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FINANCIAL MANAGEMENT

Title: Financial Management



Objective
In todays dynamic world engineers along with taking technical decisions
also have to take financial decisions. So they need to understand,
analyze and interpret financial data and financial issues. This course
will help them in understanding the concepts and principles of
accounting and finance with the support of software packages so that
they can make quick informed financial decisions.
Learning Outcomes
At the end of the course the students will be able to understand:
- basic accounting principles.
- how to measure the performance of a business.
- how to make and evaluate the impact of business decisions at all levels.
Methodology
The course will be taught with the aid of lectures, case studies, and use of
computer spreadsheet programs. The students will self-learn the usage
of accounting packages available in the industry.

Text Book
Financial Management by M.Y. Khan, and P.K. Jain, Tata McGraw
Hill.
Financial Management by Prasanna Chandra, Tata McGraw Hill.

Books for Reference
Principles of corporate finance by Brealey, Richard A. and Myers,
Stewart C. Tata McGraw-Hill Publishing Delhi.
Fundamentals of financial management by Brigham, Eugene
F,Houston, Joel F. Thomson Asia Pte Ltd.
Financial management by I.M. Pandey, Vikas Publishing House Pvt
Ltd.
Course Contents
Topic-
Introduction
Basic Financial Concepts
Long Term Sources of Finance
Capital Budgeting: Principle Techniques
Concept and measurement of cost of capital
Cash Flows for Capital Budgeting
Financial statements & analysis
Leverages and Capital structure decision
Working capital management
Dividend Policy
Evaluation (Lecture Course)
Exam % of Marks Duration of
Examination
Coverage / Scope
(i) TEST-1
(T-1)
20 1 Hour

Syllabus covered upto test 1
(ii) TEST -2
(T-2)
25 1 Hour 15
Minutes
Mainly syllabus covered after
Test-1, plus some questions from
portions covered upto test 1
(iii)TEST-3
(T-3)
30 1 Hour 30
Minutes
Mainly syllabus covered after
Test-2, and upto Test-3 Plus some
questions from portions covered
Test-1 and Test-2.
(iv)
Assignments,
Quizzes, home
work &
Regularity in
attendance.
25
Quizzes: 5
Attendance: 5
Assignment: 5
Project work:
10
Entire
Semester
As decided and announced by the
teacher concerned in the class at
the beginning of the course

AN OVERVIEW
DEFINITION
Financial Management is broadly
concerned with the acquisition
(investment), financing and
management of assets by a
business firm
GOALS OF THE FIRM
Maximizing owners/shareholders wealth
Maximizing the price per share
Market price of a share serves as a barometer for
business performance
It indicates how well management is doing on behalf
of its shareholders
OBJECTIVES OF FINANCIAL
MANAGEMENT
Maximize owners' wealth


Market value of equity


SCOPE OF FINANCIAL MANAGEMENT

What should be the composition of the firms
assets?
What should be the mix of the firms
financing?
How should the firm analyse, plan and control
its financial affairs?

Financial Analysis, Planning and Control
Balance Sheet
Long Term
Financing

Short Term
Financing
Fixed Assets


Current
Assets
Management
of the
Firms Asset
Structure
Management
of
the Firms
Financial
Structure
KEY ACTIVITIES OF FINANCIAL
MANAGEMENT
Capital Budgeting
Decisions
Capital Structure
Decisions
Dividend
Decisions
Working Capital
Decisions
Return
Risk
Market Value of
the Firm
RISK RETURN TRADE OFF
FINANCE AND ECONOMICS
Macro Economics
Necessary for understanding the environment in
which the firm operates
Growth rate of economy, tax environment,
availability of funds, rate of inflation, terms on which
the firm can raise finances
Micro Economics
Helpful in sharpening the tools of decision making
Principle of marginal analysis is applicable to
decision making

FINANCE AND ACCOUNTING
Value Maximising vs. Score Keeping

Cash Flow Method vs. Accrual Method

Uncertainty vs. Certainty
Time Value of
Money
Obviously, Rs10,000 today.
You already recognize that there is
TIME VALUE TO MONEY!!
The Interest Rate
Which would you prefer Rs10,000
today or Rs10,000 in 5 years?
TIME allows you the opportunity to postpone
consumption and earn INTEREST
A rupee today represents a greater real
purchasing power than a rupee a year hence
Receiving a rupee a year hence is uncertain so
risk is involved

Why TIME?
Why is TIME such an important element
in your decision?
Time Value Adjustment
Two most common methods of
adjusting cash flows for time value of
money:
Compoundingthe process of
calculating future values of cash
flows and
Discountingthe process of
calculating present values of cash
flows.

