THE GOAL OF FINANCIAL MANAGEMENT

Possible Goals
➢ Survive.
➢ Avoid financial distress and bankruptcy.
➢ Beat the competition.
➢ Maximize sales or market share.
➢ Minimize costs.
➢ Maximize profits.
➢ Maintain steady earnings growth
The goal of financial management is to maximize the current value per share of the existing stock.

Capital budgeting & Process

The process of planning and managing a firm’s long-term investments.
• Generating ideas
• Analyzing individual proposals
• Planning the capital budget
• Monitoring and post-auditing
Basic principles of Capital Budgeting
✔ Decision are based on cash flows
✔ Timing of cash flows is crucial
✔ Cash flows are based on opportunity cost
✔ Cash flows are analyzed on an after tax bases
✔ Financing costs are ignored
✔ Capital budgeting cash flows are not accounting net income

Decision making and investment criteria

1.Net present value (NPV)
The difference between an investment’s market value and its cost.
2.Internal rate of return (IRR)
The rate of return for an investment shows the % of capital inflow against outflow.
Discounted cash flow (DCF) valuation
The process of valuing an investment by discounting its future cash flows.
3.Payback period
The amount of time required for an investment to generate cash flows sufficient to
recover its initial cost. OR

4.Discounted payback period

5.Average accountings return (AAR)

An investment’s average net income divided by its average book value.
6.Profitability index (PI)
The present value of an investment’s future cash flows divided by its initial cost.
Also, benefit-cost ratio.

Sunk cost
A cost that has already been incurred and cannot be removed and therefore should not be
considered in an investment decision.
Opportunity cost
The most valuable alternative that is given up if a particular investment is
undertaken.
Erosion
The cash flows of a new project that come at the expense of a firm’s existing
projects.
Accounting break-even
The sales level that results in zero project net income.

Marginal, or incremental, revenue

The change in revenue that occurs when there is a small change in output.
Operating leverage
The degree to which a firm or project relies on fixed costs.
Degree of operating leverage (DOL)
The percentage change in operating cash flow relative to the percentage change in quantity sold.
DOL = 1+ FC/OCF
Capital rationing
The situation that exists if a firm has positive NPV projects but cannot find the
necessary financing.
Soft rationing
The situation that occurs when units in a business are allocated a certain amount
of financing for capital budgeting.
Hard rationing
The situation that occurs when a business cannot raise financing for a project
under any circumstances.
Zero coupon bonds
A bond that makes no coupon payments, thus initially priced at a deep discount.
Floating-Rate Bonds
With floating-rate bonds (floaters), the coupon payments are adjustable
Current yield
A bond’s coupon payment divided by its closing price.
Dividend yield
A stock’s expected cash dividend divided by its current price.
Capital gains yield
The dividend growth rate or the rate at which the value of an investment grows.
Bid price
The price a dealer is willing to pay for a security.
Asked price
The price a dealer is willing to take for a security.
Bid-ask spread
The difference between the bid price and the asked price.
Nominal rates
Interest rates or rates of return that have not been adjusted for inflation.
Real rates
Interest rates or rates of return that have been adjusted for inflation.