What is

FINANCE ?
 Finance For MANAGERS
Major Areas and
opportunities in Finance

 Financial Services

 Managerial Finance
An Overview of Financial
Management
 Meaning of Financial Management

 Evolution of Financial Management

 Interface of Financial Management

with other disciplines
Meaning of Financial
Management

 According to Van Horne “ Financial

management is concerned with the
acquisition, financing and
management of assets to achieve
the organizational goal in the best
possible way.
Evolution of Financial
Management
 The Traditional Phase

 The Transition Phase

 The Modern Phase

Interface of Financial
Management with other
disciplines
 Relationship to Economics
 Relationship to Accounting
 Relationship to HR
 Relationship to Production
 Relationship to Marketing
 Relationship to R & D
Financial Decisions &
Risk-Return trade off

Market value of the firm

Capital budgeting

Capital Structure Risk

Dividend Return

Working Capital
 Organization of finance
functions
Chief
ChiefFinance
Chief Finance
Finance
Officer
Officer
Officer

Treasurer
Treasurer
Treasurer Controller
Controller
Controller

Credit
Credit
Credit Financial
Financial
Financial Cost
Cost
Cost
Cash
CashManager
Cash Manager
Manager Accounting
Accounting
Accounting
Manager
Manager
Manager Accounting
Accounting
Accounting
Manager
Manager
Manager Manager
Manager
Manager
Capital
Capital
Capital
Fund
FundRaising
Raising Data Processing
Budgeting
Budgeting
Budgeting
Manager
Manager Tax
TaxManager
Manager Manager
Manager
Manager
Manager

Portfolio Internal
Manager Auditor
Aim of Finance Function

 Anticipation of Funds Needed

 Acquire the Anticipated Funds
 Allocation and Utilization of Funds
 Increase Profitability
 Maximizing Firm’s Value
SUMMARY

 What is FINANCE?  Major Finance

Functions
 Finance for Managers

 Aims of Finance
 Risk Return Trade off
Function
 WHAT IS A FINANCIAL SYSTEM?

Transfer of Financial resources from

Savers to Borrowers
FINANCIAL INTERMEDIATION

TRANSFORMING SAVINGS IN TO
INVESTMENT
INDIAN FINANCIAL SYSTEM

 FINANCIAL INSTITUTIONS

 FINANCIAL MARKETS

 FINANCIAL INSTRUMENTS

 FINANCIAL SERVICES
FINANCIAL INSTITUTIONS

 Banking Institutions (RBI,SBI…)

 Non Banking Financial Institutions

(Pension Funds, LIC, GIC…)

 Specialized Institutions
(IDBI,NABARD,ICICI…)
FINANCIAL MARKETS
FINANCIAL MARKETS

 Money Market

 Capital Market

 Industrial securities Market

 Government Securities market
 Long Term Loans Market

 Foreign Exchange Market

Industrial securities
Market
 Primary Market or New Issue Market
Public Issue
Right Issue
Private Placement

 Secondary Market or Stock Exchange

Capital Market

 Industrial securities Market

 Government Securities market/Gilt-Edged
Securities market
 Long Term Loans Market
Capital Market

 Industrial securities Market

 Government Securities market
 Long Term Loans Market
Term Loans Market
Mortgages Market
Financial Guarantees Market
Foreign Exchange Market

 Market where foreign exchange

transactions take place

 Functions:
 Transfer of Purchasing power
 Promotion of foreign trade
 Risk Management
FINANCIAL INSTRUMENTS
 Money Market Instruments

 Capital Market Instruments

FINANCIAL INSTRUMENTS

Money Market Instruments

 Call Money
 Treasury Bills
 Certificate of Deposits
 Commercial Papers
 Commercial Bills
FINANCIAL INSTRUMENTS

Capital Market Instruments

 Equity Shares
 Preference Shares
 Debentures
 Bonds
 Derivative Instruments
FINANCIAL SERVICES
 Merchant Banking
 Leasing
 Factoring
 Credit Rating
 Depository
 Venture Capital Financing
 Hire Purchase
SUMMARY

INDIAN FINANCIAL SYSTEM

 WHAT IS A FINANCIAL
 FINANCIAL INSTITUTIONS SYSTEM?

