FINANCIAL MANAGEMENT

Ekrem Tufanetufan@yahoo.com

Anadolu UniversityOpen Education Faculty

Canakkale Office

What will we learn?1. An overview of managerial finance

- What is the finance?-Managerial finance in the 1990s-The financial manager’s responsibility-The goals of the corporation

What will we learn?1. The financial environment: Markets,

institutions

-The financial markets-Financial institutions-The stock market

What will we learn?3. Financial Ratios as a tool of financial

analysis

• Profitability Ratios—ability of the firm to earn an adequate return and control costs.

• Asset Utilization Ratios—How efficiently the firm’s assets are being utilized.

• Liquidity Ratios—focus on short term risk management.

• Debt Utilization Ratios—focus on the capital structure and long-term risk management

What will we learn?

2. Risk and rates of return

-Defining and measuring risk-Expected rate of return

What will we learn?4. Strategic long-term investment

decisions-Generating ideas for capital projects-Project classifications-Similarities between capital budgeting evaluation techniques

What will we learn?5. Capital budgeting evaluation

techniques

-Payback period method-Net present value method-Internal rate of return method

What will we learn?6. Practice of NPV and IRR methods

-Example of NPV-Example of IRR-Example of sensitivity analysis

Continuation of examples…

So on, so far…

What kind of resources can we use when we doing research?

1. All finance books2. All articles about finance3. www.ssrn.com4. www.makalem.com5. www.ceterisparibus.com6. Essentials of Managerial Finance, J. Fred

Weston and Eugene Brigham, Harcourt Brace&Company International Edition, 1992.

7. Finansal Yönetim, Semih Büker and et all, 2005. (The main book of our lesson!)

What is the finance?

• Money• Stock exchange• Banks• What else?• How about the companies?• Balance sheet

What is the finance?

To achieve the goals of company;

4. Finding funds from the most suitable sources

5. Using them effectively and6. Control the results…

An Overview of Managerial Finance

A Short History of Managerial Finance• 1930s: Liabilities and equity, Great Depression• 1940 and 1950s: Assets, quantitative methods,

discounted cash flow methods World War II• 1960 and 1970s: Optimization of assets and

liabilities and equity, statistical methods, oil crises

• 1980s: Globalization, interest rate and exchange risk, macintosh

• 1990s to today: More risk, more computer, new financial instruments and methods, Wall Street

An Overview of Managerial Finance

Board of Directors

President

Vice President:Sales

Vice President:Manufacturing

Vice President:Finance

Treasurer Controller

Credit Manager

Inventory Manager

Director of Capital Budgeting

Cost Accounting

Financial Accounting

Tax department

An Overview of Managerial Finance

The Financial Manager’s Responsibility

• Forecasting and planning• Major investment and control• Coordination and control• Dealing with the financial markets

An Overview of Managerial Finance

The goals of the corporation

• Managerial incentives to maximize shareholder wealth

• Social responsibility• Stock price maximization and social

welfare

Managerial incentives to maximize shareholder wealthStockholders

•Make the highest money from the company•Do not want to share theirs company with others.

Managers•Having autonomy•Protect themselves from a hostile takeover or a proxy fightHostile takeover.doc•Try to maximize stock prices in reasonable level

Social responsibility• Ethical responsibility to provide a safe

working environment• To avoid polluting water and air• Produce safe products• But social responsibility has a cost• If the other firms in its industry do not follow

suit, their prices and costs will be lower• Most investors do not like to buy socially

oriented companies shares.

Stock price maximization and social welfare

What requires stock price maximization?

3. Efficient, low-cost plants that produce high-quality goods and services at the lowest possible cost

4. Development of products that consumers want and need, so the profit motive leads to new technology, to new products, and to new jobs

The Financial Environment: Markets, Institutions

The Financial Markets

• Physical asset markets• Spot markets and futures markets• Money markets• Mortgage markets• World, national, regional and local markets• Primary markets-secondary markets

Physical asset markets(Real asset markets)

•Wheat,•autos,•real estate,•computers,•stocks,•bonds,•notes, •mortgages etc.

Spot markets, futures markets, money markets, capital markets

•In spot and futures markets you can buy and sell assets on the spot delivery or for delivery at some future date, such as six months, or a year in the future.•Money markets are the markets for debt securities with maturities of less than one year where capital markets for the long term.

World, national, regional and local markets, primary-secondary markets

•Primary markets, are the markets in which corporations raise new capital.•Secondary markets, are markets in which existing, already outstanding securities are traded among investors.

