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Introduction to Corporate

Finance & Time Value of

Money

Module-1

2

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

3

What is Finance?

•The concept of finance includes capital, funds,

through an organization

4

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”

▫ Acquisition of Funds

▫ Utilization of Funds Acquired

5

• 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

6

Evolution of Financial

Management

• The Traditional phase

• The Modern phase

7

• 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

8

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

9

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?

10

• 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.

11

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

12

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

13

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

of a firm

14

firm

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

15

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

16

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

17

• 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

18

Benefits of Wealth

Maximization

• It considers the time value of money

factors

19

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

20

Creators Company

Apple Inc

Microsoft

Amazon

Berkshire Hathaway

JPMorgan Chase

Bank of America

Johnson & Johnson

Exxon Mobil Corp

21

Finance Function

22

Organization of Finance

Function

23

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

24

Treasurer Controller

Obtaining Finances Financial Accounting

& Control

Capital Budgeting

25

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

26

V

Mr. Alok Kumar Mr Srinivas

Ramakrishnan-

Agarwal-RIL Phatak -HUL

TCS

27

• A rupee receivable today is more valuable than a

rupee receivable in future.

future money.

reinvested and it can earn an additional amount

in the form of interest or any other form

reinvested

28

• Uncertainty: An individual is not certain about

future cash receipts, he prefers receiving cash now.

• Current Consumption

has higher purchasing power than a rupee in the

future.

possibility of investment opportunity through which

they can earn additional cash

29

• 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

30

• 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

31

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

32

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

33

• 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.

describes the process of determining

what a cash flow to be received in the

future is worth in today’s rupees.

34

• 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’.

35

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)

36

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

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)

37

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.

4 years of Rs.10,000 invested today at

an interest rate of 10% p.a.

compounded Semi Annually

38

Flow

• The process of finding present value of a

future cash flow is called ‘discounting’

present values is called the discount

rate.

39

Flow

40

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.

receivable 10 years hence if the interest

rate is 8% p.a.?

41

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

regular intervals of time.

premium payments of a life insurance policy.

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.

42

43

• 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

future value interest factor for an annuity

(FVIFA r.n).

44

45

• 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

46

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.

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.

47

• 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.

48

• 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

factor for an annuity (PVIFA r.n).

49

50

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

51

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

Annuity

• A cash flow that grows at a constant rate

for a specified period of time is known as

Growing Annuity.

53

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

• 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.

55

• A growing perpetuity is a series of periodic

payments that grow at a proportionate rate

and are received for an infinite amount of

time.

• R= Discount rate

• G= Growth rate in Annuity received every year

56

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

57

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

58

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

59

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.

60

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

61

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?

67

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.

68

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?

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

• 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