 FINANCIAL MARKETS

 FINANCIAL
 FINANCIAL INSTRUMENTS
INTERMEDIATION
 FINANCIAL SERVICES
Assignment:

 Regulators in Money Market

 Regulators In Capital Market
 Discuss the various components of
Money Market and Capital Market
 Identify and write any five news
about INDIAN CAPITAL MARKET from
Economic Times of March 22nd , 23rd
and 24th
INTERNATIONAL FINANCIAL
SYSTEM
 Refers to trading in International money and
monetary assets

 INCLUDES:
 Borrowing and Lending operations in foreign
currencies (Foreign currency market)
 A foreign exchange transactions i.e exchange of one
currency for another (Foreign exchange market)
Foreign Exchange Market

 Exchange of goods and services and

payment for these exchanges

 Exchange Rate
 Balance of Payments
 International Monetary Fund
International Currency
Market
 Internationally –accepted currencies
/reserve currencies are traded

 Deposits of these currencies with

international banks

 Short term borrowing and lending

constitute International money market
Popular Currencies Used

 U.S Dollar
 Euro
 Pound Sterling
 Deutsche Mark
 Swiss Francs
 Yen
 Dutch Guilder
 Canadian Dollar
International Bond
Market
 International Market for purchase
and sale of bonds

 Benefits:

 Ideal alternative source of raising

international capital
 Provides flexibility by considering
various market conditions
Institutions in
international Financial
System
 Financial Institutions dealing in foreign
currencies and foreign credits
 International Brokers
 Regional Finance and Development
Corporations
 Asian Development Banks
 Commonwealth Finance Corporations
 Latin American Development bank
 African Development banks
 Continued…
Institutions in
international Financial
System
 International Monetary Fund

 International Bank for Reconstruction and

Development (IBRD)

 International Finance Corporation (IFC)

 International Development Agency (IDA)

Global Innovative
Instruments
1. SWAPS

1. Interest Swaps
2. Currency Swaps
3. Debt-Equity Swaps

2. DEPOSITORY RECEIPTS
1. American Depository Receipts (ADR)
2. European Depository Receipts (EDR)
3. Global Depository Receipts (GDR)
SUMMARY

 INTERNATIONAL  Foreign Exchange

FINANCIAL Market
SYSTEM  International
 INSTITUTIONS IN
Currency Market
INTERNATIONAL
FINANCIAL SYSTEM  International Bond
 SWAPS Market
 DEPOSITORY RECEIPTS
Assignment:

 Write a note on India’s Foreign trade

 Also write about the major players in

INDIAN FOREIGN TRADE
CONCEPT OF TIME VALUE OF
MONEY
 Uncertainty and Risk

 Preference for Present Consumption

 Opportunity to invest

 More Purchasing Power

Examples

 A loan of Rs.5000 is given and receives an amount equal

to Rs.5500 at the end of the year.
 A project needs initial investment of Rs.1,00,ooo and
return is spread over a period of 8 years.
 A firm has an option to receive two types of return for
initial investment of Rs.20 lakhs. First is to receive Rs.5
lakhs for 7 years or to receive 10 lakhs for five years
from the end of the third year of investment.
Time preference Rate and
Required rate of Return
 Required rate of Return = Risk Free
Rate + Risk Premium

 Risk-free rate compensates for time

 Risk Premium compensates for risk

 Eg. Bank deposit which has

compensation for time only
Techniques of Time Value
of Money
 Compounding Technique

 Discounted or Present Value of

Technique
Compounding Technique

 Equation
 A = P (1 + i)n

Where

A=Amountattheendoftheperiod
P=Principal atthebeginningoftheperiod
i=Interestrate
n=NumberofYears
Multiple Compounding
Periods
Equation
 A = P (1 + i/m)m*n

Where

A=Amountattheendof theperiod

P=Principal atthebeginningof theperiod

i=Interestrate

n=Numberof Years

m=numberof timesforwhichcompoundingistobedone
Illustration 1

 Calculate the compound value when

Rs.10,000 is invested for 3 years and
interest 10% per annum
 Compounded annually
 On Quarterly basis

