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INTRODUCTION ON FINANCIAL MANAGEMENT

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Management

3/22/17 1

MONEY:

required for running any organisation, it is

just like blood, without which there is no

human being similarly without finance

there is no organisation.

3/22/17 2

MONEY

3/22/17 3

MONEY & FINANCE

A currency as long as you have with you it

is money only.

investment avenues (opportunities) it

becomes finance.

3/22/17 4

MEANING OF FINANCIAL

MANAGEMENT

FM is concerned with the acquisition,

financing and management of assets to

achieve organizational goal.

ACQUISITION

OF ASSETS

MANAGEMEN FINANCING

T OF ASSETS THE ASSETS

3/22/17 5

MEANING OF

FINANCIAL MANAGEMENT

activities:

1. Anticipating (look forward to) financial

needs.

2. Acquiring financial resources.

3. Allocating funds in business.

3/22/17 6

1. Anticipating financial needs: Estimation

of funds required for investment in fixed and

current assets.

how to obtain the funds to finance the

anticipated financial needs.

means allocation of available funds among

the best plans of assets, which are able to

maximise shareholders wealth.

3/22/17 7

FINANCIAL DECISIONS

The financial management can be broken

down into 3 major decisions. (which are

important finance functions)

A firm takes these decisions simultaneously

business.

Firm may not take these decisions in a

with the objective of maximizing

shareholders wealth.

3/22/17 13

FINANCIAL

DECISIONS

INVESTMEN

FINANCING DIVIDEND

T

DECISION DECISION

DECISION

3/22/17 14

Investment Decision

Decision which is related to the selection of

assets.

The required assets fall into 2 groups:

& building. Investment in long-term assets is

popularly known as CAPITAL BUDGETING.

ii) Short-term Assets: Ex: raw materials,

work in process, finished goods, debtors,

cash, etc. which can be converted into cash

within a financial year.

Investment in currents assets is popularly

termed as WORKING CAPITAL

MANAGEMENT

3/22/17 15

FINANCING DECISION

Determination of proportion of debt and

equity in capital structure.

Debt involves fixed cost (interest), which

but also increases risk.

Rising of funds by issue of equity shares is

will expect higher rate of earnings.

maximizes shareholders wealth.

3/22/17 16

Dividend decision

Which relates to dividend policy. Dividend is

distribution to equity shareholders.

It involves determination of portion of

dividend per share.

There are two options available in dealing

a. Distribution of profits as dividends

b. Retention of earnings in the firms itself if

they require for financing of any business

activity.

3/22/17 17

FINANCIAL MANAGER SHOULD DETERMINE

OPTIMUM DIVIDEND POLICY, WHICH

MAXIMIZES MARKET VALUE OF THE SHARE

THERE BY MARKET VALUE OF THE FIRM.

3/22/17 18

INTER-RELATION AMONG

FINANCIAL DECISIONS.

There is a interrelation between investment

decision and financing decision, without

knowing the amount of funds required and

types of funds (short-term & long-term) it is

not possible to raise funds.

These two are dependent on each other.

3/22/17 19

Financing decisions influences and is

influenced by dividend decision, since

retention of profits for financing selected

projects reduces the profit available to

ordinary shareholders, there by reducing

dividend payout ratio.

financing decision and dividend decision.

3/22/17 20

Dividend decision and investment decisions

are interrelated because retention of profits

for financing the selected assets depends

on the rate of return of proposed

investment and the opportunity cost.

investment is higher than the opportunity

cost of retained profits and vice-versa.

3/22/17 21

INTER-RELATION AMONG

FINANCIAL DECISIOINS

INVESTMENT

DECISION

FINANCING DIVIDEND

DECISION DECISION

3/22/17 22

FEW INDIAN COMPAYNIES

BUY BACK OFFER

3/22/17 23

Profit maximization

VS Wealth

maximization

Broadly, there are two alternative

objectives that a business firm can pursue

Profit Maximization

Wealth Maximization

Profit Maximization

It is a term which denotes the maximum profit to

be earned by an organization in a given period of

time.

The profit maximization goal implies that the

Investment, Financing and Dividend decisions of

the enterprise should be oriented to profit

maximization.

Merits of Profit

Maximization

Best Criterion on decision making.

Optimum utilization.

Drawbacks of Profit

Maximization

It ignores time value of money.

It is vague conceptually.

It ignores the risk factor.

It may tempt to make such decisions which

may in the long run prove disastrous.

Its emphasis is generally on Short run projects.

