Professional Documents
Culture Documents
K.V.RAMESH
Assistant Professor
Coordinator MBA ( PE )
Institute of Public Enterprise
Lay out
Dividend Decisions.
What is Finance ?
Approaches to finance
Providing of funds needed by a business on
most suitable terms.
Cash.
Concerned with raising of funds and their
effective utilisation.
Financial Management
Financial plan
Is a statement estimating the amount of capital and determining its
composition.
Objectives:
Considerations
Nature of Industry.
Credit rating of the concern.
Future plans- Expansion and diversification.
Availability of sources.
General economic conditions.
Government control.
Profit
Vs
Wealth
Dividend policy.
Controversy objectives
Maximize stockholders
wealth or wealth of firm.
Ownership and management
are separated.
Functional areas of FM
Determining financial needs.
Selecting the source of funds.
Financial analysis and Interpretation.
C-V-P analysis.
Capital budgeting.
Working capital management.
Profit planning and control.
Dividend policy.
Responsibilities of FE
The basic responsibility of the treasurer is to
provide, manage and protect the firms capital.
The basic responsibility of the controller is to
check that the funds are used efficiently.
Functions of FE
Treasurer :
Obtaining finance
Banking relationship
Investor relationship
Short- term financing
Cash management
Credit administration
Investments
Insurance
Functions of FE
Controller:
Financial Accounting
Internal audit
Taxation
Management accounting and control
Budgeting, planning and control
Economic appraisal
Reporting to Government
FM Process
FM is a dynamic decision-making process
include a series of interrelated activities
involving:
Financial planning
Financial decision-making
Financial analysis
Financial control
Compounding Technique
Interest is compounded when the amount earned on an initial deposit
becomes part of the principal at the end of the first compounding period.
Principal refers to the amount of money on which interest is received.
n
Vn = Vo(1+i)
Where Vn = Future value at the period.
Vo = Value of money at time 0.
i = Interest rate.
Note: If calculations becomes difficult, the future value of money can be
calculated with the help of Compound factor tables.
Vn = Vo (CFi,n)
Where CFi,n is compound factor at i percent and n periods.
Po(1+i) - Po
Where
Vn = Vo ( 1 + i/m)
Vn = Future value of money after n years.
Vo = Value of money at time 0
i = Interest rate
m = Number of times of compounding per year
( 1 + i/m) 1
Where i refers to nominal rate of interest
m refers to frequency of compounding per year
Problems
1.
2.
3.
4.
5.
6.
7.
What will be the value of Rs.100 after two years at 10% p.a. Rate of interest if
neither the principal sum of Rs.100 nor interest is withdrawn at the end of one
year.
From the above calculate the value of Rs.100 @ 10% after ten years.
If you deposit Rs.1000 in an account earning 7% simple interest for two years.
What is the accumulated interest at the end of the second year?
Calculate the compound value of Rs.10,000 at the end of third year @ 12%
rate of interest when interest is calculated on yearly and quarterly basis.
A company offers 12% rate of interest on deposits. What is the effective rate
of interest if the compounding is done half yearly, quarterly and monthly?
Mr. A deposits Rs.1000 at the end of every year for four years and the deposit
earns a compound interest @ 10% p.a. Determine how much money he will
have at the end of four years.
year for five years in a bank and the deposit earns a compound Mr. B deposits
Rs.5000 at the beginning of each interest @ 8% p.a. Determine how much
money he will have at the end of five years?
Problems
1.
2.
3.
4.
5.
6.
Valuation of Securities
Bonds with a maturity period:
n
Vd =
Rt
Mn
(1+ Kd)t
(1+ Kd)n
Vd = Value of bond
R1, R2 ----- = Annual interest in period 1, 2 & so on.
Kd = Required rate of return
M = Maturity value of bond
n = Number of years to maturity
Note: If n becomes large we use present value tables, formula
is
Vd = (R)(ADFi,n) + (M)(DFi,n)
Bonds in Perpetuity/DDBs
Bonds which never mature or have infinite maturity period.
The value of such bonds is the discounted value of infinite
streams of interest (cash) flows.
Vd = R
Kd
Deep Discount Bonds:
n
Vddb = FV / ( 1 + r )
Or
Vddb = (FV) x (DFi,n)
Where Vddb = Value of a deep discount bond
FV = Face value at maturity
r = Required rate of return
n = Number of years to mature / Life of DDB
Problems
1.
2.
3.
4.
5.
2.
D is constant
t
Po = Dt / (1+ke)
t=1
No growth:
Po = D/Ke
Constant growth: Po = D1 =
Do(1+g)
Ke - g
Ke - g
Where Do is current dividend
D1 is expected dividend
Ke is required rate of return on equity
g
Problems
1.
2.
3.
D1
Ke - g
OR
D1
Ke
Po + g
P1-P0
+
Po
P0
The market price of a share is Rs.80. The company is
expected to pay a dividend of Rs.4 and the share can
be sold at Rs.88. Calculate return on share. Advise
the investor to buy or not if his capitalisation rate is
10%.
