]
i
Where A= Annual Cash Flow
i= Rate of Interest or Return
n= Number of years or duration of the
annuity
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Problems on Future value of Annuity


1. Akshaya deposits Rs.1,000/- annually in a bank
for 5 years at a compound interest rate of 10
%. What will be the value of this series of
deposits at the end of 5 years? Assuming that
each deposit occurs at the end of the year.

2. Keerthi invests Rs.10,000/- annually in a bank


deposit for 6 years at the compound rate of
interest of 12 percent. What will be the value
of this series of deposits at the end of 6 years?
Deposits are made at the end of the year.
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Present Value of an Ordinary Annuity


• How much is the actual value as on today
for the series of amount one will get in
future is called the present value of an
annuity.
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Present Value of an Ordinary Annuity


• How much is the value or the amount one will
get now is called the present value of an
annuity.
• PVAn=A[{1-(1/1+i)n }/ r]
• Where PVA n = Present value of an annuity
which has a duration of n periods.
A=Constant periodic flow.
r=Discount rate

[1-(1/1+r)n / r] is referred to as the present value interest


factor for an annuity (PVIFA r.n).
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Present Value of an Annuity Due


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Present Value of an Annuity


Due
• PVAn=A[{1-(1/1+i)n }/ r]
• Where PVA n = Present value of an
annuity which has a duration of n periods.
A=Constant periodic flow.
r=Discount rate
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Problems on Present Value of Annuity


1. Shankar is expected to receive Rs.1,000
annually for 3 years and each receipt is
occurring at the end of the year. What is
the present value of this stream of
benefits if the discount rate is 10 %?
2. What is the present vale of a 5 Yr
annuity of Rs 2,000 at 10%
52

Present value of Growing


Annuity
• A cash flow that grows at a constant rate
for a specified period of time is known as
Growing Annuity.
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Problem on Present value of Growing


Annuity
• You are negotiating with the government
the right to mine 1,00,000 tons of iron ore
per year for 15 years. The current price
per ton of iron is Rs 3,000 and it is
expected to increase at the rate of 6% per
year. What is the present value of the iron
ore that you can mine if the discount rate
is 16%
54

Present Value of Perpetuity


• Perpetuity refers to an infinite amount of
time.
• In simple words it refers to lasting forever
• A perpetuity is a type of annuity that lasts
forever, into perpetuity with no end.
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Present Value of Growing Perpetuity


• A growing perpetuity is a series of periodic
payments that grow at a proportionate rate
and are received for an infinite amount of
time.

• Where C= Cash Flow or Annuity received


• R= Discount rate
• G= Growth rate in Annuity received every year
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Problems on Perpetuity & Growing


Perpetuity
1. At the time of his retirement ,Mr. Lobo is
given a choice between 2 alternatives:
A. An Annual pension of Rs 10,000 as long
as he lives
B. A lump sum amount of Rs 50,000. If Mr.
Lobo is expected to live for 15 years and
the interest rate is 15% which option
appears more attractive
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Problems on Perpetuity & Growing


Perpetuity
• An office complex is expected to generate
a net rental of Rs 3 Millions next year,
which is expected to increase at 5% every
year. If we assume that increase will
continue for ever indefinitely, with
discount rate of 10%. What is the present
value of this stream of cashflows
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Practice Problem 1
 As a winner of a competition,you can
choose one of the following:
1. Rs 5,00,000 now
2. Rs 10,00,000 at end of 6 years
3. Rs 60,000 a year forever
4. Rs 1,00,000 per year for 10 years
5. Rs 35,000 next year and rising thereafter
by 5 % forever.
If interest rate is 10%,which prize has the
highest present value
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Case Study 1
• As an investment advisor, you have been
approached by a client called Yogesh for your
advice on investment plan. He is currently 35
years old and has Rs.4,00,000 in the bank. He
plans to work for 25 years more and retire at the
age of 60. His present salary is Rs.3,00,000 per
year. He expects his salary to increase at the
rate of 12 percent per year until his retirement.
• Yogesh has decided to invest his bank balance
and future savings in a balanced mutual fund
scheme that he believes will provide a return of
9 percent per year. You agree with his
assessment.
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Questions
• Yogesh seeks your help in answering several questions
given below. In answering these questions, ignore the
tax factor.
▫ Once he retires at the age of 60, he would like to
withdraw Rs.6,00,000 per year for his consumption needs
from his investments for the following 15 years (He
expects to live up to the age of 75 years). Each annual
withdrawal will be made at the end of each year. How
much should be the value of his investments when Yogesh
turns 60, to meet this retirement need?
▫ How much should Yogesh save each year for the next 25
years to be able to withdraw Rs.6,00,000 per year from
the end of the 26th year ? Assume that the savings will
occur at the end of each year.
▫ Yogesh is curious to find out the present value of his
lifetime salary income. For the sake of simplicity, assume
that his current salary of Rs 3,00,000 will be paid exactly
one year from now, and his salary is paid annually. What is
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Practice Problem 3
• ABC Ltd has borrowed Rs 1,000 to be
repaid in equal instalments at the end of
each of the next 3 years. The interest rate
is 15 per cent. Prepare a loan
amortisation schedule. How much total
interest is paid over the life of the loan?
62

Practice Problem 4
• You want to borrow Rs.3,000,000 to buy a
flat. You approach a housing company
which charges 10 percent interest. You
can pay Rs.400,000 per year toward loan
amortisation. What should be the maturity
period of the loan?
66

Practice Problem
• A Finance company advertises that it will
pay a lump sum of Rs 10,000 at the end of
6 years to investors who deposit Rs 1,000
annually. What interest rate is applicable
on this offer?
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Practice Problems 7 & 8


 Mr.Vinay plans to send his son for higher
studies abroad after 10 years. He expects the
cost of these studies to be Rs 1,00,000. How
much should he save annually to have Rs
1,00,000 at end of 10 years, if interest rate is
12%
 Mr. X deposits Rs 1,00,000 in a bank which
pays 10% interest. How much can he
withdraw annually for a period of 30 years.
Assume that at end of 30 years the amount
deposited will become zero at end of 30 years.
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Practice Problems 9 &10


Someone promises to pay Rs 5,000 after
10 years in exchange of Rs 1,000 today.
What interest rate is applicable on this
offer?

A Finance company advertises that it will


pay a lump sum of Rs 10,000 at the end of
6 years to investors who deposit Rs 1,000
annually. What interest rate is applicable
on this offer?
69

Practice Problems 11 & 12


• Anurag Limited borrows Rs.2,000,000 at an
interest rate of 12 percent. The loan is to be
repaid in 5 equal annual installments payable
at the end of each of the next 5 years. Prepare
the loan amortization schedule.
• You want to borrow Rs.3,000,000 to buy a flat.
You approach a housing company which
charges 10 percent interest. You can pay
Rs.400,000 per year toward loan amortisation.
What should be the maturity period of the
loan?
70

Practice Problems