 Ans : A = 10,000 (1+ .10)3

A = 10,000 (1+ .10/4)12

ANNUITY

 Fixed amount ,either receipt or

payment at regular intervals for a
specified period
Compound Value of
Annuity
Equation
F n =A (1+i)n – 1
i
Where
F n =Futurevalueof Annuity

A =Annuity

i=Interestrate
Illustration 2

 Mr. X deposits Rs.1,000 at the end of

every year for 4 years and the
deposit earns a compound interest of
10% per annum. Calculate the
amount at the end of 4th year.

 Ans.= 1000 .4641/.10

 = 4,641
SINKING FUND

 To create a fund when a big liability

is to be repaid at the end of a known
period
SINKING FUND

Equation

i
 A= FV (1+i)n – 1

 Where
 A = Annuity
 FV= Future Value
Illustration 3

 A company has issued debentures of Rs.50

lakh to be repaid after 7 years. How much
should the company invest in a sinking fund
earning 12% in order to repay Debentures ?

 Ans. 50,00,00o * .12/1.210= 4,95,867.77

Or
50,00,000/FVIFA
LOAN AMORTISATION

Payment of loan is known as amortization

Equation
LI = PA i (1+i)n
(1+i)n – 1

Where

PA = Principal Amount
LI =Loan installment

Or

LI =PA/PVIFA
Illustration 4

 A limited company borrows from a

commercial bank Rs.10,oo,ooo at 12%
rate of interest to be paid in equal
annual end-of-year installments. What
would be the size of the installment
be ? Assume the repayment period is 5
years.

 Ans : Rs.10,00,000/3.605
=Rs.2,77,393
Present Value or
Discounting Techniques
 Eg: Arun had been given an
opportunity to receive Rs.1,060 one
year from now. He knows that he can
earn 6% interest on his investments.
What amount will he be prepared to
invest for this opportunity?
 P (1+.06)=1,060
 So P= 1,060/1.06
 =1,000
Present Value or
Discounting Techniques
Equation
A
P = (1 + i)
n

or
P =A(PVIF)
Present Value of series
of Cash Flow
Year Cash Flows
1 Rs.500
2 1,000
3 1,500
4 2,000
5 2,500
Present Value of Mixed
series of Cash Flow
Year End Cash Present Present
Flows Value Value
Factor
1 Rs.500 .909 Rs.454.5
0
2 1,000 .826
826.00
3 1,500 .751
1,126.50
Present Value of
Perpetuity
 Perpetuity is an annuity of infinite
duration
 Equation
 PV = CIF / i
Where
 PV= Present value of perpetuity
 CIF = Constant annual cash inflow
 i= interest
Illustration 6

 An investor expects a perpetual

amount of Rs.1,000 annually from
his investment. What is his present
value of perpetuity if the interest
rate is 8%.

 Ans : 1000/.08 =12,500

SUMMARY

CONCEPT OF TIME VALUE OF

MONEY
 COMPOUNTING  ANNUITY
 DISCOUNTING  SINKING FUND
 LOAN AMORTIZATION
 PERPETUITY
 MIXED SERIES OF
CASH FLOW
CAPITAL BUDGETING

 Decisions pertaining to fixed/long-term assets

 Refers to total process of generating ,
evaluating, selecting and following up on
capital expenditure alternatives

 IMPORTANCE
 Decisions affecting revenues
 Benefits from investment are received in future
Proposals for long-term
investment decisions

 Expansion Proposals
 Replacement Proposals
 Strategic Proposals
 Safety/environmental proposals
Types of Capital
Budgeting Decisions
1. Accept- Reject Decision

2. Mutually Exclusive Project Decisions

3. Capital Rationing Decision

DATA REQUIREMENT

 Quantifying benefits through :

 Accounting Profit
 Cash Flow
The Concept of Cash
Flows
 Cash flow in long-term investment of
funds is trifurcated.