In the new business environment Profit

maximization is regarded as unrealistic,

difficult, inappropriate and immoral.

Wealth Maximization

to maximize the market value of the firms

shares.

Maximizes the net present value of a course of

action to the shareholders.

Benefits are measured in terms of cash flows.

Merits of Wealth

Maximization

The wealth maximization objective takes care of

the:

Shareholders interest

lenders or creditors interest

Workers or employees interest

It also ensures fair return to the shareholders,

building up reserves for growth and expansion,

ensuring financial discipline in the management.

Merits of Wealth

Maximization

It focuses on the long term.

It takes into account the time value of money.

It considers risk.

It maintains market price of the shares of the

organization.

It recognizes the value of regular dividend

payments.

Conflict:

Profit Maximization Wealth Maximization

Its main objective is to achieve

highest market value of

common stock.

Its main objective is to earn

It emphasizes long term

large amount of profits.

It considers time value of

It emphasizes short term money.

It ignores time value of It recognizes risk and

money. uncertainty.

It recognizes the timings of

return.

uncertainty.

It ignores timing of return

3/22/17 35

Risk Return Trade of

What is Risk?

3/22/17 52

3/22/17 53

3/22/17 54

3/22/17 55

RISK

It

is the variability of actual

return from the expected return

associated with a given asset.

3/22/17 56

RETURN

It

is the actual income received

plus any change in market price

of an asset / investment

3/22/17 57

Trade of

forgoing one or more desirable outcomes in

exchange for increasing or obtaining other

desirable outcomes in order to maximize

the total return or effectiveness under given

circumstances.

3/22/17 58

Risk Return Trade of

What is Risk? Many investors view investment risk

as the possibility of losing part of your capital.

Think of risk as the potential for a negative return

on an investment -- the higher the probability of a

negative return, the greater the risk.

returns associated with an investment, the higher

the risk. Therefore, risk refers to the variability or

volatility of an investment's return. If an

investment's value fluctuates only slightly from

year to year, the investment has relatively low risk,

while wider value fluctuations reflect a relatively

high risk.

Riskis the chance that an investment's actual

return will be different than expected. 3/22/17 59

Roller Coaster

3/22/17 60

If investment's returns have been going up

and down like a roller coaster ride and

keeping you up at night, then understanding

a fundamental investment principle called

Risk/Return Trade-off may help.

The concept is also known as the "ability-to-

sleep-at-night test".

A common misconception is that higher risk

off tells us that higher risk gives us the

possibility of higher returns. But there is no

guarantee.

3/22/17 61

Deciding what amount of risk an investor can

take while remaining comfortable with

investments is very important.

chance that an investment's actual return will be

different than expected.

bystandard deviation. Risk means having the

possibility of losing some, or even all, of the

original investment.

3/22/17 62

Standard deviation

increases or decreases for a given set of

returns.

Volatility is measured by calculating the

over a given period of time. It shows the

range to which the price of a security may

increase or decrease.

3/22/17 63

Low levels of uncertainty (low risk) are associated

with low potential returns. High levels of

uncertainty (high risk) are associated with high

potential returns.

desire for the lowest possible risk and the highest

possible return. This is demonstrated graphically in

the chart below. A higher standard deviation means

a higher risk and higher possible return.

3/22/17 64

Risk/Return Tradeof

3/22/17 65

A common misconception is that higher risk

equals greater return. The risk/return

tradeoff tells us that the higher risk gives us

thepossibilityof higher returns. There are

no guarantees. Just as risk means higher

potential returns, it also means higher

potential losses.

3/22/17 66

Determining what risk level is most

appropriate for an investor isn't an easy

question to answer. Risk tolerance differs

from person to person.

Investor decision will depend on his goals,

factors.

3/22/17 67

On the lower end of the scale, therisk-free

rate of returnis represented by the return

on Government Securities because their

chance ofdefaultis next to nothing. If the

risk-free rate is currently 6%, this means,

with virtually no risk, we can earn 6% per

year on deposited money.

3/22/17 68

Definition:Higher risk is associated with greater

probability of higher return and lower risk with a greater

probability of smaller return. This trade off which an

investor faces between risk and return while considering

investment decisions is called the risk return trade off.

trade off while making his decision to invest. If he deposits

all his money in a saving bank account, he will earn a low

return i.e. the interest rate paid by the bank, but all his

money will be insured up to an amount of Rs 1 lakh

(currently the Deposit Insurance and Credit Guarantee

Corporation in India provides insurance up to Rs 1 lakh).

losing a major part of his capital along with a chance to

get a much higher return than compared to a saving

deposit in a bank.