Types of Interest
Compound Interest
Interest paid (earned) on any previous
interest earned, as well as on the
principal borrowed (lent).
Simple Interest
Interest paid (earned) on only the original
amount, or principal borrowed (lent).
Simple Interest Formula
Formula SI = P
0
(i)(n)
SI: Simple Interest
P
0
: Deposit today (t=0)
i: Interest Rate per Period
n: Number of Time Periods
SI = P
0
(i)(n)
= Rs1,000(.07)(2)
= Rs140
Simple Interest Example
Assume that you deposit Rs1,000 in an
account earning 7% simple interest for
2 years. What is the accumulated
interest at the end of the 2nd year?
FV = P
0
+ SI
= Rs1,000 + Rs140
= Rs 1,140
Future Value is the value at some future
time of a present amount of money, or a
series of payments, evaluated at a given
interest rate.
Simple Interest (FV)
What is the Future Value (FV) of the
deposit?
The Present Value is simply the
Rs 1,000 you originally deposited.
That is the value today!
Present Value is the current value of a
future amount of money, or a series of
payments, evaluated at a given interest
rate.
Simple Interest (PV)
What is the Present Value (PV) of the
previous problem?
Assume that you deposit Rs 1,000
at a compound interest rate of 7%
for 2 years.
Future Value
Single Deposit (Graphic)
0 1 2
Rs 1,000
FV
2
7%
FV
1
= P
0
(1+i)
1
= Rs 1,000 (1.07)
= Rs 1,070
FV
2
= FV
1
(1+i)
1

= P
0
(1+i)(1+i) = Rs1,000(1.07)(1.07)
= P
0
(1+i)
2
= Rs1,000(1.07)
2

= Rs1,144.90
You earned an EXTRA Rs 4.90 in Year 2 with
compound over simple interest.
Future Value
Single Deposit (Formula)
FV
1
= P
0
(1+i)
1

FV
2
= P
0
(1+i)
2


General Future Value Formula:
FV
n
= P
0
(1+i)
n

or FV
n
= P
0
(FVIF
i,n
)
General Future
Value Formula
etc.
Reena wants to know how large her deposit of
Rs 10,000 today will become at a compound
annual interest rate of 10% for 5 years.
Problem
0 1 2 3 4 5
Rs10,000
FV
5
10%
Solution
Calculation based on general formula:
FV
n
= P
0
(1+i)
n

FV
5
= Rs10,000 (1+ 0.10)
5

= Rs 16,105.10
We will use the Rule-of-72.
Double Your Money!!!
Quick! How long does it take to double
Rs 5,000 at a compound rate of 12%
per year (approx.)?
Doubling Period = 72 / Interest Rate
6 years
For accuracy use the Rule-of-69.
Doubling Period
=0.35 +(69 / Interest Rate)
6.1 years
Assume that you need Rs 1,000 in 2 years.
Lets examine the process to determine
how much you need to deposit today at a
discount rate of 7% compounded annually.
0 1 2
Rs 1,000
7%
PV
1
PV
0
Present Value
Single Deposit (Graphic)
PV
0
= FV
2
/ (1+i)
2
= Rs 1,000 / (1.07)
2

= FV
2
/ (1+i)
2
= Rs 873.44
Present Value
Single Deposit (Formula)
0 1 2
Rs 1,000
7%
PV
0
PV
0
= FV
1
/ (1+i)
1

PV
0
= FV
2
/ (1+i)
2


General Present Value Formula:
PV
0
= FV
n
/ (1+i)
n

or PV
0
= FV
n
(PVIF
i,n
)
General Present
Value Formula
etc.
Reena wants to know how large of a
deposit to make so that the money will
grow to Rs 10,000 in 5 years at a discount
rate of 10%.
Problem
0 1 2 3 4 5
Rs 10,000
PV
0
10%
Calculation based on general formula:
PV
0
= FV
n
/ (1+i)
n

PV
0
= Rs 10,000 / (1+ 0.10)
5

= Rs 6,209.21

Problem Solution
Types of Annuities
Ordinary Annuity: Payments or receipts
occur at the end of each period.
Annuity Due: Payments or receipts
occur at the beginning of each period.
An Annuity represents a series of equal
payments (or receipts) occurring over a
specified number of equidistant periods.
Examples of Annuities
Student Loan Payments
Car Loan Payments
Insurance Premiums
Retirement Savings
Parts of an Annuity
0 1 2 3
Rs 100 Rs 100 Rs 100
(Ordinary Annuity)
End of
Period 1