 The three parts are :

 Initial cash flow
 Operating cash flow
 Terminal cash flow
INITIAL CASH FLOW

 Cash outflow

 Expenditure incurred for making

machine operational

 The opportunity cost

 Increase in net working capital

OPERATING CASH FLOW

 Initial cash flow

 Operating cash flow
 Terminal cash flow
 Operating cash flow represent
various revenues and cash expenses
consequent upon the operating of
the firm.
Terminal cash flow

 Initial cash flow

 Operating cash flow
 Terminal cash flow

 Terminal cash flow represents salvage

value or scrap value.
Factors to be considered
for Cash Flow
Computation
 To be computed on after-tax basis
 Should exclude depreciation
 Should exclude financing cost
 Should be computed on an
incremental
basis
Cash Flow Pattern

 Conventional Cash Flow

 Non-Conventional Cash Flow

Illustration 1

 A project involving Rs.50,000 as

initial outlay generate Rs.20,000
annually. The operating expenses
amount to Rs.10,000 and the
amount of depreciation is
Rs.5,000.The tax rate is 30%.Find
out cash flow after tax (CFAT)
Illustration 1

 Ans:
 Cash receipt Rs.20,000
 Less: cash expenses
and depreciation Rs.15,000
Taxable Income Rs.5,000
Less: Taxes Rs.1,500
Net Income after tax Rs.3,500
Add : Depreciation Rs.5,000
Net cash Flow after tax Rs.8,500
Evaluation Techniques

 Traditional
 Average Rate of Return
 Pay Back Method

 Time-Adjusted (Discounted cash

flow)
 Net Present Value Method
 Internal Rate of Return Method
 Profitability Index
AVERAGE RATE OF RETURN

 Traditional
 Average Rate of Return
 Pay Back Method

 ARR method is based on accounting

information
AVERAGE RATE OF RETURN

 ARR= Average annual profits after tax

Average investment over the life of
the project

100
Illustration 2

 Determine the ARR fro the following

data of two machines, A & B
Illustration 2
Machine A Machine B
Cost Rs.56,125 Rs.56,125
Annual estimated
income after
depreciation and
tax
Year 1 3,375 11,375
2 5,375 9,375
3 7,375 7,375
4 9,375 5,375
5 11,375 3,375
Estimated Life 5 years 5 years

Estimated Salvage 3,000 3,000

Value
Illustration 2

 Ans:

 ARR = Average income

 Average investment
* 100

 ARR for Machine A & B =

24.9%
PAY BACK METHOD

 How many years it will take for the

cash benefits to pay the original cost
of the investment….normally
disregarding salvage value?
 FORMULA
 where CFAT is uniform:
 PB = INVESTMENT
CONSTANT ANNUAL CASH
FLOW
Illustration 3

 An investor of Rs.40,000 is expected

to produce CFAT of Rs.8,000 for 10
years. Calculate the PB?

 PB = 40,000/8000 =5 years
Illustration 4
 Mixed Stream & PB Method
 Initial Investment Rs.56,125
YEAR A B
1 Rs.14,000 Rs.22,000
2 16,000 20,000
3 18,000 18,000
4 20,000 16,000
5 25,000 17,000
Illustration 4
 Ans:
CUMULATIVE
CFAT
A B
Rs.14,000 Rs.22,000
30,000 42,000
48,000 60,000
68,000 76,000
93,000 93,000
Illustration 4

 PB for A = 3.406 years

 PB for B = 2.785 years

Limitations of Pay Back
Method
 Ignores all cash inflows after the pay
back period

 Time value of money is not

considered
Steps in Capital
Budgeting Process
 Identification of Long Term goals
 Screening of Proposals
 Project Evaluation
 Control
 Project Audit
Present Value or
Discounting Techniques
Equation
A
P = (1 + i)
n

or
P =A(PVIF)
The Net Present Value
Method
 Difference between the total present
value of future cash inflows and the
total present value of future cash
outflows
Illustration 5

 Calculate the net present value for a

small sized project requiring an initial
investment of Rs.20,000 and which
provides a net cash inflow of Rs.6000
each year for six years. Assume the
cost of funds to be 8% and that there
is no scrap value
Illustration 5