3/22/17 69

THE TIME VALUE OF

MONEY

TODAY IS MORE VALUABLE

THAN A RUPEE RECEIVABLE

IN FUTURE ?

3/22/17 70

The finance manager must keep the Time

factor in mind to take the appropriate

decisions on financing, investment and

dividends.

Finance Manager must know the various

Concept, Annuity Concept, Present Value

Concept etc.

All these concepts are basically based upon

3/22/17 71

Money has time Value means that the

value of money changes over a period of

time. The value of a rupee, today is

different from what it will be, say, after one

year.

Factors contributing to the Time Value

because of the following reasons:

3/22/17 72

CURRENT

CONSUMPTION

POSSIBILITY

OF

UNCERTAINTY INVESTMENT

OPPORTUNITY

RATIONALE

(JUSTIFICATION)

OF THE TIME

PREFERENCE FOR

MONEY

is one of the central ideas in finance.

3/22/17 73

Valuation Concepts/Techniques

The Time value of money implies:-

1. That a person will have to pay in future

more, for a rupee received today and

rupee to be received in the future.

DIFFERENT CONCEPTS.

3/22/17 75

Compound value

concept

Valuation

Concepts

Discounting /

present value

concept

3/22/17 76

COMPOUND VALUE CONCEPT

(INTEREST)

initial principal amount becomes a part of

the principal at the end of the a

compounding period.

OR

The interest that is earned on a given

deposit and has become part of principal at

the end of a specified period.

3/22/17 77

Ex:- Rs.1,000 invested at 10% is

compounded annually for three years,

calculate the compound value after 3 years.

Particulars Amount

Amount at the end of 1st year will be 1000 X 1,100

110/100

Amount at the end of 1st year will be 1100 X 1,210

110/10

Amount at the end of 1st year will be 1210 X 1,331

110/100

This compounding process will continue for an indefinite

time period. We can calculate the same by using an

equation also.

3/22/17 78

CV = Po ( 1 + I ) n

CV = Compound Value

Po = Principal amount

( I ) = Interest rate per annum

n = Number of years for which compound is

done.

CV = 1,000 ( 1 + .10 ) 3

= 1,331.

3/22/17 79

Ex. 1:- Mr. X who is deposited `10,00,000 in

a financial institute, which pay 8%

compound interest for a period of 5 years.

Calculate the amount to be received at the

end of 5 years.

CV P (1 I ) n

0

10,00,000 ( 1 + 0.08) 5

10,00,000 (1.469328)

14,69,328

3/22/17 80

Computation by this formula can also

become very time consuming if the

number of years increase, say 10, 20 or

more. In such cases to save upon the

computational efforts, Compound Table

Value can be used. The table gives the

compound value of Rs.1, after n years

for a wide range of combination of I and

n.

3/22/17 81

Ex. 2:- Mr. Shravan who is deposited `.

28,000 in a financial institute, which pay 6%

compound interest for a period of 7 years.

Calculate the amount to be received at the

end of 7 years.

CV = P0 ( 1 + I ) n

P0 = 28,000;

I=6%;

n=7

3/22/17 82

Ex. 3:- Mr. X who is deposited `.1,00,000 in

a Bank, which pay 10% compound interest

for a period of 5 years. Calculate the

amount to be received at the end of 5

years.

CV P0 (1 I ) n

1,00,000 ( 1 +

0.10) 5

1,00,000 (1.610)

1,61,051 3/22/17 86

VARIABLE COMPOUNDING PERIODS

Generally compounding is done once in a

year. In the above problem and we assumed

also that the compound is done annually.

If the investor promised to pay compound

interest for variable periods (semi annual,

quarter etc). This is calculated as follows:

CV n = P0 (1 + I/m) m x n

CV n = compound value at the end of year n

maturity period.

3/22/17 87

Ex;- How much does a deposit of Rs.40,000 grow to at

the end of 10 year at the rate of 6% PA interest

compounding is done semi-annually. Determine the

amount at the end of 10 years.

CV n = P0 (1 + I/m) mxn

40,000 [ 1 + 0.06/2] 2 x 10

*see the compound sum of one rupee table (A-1) for 20 years @ 3% interest rate.

3/22/17 88

Ex. 2:- Mr. Shravan who is deposited Rs.

28,000 in a financial institute, which pay 6%

compound interest half yearly for a period

of 5 years. Calculate the amount to be

received at the end of 5 years.

