Financial management objectives:

The raising of long term finance:

Company needs finance for investments and for expansion

Job of the financial manager is to Identify the different sources of finance.

Investment decisions:

Decions have to be made where investments are to be made .

Management of working Capital: Adequate maintenance of working capital

Management of risk:

Exchange rate risks if business trdes abroad and interest rate risks if the business borrows or
deposits money.

Financial intermediation:

Companies need to raise money inorder to finance their operations.

It is difficult to raise money directly from private individuals and therefore turns to institutions and
organisations.

One of the ex of financial intermediary is bank.

Features of service that are prvided by FI are:

Aggregation:

Many small deposits get aggregated into a lumpsun]m amount.

Maturity transformation:

Diversification of risk:

Money is lent to many sectors of companies and not to an individual co.

Other examples of FIs are

Pension Funds

Investment trusts

State savings banks

Financial markets
Includes both money markets and capital markets

Primary market activity – Selling of new issues to raise funds

Secondary market – trading of existing financial instruments.

The main capital markets are

The official list at londin stock exchange

Euro bond markets – Markets where bonds denominate din any currency other than that of the
national currency of the issuer are traded.

Money markets :Main areas of trading include

Dicount market : where bills of exchange are traded

Interbank markets where bank lends each other short term funds

Euro currency market where banks trade in all foreign cerrencies

FINANCIAL MARKET EFFICIENCY

An efficient market is one in which the market price of all securities tradedon it reflects all the
information available.

Perfect market is one which responds immediately to the information made available to it.

Efficient market hypothesis:

Weak form of efficiency:

Past information

Semi strong : Present Share prices reflect all information currently publicly available

Strong form Efficieny: Share prices reflect all information published and unpublished. No possibility
of insider trading.

Factors which determines interest rates:

General level of interest rates in the economy

The level of risk

Duration need and size

Yield curves:

Shape of the curve can be explained by expectations theory, Luquidity,Segmentation

MANAGEMENT OF WORKING CAPItAL

Working capital : Net current assets that are required for day to day operating activities

Investment in working capital

Financing of working capital

Short finance is often cheaper but risky as it is repayable on demand.

Permanent working capital should be financed by longterm finance

Temoporary working capita (additional capital above the permanent working capital) should be
financed by short term finance.

MANAGEMENT OF WORKING CAPITAL INVENTORY:

EOQ MODEL

Costs involved in an inventory ordering syatems are:

Purchase cost

Reorder cost inventory holding cost

EOQ = SQRTof( 2* ANNUAL DEMAND * Costs per order)/holding cost per unit per annum

JIT SYSTEM :
INVESTMENT APPRAISAL METHODS:

Capital investment decisions

Discounted cash flow – NPV

IRR : the rate of interest at which NPV of the project is zero is called IRR.

Intheory DCF approach is the best method of appraisal

It considers cash flows and also timing of these cash flows

It is the cash that is needed to pay dividend to the share holders and cash that is needed to expand
the company by acquisition of new investments.

ACCOUNTING Rate of return = Avg profits p.a from an investment/average bookvalue of the
investment *100

Pay back period : no.of years it takes to recoup the initial investment made in cash terms.

Investment Appraisal

Working capital notes

Normal assumptions are (but read the question!):

• Working capital is needed right at the start of a project.

• Working capital levels may vary over the project life and are often linked to forthcoming
production/sales.

• Working capital changes cause incremental cash flows.

• All working capital is recovered at the end.

• Working capital has no tax effects.

Leases

Discount rate is always after tax

NPV Selection is always and not highest.

ASSET REPLACEMENT DECISION

STEP 1 : CALCULATION OF NPV

STEP 2 CALCULATION OF EQUIVALENT ANNUAL COST

EAC= NPV/ANNUITY Factor

ASSET REPLACEMENT WHEN TOTAL COST IS MINIMUM.

CAPITAL RATIONING

Projects are divisible

Steps

1. Calculate the Profitability index

2. Allocation of funds on balancing basis
3. Adjust NPV

Projects are indivisible

Steps
Find the best combination
NPV is Maximised
Initial capital can cover the cost.

Sources of FINANCEand Dividend Policy

Shortterm
Od
Shirt term loan
Trade credit
Lease finance

Calculation of EMI= P*R(1+r)^N/(1+r)^n-1

Finacial gearing
Prior charge capital 0r debt
= Loans + Preference share capital • Capital is measured using the SOFP amounts. If given
market values, use these instead. • If a question defines gearing in another way, use that.
Debt ratio = Total debts/Total assets

Operation gearing = Contribution/PBIT

Foreign Exchange risk

Types
Economic ; Longer term ex Rates fluctuations may Affect the competitiveness of business
Translation : Differences arise when translating Foreign assets and liabilies at a reporting
deadline
Transaction Imports and exports where payents and receipts depend n ex rates
TRANSACTION
Transaction: imports and exports where payments and receipts depend on exchange rates. •
The most important source of currency risk in the exam • Many techniques to reduce the
 risk: – Invoicing in domestic currency – Leading and lagging – Matching assets and liabilities –
Forward contracts – Interest rate hedging – Futures – Options

Business finance

Market Capitalization = Current Share price * Outstanding Shares

Also called as value othe co

Asset Valuation Basis

• Net Asset method of share valuation. Conservative approach!

• Using this method of valuation, the value of an equity share is equal to the net tangible
assets divided by the number of shares.
• Net tangible assets = Tangible (non-current assets (Net of dep)+current assets – all
liabilities) • *All liabilities exclude equity & reserves.
• Intangible assets (including goodwill) should be excluded, unless they have a market value.
E.g. Patents/copyrights

Use revalued values if given

While calculation of NPV WC and scrap values are not taxed but only discounted.

Advance lease payments tax is calculated from 2nd year not first year

Forecasting foreign currency exchange rates

Factors affecting ex rates

Supply and demand

These are influenced by
Interest rates
Inflation
Political and economic effects
Balance of payments

Purchase power parity

Inflation has to be adjusted in forex rates
i.e purchased in other currecy and translated should also show same amount

calcu Future rates = spt rate*(1+inf Foreign C)/(1+inflation of Home Currency).

Interest rate parity is also same with interest rates.

Foreign exchange risk mgmt.

Types

Transaction Risk transaction at one rate and settlement in another rate Financisl manager risk

Translation risk translating balances for preparation of accounts

Economic risK unespected mmmovements in foreign exchange

Growth in calculating KE

Growth = proportion of profits retained * rate of retun on invetments

PPR =div – eps/ div

RRI = EPS/net assets

Cum dividend Pref Shares irredeemable

Ex dividend= mp-int*Actual Price

R=Nv*int/ex div Mp

Int is not taxed on dividends

Methods of hedging transaction exposure

Invoicing in home currency

Leading and lagging

Netting

Matching