FINANCIAL MANAGEMENT

Ekrem Tufan
etufan@yahoo.com

Anadolu University
Open Education Faculty Canakkale Office

What will we learn?

1. An overview of managerial finance - What is the finance? -Managerial finance in the 1990s -The financial managers responsibility -The goals of the corporation

What will we learn?

2. The financial environment: Markets, institutions -The financial markets -Financial institutions -The stock market

What will we learn?

3. Financial Ratios as a tool of financial analysis
Profitability Ratiosability of the firm to earn an adequate return and control costs. Asset Utilization RatiosHow efficiently the firms assets are being utilized. Liquidity Ratiosfocus on short term risk management. Debt Utilization Ratiosfocus on the capital structure and long-term risk management

What will we learn?

3. Risk and rates of return -Defining and measuring risk -Expected rate of return

What will we learn?

4. Strategic long-term investment decisions -Generating ideas for capital projects -Project classifications -Similarities between capital budgeting evaluation techniques

What will we learn?

5. Capital budgeting evaluation techniques -Payback period method -Net present value method -Internal rate of return method

What will we learn?

6. Practice of NPV and IRR methods -Example of NPV -Example of IRR -Example of sensitivity analysis Continuation of examples So on, so far

What kind of resources can we use when we doing research?

1. 2. 3. 4. 5. 6. All finance books All articles about finance www.ssrn.com www.makalem.com www.ceterisparibus.com Essentials of Managerial Finance, J. Fred Weston
and Eugene Brigham, Harcourt Brace&Company International Edition, 1992.

7. Finansal Ynetim, Semih Bker and et all, 2005. (The main book of our lesson!)

What is the finance?

Money Stock exchange Banks What else? How about the companies? Balance sheet

What is the finance?

To achieve the goals of company; 1. Finding funds from the most suitable sources 2. Using them effectively and 3. Control the results

An Overview of Managerial Finance

A Short History of Managerial Finance
1930s: Liabilities and equity, Great Depression 1940 and 1950s: Assets, quantitative methods, discounted cash flow methods World War II 1960 and 1970s: Optimization of assets and liabilities and equity, statistical methods, oil crises 1980s: Globalization, interest rate and exchange risk, macintosh 1990s to today: More risk, more computer, new financial instruments and methods, Wall Street

An Overview of Managerial Finance

Board of Directors President Vice President:Sales Treasurer Credit Manager Inventory Manager Director of Capital Budgeting Vice President:Manufacturing Vice President:Finance Controller Cost Accounting Financial Accounting Tax department

An Overview of Managerial Finance

The Financial Managers Responsibility Forecasting and planning Major investment and control Coordination and control Dealing with the financial markets

An Overview of Managerial Finance

The goals of the corporation Managerial incentives to maximize shareholder wealth Social responsibility Stock price maximization and social welfare

Managerial incentives to maximize shareholder wealth

Stockholders Make the highest money from the company Do not want to share theirs company with others. Managers Having autonomy Protect themselves from a hostile takeover or a proxy fightHostile takeover.doc Try to maximize stock prices in reasonable level

Social responsibility
Ethical responsibility to provide a safe working environment To avoid polluting water and air Produce safe products But social responsibility has a cost If the other firms in its industry do not follow suit, their prices and costs will be lower Most investors do not like to buy socially oriented companies shares.

Stock price maximization and social welfare

What requires stock price maximization?
1. Efficient, low-cost plants that produce highquality goods and services at the lowest possible cost 2. Development of products that consumers want and need, so the profit motive leads to new technology, to new products, and to new jobs

The Financial Environment: Markets, Institutions

The Financial Markets
Physical asset markets Spot markets and futures markets Money markets Mortgage markets World, national, regional and local markets Primary markets-secondary markets

Physical asset markets

(Real asset markets) Wheat, autos, real estate, computers, stocks, bonds, notes, mortgages etc.

Spot markets, futures markets, money markets, capital markets

In spot and futures markets you can buy and sell assets on the spot delivery or for delivery at some future date, such as six months, or a year in the future. Money markets are the markets for debt securities with maturities of less than one year where capital markets for the long term.

World, national, regional and local markets, primary-secondary markets

Primary markets, are the markets in which corporations raise new capital. Secondary markets, are markets in which existing, already outstanding securities are traded among investors.

The Financial Environment: Markets, Institutions

Financial Institutions in Turkey
1. 2. 3. 4. 5. 6. 7. Commercial banks Pension funds Mutual funds Life insurance companies Stock exchange (ISE) Gold exchange (IGE) Futures markets (Izmir Futures Market)

The Financial Environment: Markets, Institutions

Stock Exchanges ISE IGE
Turkish Derivatives Exchange

Over the counter market

The Financial Environment: Markets, Institutions

Istanbul Stock Exchange
1985 December Inauguration of the Istanbul Stock Exchange under the Chairmanship of Mr. Muharrem KARSLI 1986 January Commencement of stock trading at the Cagaloglu building on January 3, 1986 1991 June Initiation of the Bonds and Bills Market and commencement of Outright Purchases and Sales Transactions 1997 August launch of the Repo/Reverse Repo Market 2005 January ISE Derivatives Market is closed permanently as of January 28, 2005