CV n = P0 (1 + I/m) mxn

P0 = ?

m = ?

m x n = ?

3/22/17 89

Ex. 3:- Mr. Aditya who is deposited `

1,00,000 with an investment company,

which pay 10% interest with semi

annual compounding. How much the

deposit grows to 5 years. Calculate the

amount to be received at the end of 5

years.

CV n = Po (1 + I/M) mxn

3/22/17 90

COMPOUND VALUE OF SERIES OF

CASH FLOWS:

Annuity means a series of cash flows

(inflow/outflow) of a fixed amount for

specified number of years. This can be

divided in to 2 types.

1. Uneven cash flows 2. Even cash flows

. CV n = P1 (1 + I) n-1 + P2 (1 + I) n-2 +.

Where..

. CV n = compound value at the end of year n

. P 1 = Payment at the end of year 1

. P 2 = Payment at the end of year 2

. I = Interest rate

3/22/17 91

1. Uneven cash

flows

Mr. Raj kumar deposits Rs.5,000, Rs.10,000,

Rs.15,000 Rs.20,000, and Rs.25,000 in his

savings bank account in the of year 1,2,3,4

and 5 respectively. Interest rate is 6%. He

wants to know his future value of deposits at

the end of 5 years.

CV n = P1 (1 + I) n-1 + P2 (1 + I) n-2 +.

5-2 + 15,000(1 + 0.06) 5-3 +20,000(1 + 0.06) 5-4

3/22/17 92

= 5,000(1 .262) + 10,000(1.191) +

15,000(1.124) +20,000(1 .060) + 25,000(1 .00)

= 81,280

FOLLOWING WAY

*see the compound sum of one rupee table (A-1) for 4,3,2,1,0, years

@ 6% interest rate.

3/22/17 93

No. of

Compound

Amount times Future

Year ing factor

paid compounde value

(6%)

d

1 2 3 4 5=2x4

10,00 11,91

2 3 1.191

0 0

15,00 16,86

3 2 1.124

0 0

20,00 21,20

4 1 1.060

0 0

25,00 0 1.000 25,00

5

3/22/17

94

Mr. Chary deposits at the end of each year

Rs.2,000, Rs.3,000, Rs.4,000 Rs.5,000 and

Rs.6,000, for 1 to 5 respectively. He wants

to know his series of deposits value at the

end 5 years with 6% rate of compound

interest.

CV n = P1 (1 + I) n-1

+ P2 (1 + I) n-2

+..

3/22/17 95

2. Even cash flows : Annuity is a series of

even cash flows for a specified duration. It

involves a regular cash outflow or inflow.

Ex:- payment of LIC premium, depositing in a

recurring deposit account.

Cash flows may happen either at the end of

If cash flows happen at the beginning of he

as when the cash flows happen at the end it

is called as a deferred annuity or regular.

3/22/17 96

COMPOUND VALUE OF DEFERRED ANNUITY:

Use the above formula

Determine Mr. Satyam's money value at the end

of 6 years

Ans: 3,487.5

Shortcut formula: CV n = P (1 + I) n 1

I

P = fixed periodic cash flow, I = interest rate,

0.06

= 500 { 6.975} = 3,487.5

Ref. pg.no.54 HP.

3/22/17 97

No.of

Compoundi

Amount times Future

Year ng factor

paid compounde value

(6%)

d

2 500 4 1.262 631.00

3 500 3 1.191 595.50

4 500 2 1.124 562.00

5 500 1 1.060 530.00

6 500 0 1.00 500.00

3,487.5

TOTAL

3/22/17 98

OR

Use A-2 table as short cut .

3/22/17 99

COMPOUND VALUE OF ANNUITY DUE:

When the cash flows involves at the beginning

calculated with the following formula:

CV n = P1 (1 + I) n + P2 (1 + I) n-1 + P3 (1 + I) n-2

. Pn (1 + I) n

(OR)

CV n = P (1 + I) 1 n (1 + I)

I

Ex: if you deposit Rs.2,500 at the beginning of

every year for 6 years in a saving bank

account at 6% compound interest. What is

maturity value of your money at the end of 6

years.

3/22/17 10

0

No.of times

Amount Compoundin Future

Year compounde

paid g factor (6%) value

d

1.419

1 2,500 6 3,547.50

TOTAL 18,485.00

3/22/17 10

1

3/22/17 11

3

THANK YOU ..

3/22/17 11

4

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