Financial Management

Introduction

by

Dr. R. Nagendran BE, MBA, PhD

Know Your Professor

Name : Dr. R. Nagendran,
Phone

B.E., M.B.A., PhD

: 8095282937, 080 30938188

Cabin : EF 017, Central Campus

E-mail

: nagendran.r@alliance.edu.in,

nagu572002@yahoo.com
Open Hours: Tuesdays
Thursday

3.30 PM to 5.00 PM

3.30 PM to 5.00 PM

B.E.
M.B.A
PhD

1979
1985
2009

PSG COLLEGE OF TECHNOLOGY

PSG COLLEGE OF TECHNOLOGY
BHARATH UNIVERSITY

INDUSTRIAL EXPERIENCE: 1979 2001, 2007 2009 ( 24 years)

ACADEMIC EXPERIENCE : 2001 2007, Since 2009 ( 12 + years)

Achievement
Won the Best Paper Award Twice in the 4th and 5th National
Conferences at P.S.G. Institute of Management, Coimbatore,
in Finance sessions in December 2005 and November 2007
4 publications
Currently writing a book on Derivatives Management
Journal paper under review by IJAF

Course Objectives
After completing this course, you should be able to
Understand the Finance Functions
Identify the Goals of Finance Manager
Maximize the attainment of these goals through all
the decision making process of the activities of
finance manager
Apply these knowledge in personal life

Finance
Verb
Obtain or provide money for
Sell or provide on credit

Noun
The commercial activity of providing funds and capital
The branch of economics that studies the
management of money and other assets
The management of money and credit and banking
and investments

Why Finance? - Personal

Will 20 Lacs be enough for my sons MBA 15 years
down the line?
Will 9 Lacs take care of my daughters wedding 3
years from now?
Will I be able to buy a house worth 50 Lakhs 7 years
from now?
Will I be able to enjoy a vacation with my family once in
every 3 years?
How do I retire with an 1 Crore retirement fund?
Is the EMI given by a bank is correct or not?

What do we Deal?
In a Corporate how to manage finance?

Functions of an Organization
Financing
Manufacturing of Goods / Services
Marketing

Alternative Forms of Business

Organization
Sole proprietorship
Partnership
Corporation
Private Limited
Public Limited

Cooperatives
Trusts

REAL ASSETS Vs
FINANCIAL ASSETS
REAL ASSETS

Land, Building, Machines, Human skills

Represents societys wealth

FINANCIAL ASSETS
Stocks or Bonds
Do not represent societys wealth
But, indirectly helps firms capital
liquidity

THE DIFFERENT WAYS COMPANY

CAN RAISE FUNDS OR CAPITAL
Internal Equity

1.Shares
2.Preferred
Shares
3. Debt

External Equity

Retained
Earnings
Public
Equity

Public
Commercial Papers
NCD
Debentures
PCD
FCD
Term Loans

Public
Public

FI / Banks

Equity / Stocks
The share capital of a company limited by shares shall
be of two kinds, namely:
(a) equity share capital
(i) with voting rights; or
(ii) with differential rights as to dividend, voting or
otherwise in accordance with such rules as may
be prescribed; and
(b) preference share capital

Equity / Stocks
share or stock is a document issued by a company,
which entitles its holder to be one of the owners of
the company.
Owning a stock or a share means you are a partial
owner of the company, and you get voting rights in
certain company issues
By owning a share you can earn a portion of the
profit as Dividend and by selling shares you get
capital gain. So, your return is the dividend plus the
capital gain.

Stocks
Dividends are declared by the Board of Directors
Even a company makes good profit it need not pay
dividend for which the share holder cannot take legal
action.
If the BoDs feel profit is required for the companys
expansion / modernization etc they may not declare
dividend
But normally all the companies pay dividend part of
its profit
Company normally give constant dividend and
slightly growing in say every 3 / 5 years.