The Financial Environment: Markets, Institutions

Istanbul Gold Exchange 26 July 1995 Inauguration of the IGE 15 August 1997 establishment of the Futures and Options Market

The Financial Environment: Markets, Institutions

Turkish Derivatives Exchange (TURKDEX) 04 July 2002, establishment of the Turkish Derivatives Exchange 04 February 2005, transactions started officially

Risk And Rates Of Return

Defining and measuring risk Expected Rate of Return Measuring Risk: The Standard Deviation Measuring Risk: Coefficient of Variation

Risk And Rates Of Return

What is the risk in finance?
Risk is the financial uncertainty that the actual return on an investment will be different from the expected return. The exposure to loss of investment as a result of changes in business conditions, domestic or foreign economies, investment markets, interest rates, relative currency rates, or inflation.

Expected Rate of Return

Calculation of Expected Rates of Return: Payoff Matrix
Expected Rate of Return.xls

Expected Rate of Return

The weights are the probabilities, and the weighted average is the expected rate of return, k .
n

Expected rate of return=

Pk
i i !1

Expected Rate of Return

! P (k )  P (k 2)  P (k ) k 1 1 2 3 3 ! 0.3(100%)  0.4(15%)  0.3( 70%) ! 15%

Measuring Risk: Standard Deviation

XU1002002-12.xls

Coefficient of Variation as a Risk Measure

W CV ! k
Coefficient of variation (CV), standard deviation divided by the expected return

Strategic Long-Term Investment Decisions

Generating ideas for capital projects
Who creates the capital budgeting projects? Do we need to be an entrepreneur? Two questions for testing being entrepreneur (CV and address book)

Strategic Long-Term Investment Decisions

Project classifications
1. 2. 3. 4. 5. 6. Replacement: Maintenance of business Replacement: Cost reduction Expansion of existing products or markets Expansion into new products or markets Safety and/or environmental projects Other

Project classifications
Replacement: Maintenance of business One category consists of expenditures to replace worn-out or damaged equipment used in the production of profitable products.
Should we continue to produce these products or services? Should we continue to use our existing production processes?

Project classifications
Replacement: Cost reduction This category includes expenditures to replace serviceable but obsolete equipment.
The purpose here is to lower the costs of labor, materials, or other inputs such as electricity.

Project classifications
Expansion of existing products or markets

Expenditures to increase output of existing products, or to expand outlets or distribution facilities in markets now being served are included here.

Project classifications
Expansion into new products or markets These are expenditures necessary to produce a new product or to expand into a geographic area not currently being served.

Project classifications
Safety and/or environmental projects Expenditures necessary to comply with government orders, labor agreements, or insurance policy terms fall into this category.

Project classifications
Other project investments This catch all includes office buildings, parking lots, executive aircraft, and so on.

Strategic Long-Term Investment Decisions

Similarities between capital budgeting evaluation techniques
1. 2. 3. 4. 5. 6. Project cost Expected cash flows estimation Estimation of project riskiness Cost of capital decision Measurement of present value of cash inflows Present value of the expected cash inflows and required outlay

Capital Budgeting Evaluation Techniques

1. 2. 3. 4. Payback Period Net Present Value (NPV) Internal Rate of Return (IRR) Sensitivity Analysis

Capital Budgeting Evaluation Techniques

Payback period
Project S : Net Cash Flow Cumulative NCF

Payback period
Project (S)
Uncovered cost at start of year Payback=Year before full recovery + Cash flow during year 100 Payback Period (S)= 2 + 300 = 2,333 Years

Capital Budgeting Evaluation Techniques

Payback period
Project L
Net Cash Flow Cumulative NCF

Payback period
Project (L)
200 = 3,333 Years 600

Payback Period (L)= 3 +

Capital Budgeting Evaluation Techniques

Net Present Value (NPV)
NPV !CF0  CF1 (1 k )
1

CF2 (1 k )
2

..............

CFn (1 k ) n

CFt ! (1  k ) t t !0

Capital Budgeting Evaluation Techniques

Internal rate of return (IRR)
The IRR is defined as that discount rate which equates the present value of a projects expected cash inflows to the present value of its expected costs.

Capital Budgeting Evaluation Techniques

Internal rate of return (IRR)

CF0 

CF1 (1 IRR )

1

CF2 (1 IRR )

2

..............

CFn (1 IRR )

n

!0

CFt ! !0 t t ! 0 (1  IRR )

Net Present Value (NPV)

To implement this method, it should be proceeded as follows:
Find the present value of investment and its future cash flows with discounting at the projects cost of capital Sum discounted investment and cash flows If the NPV is positive then we accept the project. If we have to choose a project among the alternate projects, we should take into consider the highest NPV

Example of NPV and IRR

Small Scale Flower Cultivation Project
This project has written by Weitz Center experts for an area in India. The project covers an area about one acre. The aim is producing and selling flowers. Projects cost will be covered by a bank loan. All cost and sale data have been collected and realised that target sales could be achieved. Cost benefit analysisFlower.xls