8/10/2019 82_Unit-_I_PPT

1/36

Introduction to Financial Management

8/10/2019 82_Unit-_I_PPT

2/36

I am saving for retirement. Should I use apension fund, mutual fund, direct stockmarket investment ?

I want that new car. Should I use my cashsaving, lease, borrow?

Which is the best way to pay for my holidays,for my house?

Im thinking about starting a new business.Will it reward me adequately?

A Company has asked for major projectfinancing. Should my organization providethe funds?

8/10/2019 82_Unit-_I_PPT

3/36

to run a business.

For input operations.

For managerial activities.

DEFINITION: Finance may be defined as the position of

money at the time it is wanted-----according to F.W. Paish.

8/10/2019 82_Unit-_I_PPT

4/36

Financial means procuring sources of moneysupply and allocation of these sources on thebasis of forecasting monetary requirements

of the business.Management refers to planning ,organization, coordination and control ofhuman activities and physical resources for

achieving the objectives of an enterprise

8/10/2019 82_Unit-_I_PPT

5/36

The traditional approach.

The modern approach.

8/10/2019 82_Unit-_I_PPT

6/36

Under this approach financial managementwas consider as corporation finance.

The following three things were to be

studied for procurement of finances:-1. institutional sources of finance.

2. issue of financial instrument to collectnecessary funds from capital market.

3. legal and accounting relationship betweenbusiness and sources of finance.

8/10/2019 82_Unit-_I_PPT

7/36

8/10/2019 82_Unit-_I_PPT

8/36

The focus of this approach is on the followingquestions:-What is the total amount of funds anenterprise should commit?

What specific assets an enterprise shouldacquire?

How should the funds required to raised?

Fund requirement decision.

Financing decision.

Investment decision.

Dividend decision.

8/10/2019 82_Unit-_I_PPT

9/369

Introduction

Present and future values

Present and future value factors

CompoundingGrowing income streams

8/10/2019 82_Unit-_I_PPT

10/3610

Time has a value

If we owe, we would prefer to pay money later

If we are owed, we would prefer to receivemoney sooner

The longer the term of a single-payment loan,the higher the amount the borrower must repay

8/10/2019 82_Unit-_I_PPT

11/3611

Basic time value of money relationships:

1/(1 )

(1 )

t

t

PV FV DF

FV PV CF

where PV = present value;

FV = future value;

DF = discount factor = R

CF = compounding factor = R

R = interest rate per perio

d; and

t = time in periods

8/10/2019 82_Unit-_I_PPT

12/3612

Apresent valueis the discounted value ofone or more future cash flows

Afuture valueis the compounded value of apresent value

The discount factoris the present value of adollar invested in the future

The compounding factoris the future valueof a dollar invested today

8/10/2019 82_Unit-_I_PPT

13/3613

Why is a dollar today worth more than adollar tomorrow?

The discount factor: Decreases as time increases

The farther away a cash flow is, the more wediscount it

Decreases as interest rates increase

When interest rates are high, a dollar today is worth

much more than that same dollar will be in thefuture

8/10/2019 82_Unit-_I_PPT

14/36

8/10/2019 82_Unit-_I_PPT

15/3615

Single sum factors

How we get present and future value tables

Ordinary annuities and annuities due

8/10/2019 82_Unit-_I_PPT

16/3616

Present value interest factorandfuturevalue interest factor:

where

1

(1 )

(1 )

t

t

PV FV PVIF

FV PV FVIF

PVIFR

FVIF R

8/10/2019 82_Unit-_I_PPT

17/3617

Example

You just invested $2,000 in a three-year bank

certificate of deposit (CD) with a 9 percentinterest rate.

How much will you receive at maturity?

8/10/2019 82_Unit-_I_PPT

18/36

8/10/2019 82_Unit-_I_PPT

19/36

19

Standard time value of money tables presentfactors for:

Present value of a single sum

Present value of an annuity Future value of a single sum

Future value of an annuity

8/10/2019 82_Unit-_I_PPT

20/36

20

Relationships:

You can use the present value of a single sum toobtain: The present value of an annuity factor (a running total

of the single sum factors)

The future value of a single sum factor (the inverse ofthe present value of a single sum factor)

8/10/2019 82_Unit-_I_PPT

21/36

21

An annuityis a series of payments at equaltime intervals

An ordinary annuityassumes the firstpayment occurs at the end of the first year

An annuity dueassumes the first paymentoccurs at the beginning of the first year

8/10/2019 82_Unit-_I_PPT

22/36

22

Example

You have just won the lottery! You will receive

$1 million in ten installments of $100,000 each.You think you can invest the $1 million at an 8percent interest rate.

What is the present value of the $1 million if thefirst $100,000 payment occurs one year fromtoday? What is the present value if the firstpayment occurs today?

8/10/2019 82_Unit-_I_PPT

23/36

23

Example (contd)

Solution: These questions treat the cash flows as

an ordinary annuity and an annuity due,respectively:

of ordinary annuity $100,000 6.7100 $671,000

of annuity due $100,000 ($100,000 6.2468) $724,680

PV

PV

8/10/2019 82_Unit-_I_PPT

24/36

24

Definition

Discrete versus continuous intervals

Nominal versus effective yields

8/10/2019 82_Unit-_I_PPT

25/36

25

Compoundingrefers to the frequency withwhich interest is computed and added to theprincipal balance

The more frequent the compounding, the higherthe interest earned

8/10/2019 82_Unit-_I_PPT

26/36

26

Discrete compoundingmeans we cancount the number of compounding periodsper year

E.g., once a year, twice a year, quarterly,monthly, or daily

Continuous compoundingresults when

there is an infinite number ofcompounding periods

8/10/2019 82_Unit-_I_PPT

27/36

8/10/2019 82_Unit-_I_PPT

28/36

28

Mathematical equation for continuouscompounding:

2.71828

RtFV PVe

e

8/10/2019 82_Unit-_I_PPT

29/36

8/10/2019 82_Unit-_I_PPT

30/36

30

Example (contd)

Solution: For quarterly compounding:

4

(1 / )

$100.00(1 0.03/ 4)$103.03

mtFV PV R m

8/10/2019 82_Unit-_I_PPT

31/36

31

Example (contd)

Solution (contd):For continuous compounding:

0.03

$100.00$103.05

RtFV PVe

e

8/10/2019 82_Unit-_I_PPT

32/36

8/10/2019 82_Unit-_I_PPT

33/36

33

Definition

Growing annuity

Growing perpetuity

8/10/2019 82_Unit-_I_PPT

34/36

34

A growing stream is one in which eachsuccessive cash flow is larger than theprevious one

A common problem is one in which the cash flowsgrow by some fixed percentage

8/10/2019 82_Unit-_I_PPT

35/36

35

A growing annuityis an annuity in which thecash flows grow at a constant rate g:

2

2 3 1

1

(1 ) (1 ) (1 )...

(1 ) (1 ) (1 ) (1 )

111

n

n

N

C C g C g C g PV

R R R R

C gR g R

8/10/2019 82_Unit-_I_PPT

36/36