Preferred Stock
Preferred shares / preference shares, / preferreds
Constant dividend
Preference in dividends
Preference in assets, in the event of liquidation
Convertibility to common stock.
Callability, at the option of the corporation
Nonvoting
payment of dividend, either as a fixed amount or an
amount calculated at a fixed rate, which may either be
free of or subject to income-tax;
Hybrid securities

Preferred Stock Indian Scenario

Bonds / Debentures
A type of debt instrument that is not secured by physical
assets or collateral. Debentures are backed only by the
general creditworthiness and reputation of the issuer.
Both corporations and governments frequently issue this
type of bond in order to secure capital. Like other types
of bonds, debentures are documented in an indenture.
A debenture is thus like a certificate of loan or a loan
bond evidencing the fact that the company is liable to
pay a specified amount.

DebenturesFeatures

A fund into which a company sets

Face value
aside money over time, in order to
retire its preferred stock, bonds or
Interest Rate
debentures.
Maturity
Redemption
Sinking Fund
Buy-back (call) provisions
Indenture - a written contract
Security
Yield
Claim on Assets and Income

Calculation of YTM

Int1
Int 2
Int n
ParValue n
Pr ice

...

2
n
1 r (1 r )
(1 r )
(1 r ) n
Solve the equation for r , which is called YTM

Calculation of YTM
Imagine a company bond is available at
1185. The face value is 1000 ,coupon
rate is 14% and will mature in 2 years.
Find the yield (YTM) of the bond

Stock Vs Bonds
Stock (Share) is ownership or equity
Shareholders own the company
Bond is debt or liability
Bondholders are owed rupee by company
Loans, Bonds or Debts: represent liability of the
firm towards outsiders. Lenders are not owners of
the company. These provide interest tax shield.
Stock dividends paid after PAT and hence dont give
tax-benefit

The Classical Objective Function

22

STOCKHOLDE
RS
Hire&firemanagers
BoardMeeting

Maximize
stockholderwealth

BOND
NoSocialCosts
LendMoney
Managers
SOCIETY
HOLDER
Allcostscanbe
S/
Protectbondholder
tracedtofirm
LENDERS Interests
Revealinformation
Marketsareefficientand
honestlyandontime assesseffectonvalue

FINANCIAL MARKETS

Possible Goals of an Organization

Profit Maximization
Maximizing PAT
Maximizing EPS (Earnings Per Share)
Shareholder Wealth Maximization
Serve to society
Maximizing the employee welfare
Avoidance of Bankruptcy
Market leader

Profit Maximization
Maximizing the rupee income of firm
Resources are efficiently utilized
Appropriate measure of firm performance
Serves interest of society also

It is Vague
It ignores the Timing of Returns
It ignores Risk
Assumes Perfect Competition
In new business environment profit maximization is
regarded as

Unrealistic
Difficult
Inappropriate
Immoral - sometimes

EPS
EPS is Earning Per Share
=

PAT dividends to preference Shareholders

Average No. of outstanding shares

Adityas Ltd. has a net income of 25 million. If the company pays out
1 million in preferred dividends and has 10 million shares for half of
the year and 15 million shares for the other half.
Weighted average is taken to find the number of shares outstanding
(0.5 x 10M+ 0.5 x 15M = 12.5M).
Earning by the shareholders = 25 1 = 24 million
EPS would be 24 / 12.5 = 1.92
Why EPS is important?

Exercise 1
Raksha Ltd. is working at an installed capacity of 1000kgs
of Paracetamol per day. The selling price is 100/kg and
cost of sales 85/kg. The prevailing tax rate is 34.5%.
The firm wants to expand to 1500kgs/day.
No. of Shares outstanding 10,00,000
There are 2 proposals available.
1. Needs 2 crores the cost structure remains same.
2. Needs 2.5 crores and the cost of sales decreases to
75/kg.
The fund needed can be obtained by issue of 15%
preference shares.
Which one Raksha should choose? advise

Solution
Project cost
Amount raised
Dividend paid

Existing
-

Proposal 1
200,00,000
164,63,000
24,69,450

Proposal 2
250,00,000
214,63,000
32,19,450

Profit / day
15,000
22,500
37,500
Profit / year
54,00,000
81,00,000
135,00,000
PAT
35,37,000
53,05,500
88,42,500
Share holders
fund
35,37,000
28,36,050
56,23,050
No. of shares
10,00,000
10,00,000
10,00,000
EPS 3.54
2.84
5.62

Proposal 1 increases the Profit and PAT

The
EPS
increases
3.54
to 5.62
Raksha
choose
the
second
Proposalor PAT
but
EPS
decreases
. to
Mere
profit
increase
increase will not increase the EPS