End of
Period 2
Today
Equal Cash Flows
Each 1 Period Apart

End of
Period 3
Parts of an Annuity
0 1 2 3
Rs 100 Rs 100 Rs 100
(Annuity Due)
Beginning of
Period 1

Beginning of
Period 2
Today
Equal Cash Flows
Each 1 Period Apart

Beginning of
Period 3
FVA
n
= A(1+i)
n-1
+ A(1+i)
n-2
+
... + A(1+i)
1
+ A(1+i)
0
Ordinary Annuity -- FVA
A A A
0 1 2 n n+1
FVA
n
A = Periodic
Cash Flow
Cash flows occur at the end of the period
i%
. . .
Example of an
Ordinary Annuity -- FVA
Rs1,000 Rs1,000 Rs1,000
0 1 2 3 4
7%
Cash flows occur at the end of the period
FVA
3
= 1,000(1.07)
2
+
1,000(1.07)
1
+ 1,000(1.07)
0

= 1,145 + 1,070 + 1,000
= Rs 3,215
Example of an
Ordinary Annuity -- FVA
Rs1,000 Rs1,000 Rs1,000
0 1 2 3 4
Rs3,215 =
FVA
3
7%
Rs1,070
Rs1,145
Cash flows occur at the end of the period
General Formula for Calculating
Future Value of an Ordinary
Annuity
A i A i A FVAn
n n
... ) 1 ( ) 1 (
2 1
+ + + + =

(

+
=
i
i
A
n
1 ) 1 (
FVAD
n
= R(1+i)
n
+ R(1+i)
n-1
+
... + R(1+i)
2
+ R(1+i)
1


= FVA
n
(1+i)
Annuity Due -- FVAD
R R R R R
0 1 2 3 n-1 n
FVAD
n
i%
. . .
Cash flows occur at the beginning of the period
FVAD
3
= 1,000(1.07)
3
+
1,000(1.07)
2
+ 1,000(1.07)
1

= 1,225 + 1,145 + 1,070
= Rs 3,440
Example of an
Annuity Due -- FVAD
1,000 1,000 1,000 1,070
0 1 2 3 4
Rs 3,440 =
FVAD
3

7%
Rs1,225
Rs1,145
Cash flows occur at the beginning of the period
PVA
n
= R/(1+i)
1
+ R/(1+i)
2
+ ... + R/(1+i)
n
Ordinary Annuity -- PVA
R R R
0 1 2 n n+1
PVA
n
R = Periodic
Cash Flow
i%
. . .
Cash flows occur at the end of the period
Example of an
Ordinary Annuity -- PVA
Rs1,000 Rs1,000 Rs1,000
0 1 2 3 4
7%
Cash flows occur at the end of the period
PVA
3
= 1,000/(1.07)
1
+
1,000/(1.07)
2
+
1,000/(1.07)
3

= 934.58 + 873.44 + 816.30
= 2,624.32
Example of an
Ordinary Annuity -- PVA
Rs1,000 Rs1,000 Rs1,000
0 1 2 3 4
Rs 2,624.32 = PVA
3
7%
934.58
873.44
816.30
Cash flows occur at the end of the period
n
n
i
A
i
A
i
A
PVA
) 1 (
...
) 1 ( ) 1 (
2
+
+ +
+
+
+
=
(

+
+
=
n
n
i i
i
A
) 1 (
1 ) 1 (
General Formula for Calculating
Present Value of an Ordinary
Annuity
PVAD
n
= R/(1+i)
0
+ R/(1+i)
1
+ ... + R/(1+i)
n-1

= PVA
n
(1+i)
Annuity Due -- PVAD
R R R R
0 1 2 n-1 n
PVAD
n
R: Periodic
Cash Flow
i%
. . .
Cash flows occur at the beginning of the period
PVAD
n
= 1,000/(1.07)
0
+ 1,000/(1.07)
1
+
1,000/(1.07)
2
= Rs 2,808.02
Example of an
Annuity Due -- PVAD
1,000.00 1,000 1,000
0 1 2 3 4
2,808.02 = PVAD
n
7%
934.58
873.44
Cash flows occur at the beginning of the period
Reena will receive the set of cash
flows below. What is the Present
Value at a discount rate of 10%?
Mixed Flows Example
0 1 2 3 4 5
600 600 400 400 100
PV
0
10%
Solution
0 1 2 3 4 5
600 600 400 400 100
10%
545.45
495.87
300.53
273.21
62.09
Rs 1677.15 = PV
0
of the Mixed Flow
General Formula:
FV
n
= PV
0
(1 + [i/m])
mn
Or
= PV
0
* PVIF
i/m,m*n
n: Number of Years
m: Compounding Periods per Year
i: Annual Interest Rate
FV
n,m
: FV at the end of Year n
PV
0
: PV of the Cash Flow today
Shorter Discounting Periods
Reena has Rs1,000 to invest for 1 year
at an annual interest rate of 12%.

