Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
1
Financial Management
Prescribed Text Book:
Corporate Finance by Ross, S. A.Westerfield, R. W. and
Jaffe, J., The McGraw-Hill Companies, 2010.
Other Reference/Suggested Books:
Corporate Finance by Ross, S. A.Westerfield, R. W.-Jaffe, J. and
Kakani, R. K., The McGraw-Hill Education (India) Pvt. Ltd, 2014.
Corporate Finance: A Focussed Approach by Brigham, E. and
Ehrhardt, M. C., South Western Cengage Learning, 2013.
Financial Management by Khan, M. Y. and Jain, P. K., McGraw-Hill
Education (India) Pvt. Ltd, 2014.
Principles of Corporate Finance by Brealey, R.-Myers, S. and Allen,
F. The McGraw-Hill Companies, 2014.
Corporate Financial Analysis with Microsoft Excel by Francis J.
Clauss, The McGraw-Hill Companies, 2010.
Financial Management:
An Overview
Finance
Finance may be defined as the art and science of managing
money. The major areas of finance are:
1. Financial Services
Financial services is concerned with the design and delivery of advice and
financial products to individuals,
business and governments.
2. Financial Management
Financial Management is that managerial activity which is concerned
with planning, controlling and managing the financial resources of a
given firm.
Long-Term
Debt
Current Assets
Current
Liabilities
The Balance-Sheet Model
of the Firm
The Capital Budgeting and Working Capital
Decision Fixed Assets
Shareholders
1 Tangible
Equity What Long-term
investments 2 Intangible
should the firm
engage in?
Long-Term Debt
What Short-term
investments
should the firm Current Assets
Current engage in?
Liabilities
The Balance-Sheet Model
of the Firm
The Financing Decision
Fixed Assets
Shareholders
1 Tangible
Equity
2 Intangible
Current Assets
Current
Liabilities
The Balance-Sheet Model
of the Firm
The Net Working Capital Decision
Fixed Assets
Shareholders
1 Tangible
Equity
2 Intangible
Board of Directors
Debtholders
Shareholders
Management
Debt
Assets
Equity
Agency Problem
An agency problem results when managers as
agents of owners (principal) place personal goals
ahead of corporate goals. Market forces and the
threat of hostile takeover tend to act to
prevent/minimise agency problems. In addition,
firms incur agency costs in the form of monitoring
and bonding expenditures, opportunity costs and
structuring expenditures which involve both
incentive and performance-based compensation
plans to motivate management to act in the best
interest of the shareholders.
Objectives / Goals of the Corporation
Taxes (D)
i i
0 0 t
Year t
$?
$1
35
Discounting Technique: Present Value
Present Value: Present value of a future cash flow
is the current value of a future amount.
Discounting: Discounting is the process of
determining the present value of a series of future
cash flows or a lump sum amount.
Discount Rate (Required Rate of Return): It is the
interest rate used for discounting cash flows.
The Discounting Process
1. Estimating the Cash flow
Cash flow: The cash that is expected to be received
each period from investing in a particular financial/real
asset.
Reasons why cash flow of financial/real assets is not known:
38
2. Determine the appropriate Discount Rate for discounting
the future expected cash flow
It is determined by addressing two questions:
1. What is the minimum interest rate the investor
should require?
The interest rate available in the financial market
on a default(risk)-free cash flow
2. How much more than the minimum interest rate
should the investor require? (Premium required for
perceived risk)
Should reflect the risks associated with realizing
the cash flow expected
3. Value of Financial Assets= PV of Expected Cash Flow
39
Summary of
Discounting
Process
40
Calculation of Present Values
41
Present Value:
The One-Period Case (Single Cash Flow)
PV of a single cash flow (lump sum amount) to be received
in future is calculated as follows:
C1
PV =
1+ i
where C1 is cash flow at date 1 and i is the appropriate interest rate
Present Value of a Series of Cash Flows
Multi-Period Case
In many instances, especially in capital budgeting
decisions, we may be interested in the present value of a
series of receipts received by a firm at different time
periods.
n
C1 C2 C3 Cn Ct
PV = + + + ... + =
(1 + i ) (1 + i ) (1 + i )
2 3
(1 + i ) t =1 (1 + i )
n t
PV = A (PVIF)
Present value interest factor is the multiplier used to calculate at a specified
discount rate the present value of an amount to be received in a future period.
Example
46
The NPV Function for a Series of Cash Flows
= NPV(rate, value1, value2, value3)
Computes the present value of a series
(equal/mixed) of cash flows for a specified number
of periods at a specified rate of interest. Payments
can be made at either the beginning or end of each
period, as specified by the value for type.
47
Net Present Value
It is the difference between the present value
of cash inflows and the present value of cash
outflows.
NPV is used in capital budgeting to analyze
the profitability of an investment or project.
If the NPV of a prospective project is positive,
it is accepted.
If NPV is negative, the project is probably
rejected because cash flows will also be
negative.
48
Net Present Value
n
Ct
NPV = C0 +
t =1 (1 + i )
t
49
Calculation of Future Values
50
Calculation of Future Values (FV)
The process of going from todays values, or present values
(PVs), to future values (FVs) is called compounding.
Specifically, the process of finding the future values of cash
flows by applying the concept of compound interest.
The general formula for the future value of an investment over
many periods can be written as:
FVn = PV(1 + i)n
where,
PV is cash flow at date 0, r is the appropriate interest rate, and
n is the number of periods over which the cash is invested.