Congrats Raksha

Maximizing EPS
Maximizing EPS implies that the firm should make no
dividend payment so long as funds can be invested at
positive rate of return - such a policy may not always
work.
Whenever ROI > Cost of capital
Investing all the profit will increase the EPS
If the objective is maximizing EPS then no dividend can
be paid.
If no dividend is paid investors sentiment will get affected
Many investor may in need of regular income

Objective of an Organization
The mostly accepted objective of the firm by
academicians and practitioners

Shareholders Wealth
Maximization

Shareholder Wealth
Maximization (SWM) Internal
Measure
Maximizing
the NPV
n

CFt
NPV

t
t 0 1 r
NPV = Discounted cash inflows discounted cash outflows
COF0
CIF1
CIF2
CIF3
CIF4
NPV = --------1 + --------+ --------3 + ---------- --------0
4
2
(1 + r)
(1 + r)
(1 + r)
(1 + r) (1 + r)
This SWM increases the actual Market price of the share

nversely also if share price increases the SH wealth is increa

SWM - External Measure

Abhilipsa bought Infy on 2/09/13 100 shares @
3085.90 and sold it @ 3712 on 15/01/14. mean
while the company distributed a dividend of 15.
What is the ROI to Abhilipsa?
Capital Gain = 100 (3712-3085.90) = 62,610
Dividend
= 100 x 15
= 1,500
ROI
= 64110 / 3,08,590
= 20.78 %
ROI per annum = 20.78 X360
= 55.40 %
135
Increase in stock price increases wealth of Abhilipsa
Maximizing the stock price will maximize the
Shareholder wealth

Congrats Abhilipsa

Maximizing Stock Prices is too

narrow an objective:
preliminary response

Maximizing stock price is not incompatible with meeting

employee needs/ objectives.
In particular:
Employees are often stockholders in many firms
Firms that maximize stock price generally are firms that have
treated employees well.

Maximizing stock price does not mean that customers

are not critical to success. In most businesses, keeping
customers happy is the route to stock price
maximization.
Maximizing stock price does not imply that a company
has to be a social outlaw.

Why traditional corporate financial

theory focuses on maximizing
stockholder wealth
Stock price is easily observable and constantly updated
(unlike other measures of performance, which may not be
as easily observable, and certainly not updated as
frequently).
If investors are rational (are they?), stock prices reflect the
wisdom of decisions, short term and long term,
instantaneously.
The objective of stock price performance provides some
very elegant theory on:
Allocating resources across scarce uses (which investments to
take and which ones to reject)
How to finance these investments?
How much to pay in dividends?

SWM a Decision Criteria or

Objective?

Finance Functions
CFO
Treasurer

Financial
Planning

Financing

Cash
Management

Controller

Capital
Budgeting

Risk
Management

Portfolio
Management

Working Capital
Management

Financial
Accounting

Management
Accounting

Cost
Accounting

Auditing

Taxation

Data
Processing

Forex
Management
12/3/16

Dr. Nagendran R

35

Functions and Activities of

Financial
Management
Functions involve:

raising funds for the firm at minimal cost and acceptable

risk
investing those funds in company assets so as to earn an
attractive return given acceptable risks

Activities include:

Working Capital Management

short-term (S/T) financial decisions (<1 year)

ex., managing cash and other current assets

Capital Budgeting

Financing decisions (capital structure)

long-term (L/T) financial decisions (>1 year)

ex., purchasing a new machine in the future
how to raise money: loans? leases? shares? bonds?

Dividend Decisions

Out of profit made how much to distribute as dividends

Mergers & Acquisition

Functions of the Financial

Manager
Daily
Cash management
(receipt and disbursement
of funds)
Credit management
Inventory control
Short-term financing
Exchange and interest rate
hedging
Bank relations

Occasional
Intermediate
financing
Bond issues
Leasing
Stock issues
Capital budgeting
Dividend decisions
Forecasting
M&A

Profitability

Trade-off

Risk

Goal:
Maximize
shareholder
wealth

Decisions, Return, Risk and Market Value

Capital Budgeting
Decisions
Return
Capital Structure
Decisions

Market Value
of the Firm

Dividend Decisions
Risk
Working Capital
Decisions

Agency Problem
Principal-Agent Relationship
High Salary + perks
High investments and financial risk
Sacrifice SWM for stake holders

Agency Cost
Foregone share value
Cost of monitoring the agents

Stock-option
http://online.wsj.com/news/articles/SB10001424053111903703604576584480750545602
https://www.eurofidai.org/Raviv_2010.pdf

What can go wrong?