Example
Annual FV = 1,000(1+ [.12/1])
(1)(1)

= 1,120
Semi FV = 1,000(1+ [.12/2])
(2)(1)

= 1,123.6

Effective vs. Nominal Rate of
Interest
Rs. 1000 Rs.1123.6
So,
Rs. 1000 grows @ 12.36% annually
Effective Rate of Interest
r = 1 + i/m
m
- 1

Basket Wonders (BW) has a Rs1,000 CD
at the bank. The interest rate is 6%
compounded quarterly for 1 year.
What is the Effective Annual Interest
Rate (EAR)?

Problem
EAR = ( 1 + 6% / 4 )
4
- 1
= 1.0614 - 1 = .0614 or
6.14%!

Perpetuity
A perpetuity is an annuity with an
infinite number of cash flows.
The present value of cash flows
occurring in the distant future is very
close to zero.
At 10% interest, the PV of Rs 100
cash flow occurring 50 years from
today is Rs 0.85!
Present Value of a
Perpetuity
n
n
i
A
i
A
i
A
PVA
) 1 (
...
) 1 ( ) 1 (
2
+
+ +
+
+
+
=
When n=
PV
perpetuity
= [A/(1+i)]
[1-1/(1+i)]
= A(1/i) = A/i
Present Value of a
Perpetuity
What is the present value of a perpetuity
of Rs270 per year if the interest rate is
12% per year?
PV
A
i
perpetuity
=
=
=
Rs270
0.12
Rs 2250
1. Calculate the payment per period.
2. Determine the interest in Period t.
Loan balance at (t-1) x (i%)
3. Compute principal payment in Period t.
(Payment - interest from Step 2)
4. Determine ending balance in Period t.
(Balance - principal payment from Step 3)
5. Start again at Step 2 and repeat.
Steps to Amortizing a Loan
Reena is borrowing Rs10,000 at a compound
annual interest rate of 12%. Amortize the loan
if annual payments are made for 5 years.
Amortizing a Loan Example
Step 1: Payment
PV
0
= A(PVIFA
i%,n
)
Rs10,000 = A(PVIFA
12%,5
)
Rs10,000 = A(3.605)
A = Rs10,000 / 3.605 = Rs2,774
Amortizing a Loan Example
End of
Year
Payment Interest Principal Ending
Balance
0
1
2
3
4
5



Amortizing a Loan Example
End of
Year
Payment Interest Principal Ending
Balance
0 --- --- --- Rs10,000
1 Rs2,774 Rs1,200 Rs1,574 8,426
2
3
4
5



[Last Payment Slightly Higher Due to Rounding]
Amortizing a Loan Example
End of
Year
Payment Interest Principal Ending
Balance
0 --- --- --- Rs10,000
1 Rs2,774 Rs1,200 Rs1,574 8,426
2 2,774 1,011 1,763 6,663
3 2,774 800 1,974 4,689
4 2,774 563 2,211 2,478
5 2,775 297 2,478 0
Rs13,871 Rs3,871 Rs10,000


[Last Payment Slightly Higher Due to Rounding]
Usefulness of Amortization
2. Calculate Debt Outstanding -- The
quantity of outstanding debt
may be used in financing the
day-to-day activities of the firm.
1. Determine Interest Expense --
Interest expenses may reduce
taxable income of the firm.
EXERCISE
Ashish recently obtained a
Rs.50,000 loan. The loan carries
an 8% annual interest. Amortize
the loan if annual payments are
made for 5 years.
SOLUTION
50000 5 0.08
12523
TIME PAYMENT INTERESTPRINCIPAL AMOUNT
OUTSTANDING
0 50000
1 12523 4000 8523 41477
2 12523 3318 9205 32272
3 12523 2582 9941 22331
4 12523 1786 10737 11594
5 12522 928 11594 0
EXERCISE
Compute the present value of the
following future cash inflows,
assuming a required rate of 10%:
Rs. 100 a year for years 1
through 3, and Rs. 200 a year
from years 6 through 15.

ANS: 1011.75
Solution
100 100 100 200 200 200
0 1 2 3 6 7 15
248.70
i%
. . .
Cash flows occur at the end of the period
. . .
1228.9
763.05
1011.75
Till 5
th
year