51
The FV Function
= FV(rate, nper, pmt, pv, type)
rate = the interest rate per period (i.e., per year,
month, etc.), which remains constant throughout
the total number of periods
nper= total number of periods (i.e., number of
years, months, etc.)
pmt = the payment made each period (periodic
payments, if any, remain constant throughout the
total number of periods)
52
The FV Function
= FV(rate, nper, pmt, pv, type)
pv= the present value of an investment, or, if
periodic payments are made, the lump sum
amount that the series of future payments is worth
right now
type = 0 if periodic payments are made at the end
of each period, 1 if periodic payments are made at
the beginning of each period.
53
Future (compounded) Value of a Series of Payments
For simplicity, we assume that the compounding time period is one year and payment
is made at the END of each year. Suppose, Mr X deposits each year Rs 500, Rs 1,000,
Rs 1,500, Rs 2,000 and Rs 2,500 in his saving bank account for 5 years. The interest
rate is 5%. He wishes to find the future value of his deposits at the end of the 5th year.
You are required to determine the sum of money he will have.
n nt
FVn = CFt (1 + r )
t =1
where, CF is cash flow at time t, r is the appropriate interest rate, and n is the
number of periods over which the cash is invested.
Comparison of Annual, Semi-annual and Quarterly Compounding
End of year Compounding period
Annual Half-yearly Quarterly
1 Rs 1,060.00 Rs 1,060.90 Rs 1,061.36
2 1,123.60 1,125.51 1,126.49
The effect of compounding more than once a year can also be expressed in the
form of a formula. Earlier equation can be modified as below:
mn
i
FV = PV 1 +
m
in which m is the number of times per year compounding is made and n is the
time period. For semi-annual compounding, m would be 2, while for quarterly
compounding it would equal 4 and if interest is compounded monthly, weekly
and daily, would equal 12, 52 and 365 respectively.
The general applicability of the formula can be shown as follows, assuming the
same figures of Mr Xs savings of Rs 1,000:
1. For semi-annual compounding, Rs 1,000 [1 + (0.06/2)]2x2 = Rs 1,000 (1 +
0.03)4 = Rs 1,125.51
2. For quarterly compounding, Rs 1,000 [1 + (0.06/4)]4x2 = Rs 1,000 (1 +
0.015)8 = Rs 1,126.49
Continuous Compounding
One can compound much more frequently than once a year; one
could compound semiannually, quarterly, monthly, weekly, daily,
hourly, each minute, or even more often. The limiting case would
be to compound multiple times with n is infinite (every
infinitesimal instant), which is commonly called continuous
compounding.
With continuous compounding, the future value at the end of T years is expressed as:
C0(ert)
where C0 is the initial investment, r is the annual interest rate, and T is the number of years
over which the investment runs. The number e is a constant and is approximately equal to
2.718.
Excel Function:
Continuous Compounding Function
=Initial Deposit*EXP(number)
56
Continuous Compounding
57
Continuous Discounting
One can discount much more frequently than once a year; one
could discount semiannually, quarterly, monthly, weekly, daily,
hourly, each minute, or even more often. The limiting case would
be to discounting multiple times with n is infinite (every
infinitesimal instant), which is commonly called continuous
discounting.
With continuous discounting, the present value at the end of T years is expressed as:
C0(e-rt)
where C0 is the initial investment, r is the annual interest rate, and T is the number of years
over which the investment runs. The number e is a constant and is approximately equal to
2.718.
58
Cash Flows: Some Simplifications
Perpetuity
A constant stream of cash flows that lasts forever without
end.
Growing Perpetuity
A stream of cash flows that grows at a constant rate forever.
Annuity
A stream of constant cash flows that lasts for a fixed
number of periods.
Growing Annuity
A stream of cash flows that grows at a constant rate for a
fixed number of periods.
Perpetuity
A constant stream of cash flows that lasts forever without end.
C C C
0 1 2 3
C C C C
0 1 2 3 T
Note: The present value of receiving the coupons for only T periods
must be less than the present value of a consol, but how much less?
Annuity
Important Observations:
1. Consol 1 is a normal consol with its first payment at date 1. The
first payment of consol 2 occurs at date T+1.
2. The present value of having a cash flow of C at each of T dates is
equal to the present value of consol 1 minus the present value of
consol 2.
Annuity
Important Observations:
3. The present value of consol 1 is given by
4. Consol 2 is just a consol with its first payment at date T+1. From
the perpetuity formula, this consol will be worth C/r at date T.
However, we do not want the value at date T. We want the value
now, in other words, the present value at date 0. We must discount
C/r back by T periods. Therefore, the present value of consol 2 is:
Annuity
Important Observations:
5. The present value of having cash flows for T years is the present
value of a consol with its first payment at date 1 minus the present
value of a consol with its first payment at date at T+1.
6. Thus the present value of an annuity is:
0 1 2 3 T
C C (1 + g ) C (1 + g )T 1
PV = + ++
(1 + r ) (1 + r ) 2
(1 + r )T
The formula for the present value of a growing annuity:
C 1+ g
T
PV = 1
r g (1 + r )
Growing Annuity: Example
You are evaluating an income property that is providing increasing
rents. Net rent is received at the end of each year. The first year's
rent is expected to be $8,500 and rent is expected to increase 7%
each year. Each payment occur at the end of the year. What is the
present value of the estimated income stream over the first 5 years if
the discount rate is 12%?
0 1 2 3 4 5
$34,706.26