Definitions
Form of Capital
Debt
Preference Capital
Retained Earnings
Equity Capital
Redeemable debt
Before Tax
I + 1/n(RV-NP)
Kdb =
(RV+NP)
Where I is Annual Interest
n is number of years in which debt is
to be redeemed.
RV is Redeemable value of debt
NP is Net proceeds of debentures.
After Tax
I(1-t)+ 1/n(RV-NP)
Kdb =
(RV+NP)
Problems
Kr =
+ G
NP or MP
Where D1 is expected dividend at the end of the year
G is Rate of growth
Cost of Equity
It refers to the maximum rate of return that the
company must earn on equity finance in order
to maintain the present market price of the
stock.
Dividend yield method: Ke = D/NP or MP
Dividend yield plus growth method:
Ke = (D1/NP + G) = Do(1+g)/NP+G
Problems
1.
2.
Controllable factors.
Capital structure policy
Dividend policy
Investment policy
Uncontrollable factors
Tax rates
Level of Interest rates
Market risk premium
Assignment of Weights
Book value
Weights assigned on the basis of values found on the
balance sheet.
The book value of the source of fund divided by the book
value of total funds.
Merits:
1.
Simple in calculation.
2.
Book values provide a usable base, when firm is not listed
or security are not actively traded.
3.
Analysis of capital structure i.e.,D-E ratio
Demerits:
1.
No relationship between book values and present economic
value of various sources of capital.
2.
Book value proportions are not consistent with the concept
of cost of capital.
Assignment of Weights
Market value:
Weights assigned on the basis of market value of the component
of capital.
Market value of the component of capital divided by the market
value of all components of capital.
Merits:
1.
Values are closely approximate the actual amount to be
received from their sale, representing the true value of the
investors.
2.
Prevailing market prices are taken into account.
Demerits:
1.
Very difficult to determine the market values because of
frequent fluctuations.
2.
Equity capital gets greater importance.
3.
If the market value of the share is higher than the book
value, WACC would be overstated and vice-versa.
Problems
Following is the long-term capitalization of a company:
1.
2.
Importance CAPM
Assumptions
CAPM
Problems
1.
2.
Investment Decisions
Capital budgeting is the process of making
investment decisions in capital expenditures.
It is that expenditure incurred at one point of
time whereas benefits of expenditure are
realised at different points of time in future.
It is concerned with the allocation of the
firms scarce financial resources among the
available market opportunities.
Techniques of Financial
Evaluation
Pay-back period.
Discounted pay-back.
Accounting rate of return.
Net present value.
Internal rate of return.
Profitability Index.
PAY-BACK PERIOD
This method throws light as to the length of the period by
which the entire investment would be recouped from
out of the future cash flows.
Cash flow means net profit after tax before depreciation.
Advantages:
Disadvantages
It does not take into account the cash inflows earned
after the pay-back period and hence true profitability
of the projects cannot be correctly assessed.
Problems
1.
2.
Merits / Demerits
Merits:
This method is fairly a simple calculation of averages.
This method takes calculations of average rate of
return for the entire life of the project by taking the
terminal salvage / scrap value.
Demerits:
Does not take into account time value of money.
It does not take into account the quickness or the
rapidity with which the investment is recouped.
Problems
1.
2.
Demerits:
More difficult to understand and operate.
While comparing projects with unequal
investment of funds, NPV may not give
good results.
It is not easy to determine the appropriate
discount rate.
Problems
1.
Outflows
1,50,000
30,000
30,000
60,000
80,000
30,000
Rs.
Inflows
20,000
Steps
Steps
b) When annual cash flows are unequal
over
the life of the asset.
Merits / Demerits
Merits:
It takes into account time value of money.
It considers the profitability of the projects over its
entire life.
It provides for uniform ranking of various proposals.
It is method which ensures reliable technique of capital
budgeting.
Demerits:
It is difficult to understand.
It is difficult method of evaluation of investment
proposals.
This method assumes that the earnings are re-invested
in the project, which is not justified.
Size disparity
Time disparity
Projects with unequal lives
Re-investment rate assumption
NPV method is a superior to that of
IRR.
Problems
1.
2. A company has investment opportunity costing Rs.40,000 with the following expected net
cash flow after taxes and before depreciation.
Year
1
2
3
4
5
6
7
8
9
10
3.
A company can make either of two investments at the beginning of 2010. Assuming
required rate of return @ 10% per annum. Evaluate the investment proposals under
pay-back period, NPV, IRR, PI and discounted pay-back period.
The forecast particulars are given below:
Proposal A
Proposal B
Cost of Investment (Rs.)
20,000
28,000
Life (Years)
4
5
Scrap Value
Nil
Nil
Net Income (after dep & tax) Rs.
End of 2010
500
Nil
End of 2011
2,000
3,400
End of 2012
3,500
3,400
End of 2013
2,500
3,400
End of 2014
3,400
It is estimated that each of the alternative proposals will require additional networking
capital of Rs.2,000 which will be received back in full after the expiry of each project
life. Depreciation is provided under straight line method. The present value of Re.1
to be received at the end of each year, at 10% and 14% may be utilized.