The Financial Environment: Markets, Institutions

Financial Institutions in Turkey2. Commercial banks3. Pension funds4. Mutual funds5. Life insurance companies6. Stock exchange (ISE)7. Gold exchange (IGE)8. Futures markets (Izmir Futures Market)

The Financial Environment: Markets, Institutions

Stock Exchanges

• ISE• IGE• Turkish Derivatives Exchange

• Over the counter market

The Financial Environment: Markets, Institutions

Istanbul Stock Exchange• 1985 December Inauguration of the Istanbul Stock

Exchange under the Chairmanship of Mr. Muharrem KARSLI

• 1986 January Commencement of stock trading at the Cagaloglu building on January 3, 1986

• 1991 June Initiation of the Bonds and Bills Market and commencement of Outright Purchases and Sales Transactions

• 1997 August launch of the Repo/Reverse Repo Market• 2005 January ISE Derivatives Market is closed

permanently as of January 28, 2005

The Financial Environment: Markets, Institutions

Istanbul Gold Exchange

• 26 July 1995 Inauguration of the IGE• 15 August 1997 establishment of the Futures and

Options Market

The Financial Environment:Markets, Institutions

Turkish Derivatives Exchange (TURKDEX)

• 04 July 2002, establishment of the Turkish Derivatives Exchange

• 04 February 2005, transactions started officially

Risk And Rates Of Return

Defining and measuring risk• Expected Rate of Return• Measuring Risk: The Standard

Deviation• Measuring Risk: Coefficient of

Variation

Risk And Rates Of ReturnWhat is the risk in finance?• Risk is the financial uncertainty that the actual

return on an investment will be different from the expected return.

• The exposure to loss of investment as a result of changes in business conditions, domestic or foreign economies, investment markets, interest rates, relative currency rates, or inflation.

Expected Rate of Return

Calculation of Expected Rates of Return:Payoff Matrix

Expected Rate of Return.xls

Expected Rate of Return

The weights are the probabilities, and the weighted average is the expected rate of return,

Expected rate of return=

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Expected Rate of Return

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Measuring Risk: Standard Deviation

XU1002002-12.xls

Coefficient of Variation as a Risk Measure

Coefficient of variation (CV), standard deviation divided by the expected return

kCV

ˆ

Strategic Long-Term Investment Decisions

Generating ideas for capital projects

• Who creates the capital budgeting projects?• Do we need to be an entrepreneur?• Two questions for testing being entrepreneur

(CV and address book)

Strategic Long-Term Investment Decisions

Project classifications

3. Replacement: Maintenance of business4. Replacement: Cost reduction5. Expansion of existing products or markets6. Expansion into new products or markets7. Safety and/or environmental projects8. Other

Project classificationsReplacement: Maintenance of businessOne category consists of expenditures to

replace worn-out or damaged equipment used in the production of profitable products.

• Should we continue to produce these products or services?

• Should we continue to use our existing production processes?

Project classificationsReplacement: Cost reductionThis category includes expenditures to

replace serviceable but obsolete equipment.

The purpose here is to lower the costs of labor, materials, or other inputs such as electricity.

Project classificationsExpansion of existing products or markets

Expenditures to increase output of existing products, or to expand outlets or distribution facilities in markets now being served are included here.

Project classificationsExpansion into new products or markets

These are expenditures necessary to produce a new product or to expand into a geographic area not currently being served.

Project classificationsSafety and/or environmental projects

Expenditures necessary to comply with government orders, labor agreements, or insurance policy terms fall into this category.

Project classificationsOther project investments

This catch all includes office buildings, parking lots, executive aircraft, and so on.

Strategic Long-Term Investment Decisions

Similarities between capital budgeting evaluation techniques

2. Project cost3. Expected cash flows estimation4. Estimation of project riskiness5. Cost of capital decision6. Measurement of present value of cash inflows7. Present value of the expected cash inflows and

required outlay

Capital Budgeting Evaluation Techniques

1. Payback Period2. Net Present Value (NPV)3. Internal Rate of Return (IRR)4. Sensitivity Analysis

Capital Budgeting Evaluation Techniques

Payback period

Project S : Net Cash FlowCumulative NCF

Payback period

Project (S) Uncovered cost at start of year

Payback=Year before full recovery +

Cash flow during year

100Payback Period (S)= 2 + = 2,333 Years

300

Capital Budgeting Evaluation Techniques

Payback period

Project L :Net Cash FlowCumulative NCF

Payback periodProject (L)

200Payback Period (L)= 3 + = 3,333 Years

600

Capital Budgeting Evaluation Techniques

Net Present Value (NPV)

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Capital Budgeting Evaluation Techniques

Internal rate of return (IRR)

The IRR is defined as that discount rate which equates the present value of a project’s expected cash inflows to the present value of its expected costs.

Capital Budgeting Evaluation Techniques

Internal rate of return (IRR)

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Net Present Value (NPV)

To implement this method, it should be proceeded as follows:

• Find the present value of investment and its future cash flows with discounting at the project’s cost of capital

• Sum discounted investment and cash flows• If the NPV is positive then we accept the

project. If we have to choose a project among the alternate projects, we should take into consider the highest NPV

Example of NPV and IRR

Small Scale Flower Cultivation Project

This project has written by Weitz Center experts for an area in India.

The project covers an area about one acre. The aim is producing and selling flowers. Project’s cost will be covered by a bank loan. All cost and sale data have been collected and realised that target sales could be achieved. Cost benefit analysisFlower.xls