40
STOCKHOLDERS
Havelittlecontrol
overmanagers

BONDHOLDERS

LendMoney

Managersput
theirinterests
abovestockholders

Managers
Bondholderscan
getrippedoff

SignificantSocialCosts
SOCIETY
Somecostscannotbe
tracedtofirm

Delaybad
Marketsmake
newsor
mistakesand
provide
canoverreact
misleading
information
FINANCIALMARKETS

Emerging role of Financial

Manager
After Globalization Forex Management is an
important area
Derivatives & Risk Management
Complex ADRs and GDRs
Global geography and financial markets
M&A
Knowledge of finance reengineering
Investor relations
Macro & micro economics updating
Ability to deal with imperfect information and uncertainty

American Depositary Receipt

(ADR)
Introduced to the financial markets in 1927, an
American depositary receipt (ADR) is a stock that
trades in the United States but represents a specified
number of shares in a foreign corporation. ADRs are
bought and sold on American markets just like regular
stocks, and are issued/sponsored in the U.S. by a
bank or brokerage.

ADR
ADRs were introduced as a result of the complexities
involved in buying shares in foreign countries and the
difficulties associated with trading at different prices and
currency values. For this reason, U.S. banks simply
purchase a bulk lot of shares from the company, bundle
the shares into groups, and reissues them on either the
New York Stock Exchange (NYSE), American Stock
Exchange (AMEX) or the Nasdaq. In return, the foreign
company must provide detailed financial information to
the sponsor bank.

ADR
The depositary bank sets the ratio of U.S. ADRs per
home-country share. This ratio can be anything less
than or greater than 1. This is done because the banks
wish to price an ADR high enough to show substantial
value, yet low enough to make it affordable for individual
investors. Most investors try to avoid investing in
penny stocks, and many would shy away from a
company trading for 50 Russian roubles per share,
which equates to US$1.50 per share. As a result, the
majority of ADRs range between $10 and $100 per
share. If, in the home country, the shares were worth
considerably less, then each ADR would represent
several
real
shares.

Types of ADR issues

There are three different types of ADR issues:
Level 1 - This is the most basic type of ADR where
foreign companies either don't qualify or don't wish to
have their ADR listed on an exchange. Level 1 ADRs
are found on the over-the-counter market and are an
easy and inexpensive way to gauge interest for its
securities in North America. Level 1 ADRs also have
the loosest requirements from the Securities and
Exchange Commission (SEC).
Level 2 - This type of ADR is listed on an exchange or
quoted on Nasdaq. Level 2 ADRs have slightly more
requirements from the SEC, but they also get higher
visibility trading volume.

ADR
Level 3 - The most prestigious of the three, this is
when an issuer floats a public offering of ADRs on a
U.S. exchange. Level 3 ADRs are able to raise capital
and gain substantial visibility in the U.S. financial
markets.
The advantages of ADRs are twofold. For individuals,
ADRs are an easy and cost-effective way to buy
shares in a foreign company. They save money by
reducing administration costs and avoiding foreign
taxes on each transaction. Foreign entities like ADRs
because they get more U.S. exposure, allowing them
to tap into the wealthy North American equities
markets.

National Association of Securities

Dealers Automated Quote (NASDAQ)
A global electronic marketplace for buying and selling
securities, as well as the benchmark index for U.S.
technology stocks. Nasdaq was created by the National
Association of Securities Dealers (NASD) to enable
investors to trade securities on a computerized, speedy
and transparent system, and commenced operations on
February 8, 1971. The term Nasdaq (Automated
Quote) is also used to refer to the Nasdaq Composite,
an index of more than 3,000 stocks listed on the Nasdaq
exchange that includes the worlds foremost technology
and biotech giants such as Apple, Google, Microsoft,
Oracle, Amazon, Intel and Amgen.