Applying different financial tools in decision making

Nadeem Ahmed #1035010

Financing Decisions

As far we have learned from this course, financial decisions are required from starting a project as well as in the existing project. Decisions are based on several inter-related criteria. (1) maximize the value of the firm which yield a positive net present value when valued using an appropriate discount rate in consideration of risk. (2) projects must also be financed appropriately. (3) maximizing shareholder value dictates that management must return excess cash to shareholders (i.e., distribution via dividends)

Analysis in an existing project

The ratios analysis is the most powerful tool of financial statement analysis. Ratios simply means one number expressed in terms of another. A ratio is a statistical yardstick by means of which relationship between two or various figures can be compared or measured. Ratios can be found out by dividing one number by another number. Ratios show how one number is related to another

Different type of ratio analysis

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Short term solvency We can measure current ratio analysis, Quick ratio, Cash ratio. The primary concern is the firms ability to pay its bills over the short run without undue stress.

Different type of ratio analysis

Inventory measurement- how many days a company can operate with its current asset. Long term solvency measurement Total debt ratio, debt equity ratio, long term liabilities, cash coverage Profitability Measurement- Profit margin analysis, Return on asset, Return on equity

Analysis in opening a project

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Decision of capital budgeting is important while opening a project. There are several steps in capital budgeting. Project proposal Analysis Decision Taking Implementation Follow up

Decision
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Decision making is important point in the capital budgeting. Payback period- if the pay back period is less than the project life, then it is acceptable. NPV method- if the NPV i.e pv ii is greater than zero then the project is acceptable IIR method internal rate of return which is more precise than previous two methods. If the IIR is greater cost of capital then the project is acceptable.

Why Cost of Capital

A firms overall cost of capital must reflect the required return on the firms assets as a whole If a firm uses both debt and equity financing, the cost of capital must include the cost of each, weighted to proportion of each (debt and equity) in the firms capital structure

Use of cost of capital

It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet

Elements Of Capital

Ordinary Share Preference Share Debenture Retained Earnings

Importance of Risk and Return

Risk reflects the chance that the actual return on an investment may be different than the expected return. One way to measure risk is to calculate the variance and standard deviation of the distribution of returns. We will once again use a probability distribution in our calculations. The distribution used earlier is provided again for ease of use.

Why identifying Risk

The future is uncertain. Investors do not know with certainty whether the economy will be growing rapidly or be in recession. Investors do not know what rate of return their investments will yield. Therefore, they base their decisions on their expectations concerning the future. The expected rate of return on a stock represents the mean of a probability distribution of possible future returns on the stock.

A Financial Analyst should utilize all the tools above for a smart decision. Thank you All!