 Ans:
 The present value of
Rs.6000=27,738
 Less The Initial Investment
20,000

 Net Present Value = 7,738

Rule FOR accept/reject
criteria of NPV method
 NPV > Zero ACCEPT THE
PROPOSAL

 NPV < Zero REJECT THE

PROPOSAL
 Illustration 6
 The Alpha Co. Ltd is considering the purchase
of a new machine. Two alternative machines
(A and B ) have been suggested, each having
an initial cost of Rs.4,00,000 and requiring
Rs.20,000 as additional working capital at the
end of 1 st year. The company has a target of
return on capital of 10% and on this basis you
are required to compare the profitability of the
machines and state which alternative is
financially preferable. Earnings after taxation
are expected to be as follows :
Illustration 6
(continued)
Year Cash Inflows
Machine A Machine B

1 Rs 40,000 Rs.1,20,000

2 1,20,000 1,60,000

3 1,60,000 2,00,000

4 2,40,000 1,20,000

5 1,60,000 80,000
 Illustration 6
(continued)
Year Discoun MACHINE A MACHINE B
t Factor

Cash Present Cash Present

Inflow Value Inflow Value

1 .91 40,000 36,400 1,20,00 1,09,00

0 0
2 .83 1,20,00 99,600 1,60,00 1,32,80
0 0 0
3 .75 1,60,00 1,20,00 2,00,00 1,50,00
0 0 0 0
4 .68 2,40,00 1,63,20 1,20,00 81,600
0 0 0
5 .62 1,60,00 99,200 80,000 49,600
Illustration 6
(continued)
Machine A Machine B
Total Present 5,18,400 5,23,200
Value of
Cash Inflows

Total Present 4,18,200 4,18,200

Value of
Cash
outflows

NET PRESENT1,00,200 1,05,000

VALUE (Machine B is
preferable)
INTERNAL RATE OF RETURN
(IRR Method)
 Rate at which the sum of discounted
cash inflows equals the sum of
discounted cash outflows.

 Cash Inflows/Cash Outflows =1

 Project giving higher IRR would be

preferred
Illustration 7

 If a sum of Rs.800 invested in a project

becomes Rs.1000 at the end of a year ,the rate
of return comes to:
 Ans: 800 = 1000

( 1+ r)n

800r+800=1,000
800 r =2oo,r=200/800=25%
IRR where cash inflows
are uniform –
Illustration 8 an initial
 An equipment requires
investment of Rs.6000.The annual
cash flow is estimated at Rs.2000 for
5 years. Calculate Internal rate of
return.
 Ans: Steps
 Calculate the Factor or pay back
 Locate this factor in the line of 5
years in present value annuity table
IRR where cash inflows
are uniform –
Illustration
 F= I/C 8
 Where I=Original Investment
 F = Factor to be located
 C = Cash inflow per year

 6000/2000 = 3

 Internal rate of Return can be taken as

20%
IRR where cash inflows
are not uniform
 F=I/C
 Where
 F=Factor to be located
 I = Original Investment
 C= Average Cash inflow per year
Illustration 8
 A company has to select one of the
following two projects using IRR
technique Project A Project B
Cost Rs.11,000 Rs.10,000
Cash Inflows:

Year 1 6,000 1,000

Year 2 2,000 1,000

Year 3 1,000 2,000

Year 4 5,000 10,000

Illustration 8

 Ans:
 F for A=11,000/3500=3.14

 F for B = 10,000/3,000=2.86
 Illustration 8
 Project A at 15%
 Total Present Value-11,272

Project A Cash Flows Discounting Present Value

Factor @ 10%

1 6,000 .909 Rs.5,454

2 2,000 .826 1,652

3 1,000 .751 751

4 5,000 .683 3,415

 Illustration 8
 Project A at 12%
 Total Present Value 10844
Project A Cash Flows Discounting Present
Factor @ Value
12%
1 6,000 .893 5,358

2 2,000 .797 1,594

3 1,000 .712 712

4 5,000 .636 3,180

 So IRR=
Lowest rate
+
Difference in calculated present value and
required net cash outlay
Difference in calculated present values

*
Difference in rate
 10% + 272 *2
428