chapter3 · Title: chapter3.CDR Author: admin Created Date: 20191106115948Z
chapter3-1223257070915039-9_2
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Transcript of chapter3-1223257070915039-9_2
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An overview of financial
management
Chapter 1
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Finance Finance may be defined as the art
and science of managing money
Area of finance:
The major areas of finance are-
I. financial service
II. managerial finance/corporatefinance/financial management
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Financial management is the
managerial activity which is concernedwith the planning and controlling of thefirms financial resources
The most important activities of abusiness firm are
- Production
- Marketing
- Finance
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Financial manager actively manage the
financial affairs of any type of businessnamely
- financial and non financial
- private and public
- large and small- Profit seeking and non-profit seeking
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Finance and related
disciplines Financial management is an
integral part of overall
management- finance and economics
- finance and accounting
- finance and other related disciplines
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Finance and economics The relevance of economics to financial
management can be described in the light of
the two broad areas of economics
- micro economics
- macro economics
The marginal analysis: it suggest that financial
decisions should be made on the basis of
comparision of marginal revenue and marginalcost
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Finance and accounting
Relation:
- accounting function is a necessary
input into the finance function
- the end product in accountingconstitutes financial statements
- it shows past performance and future
directions of the firm
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Finance and accounting Differences:
there are two differences between
finance and accounting- treatment of funds
- decisions making
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Finance and other related discipline
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Scope of financial management
The investment decision The financing decision
The dividend policy decision
Key functions of the financial managers: Performing financial manager
Making investment decisions
Making financing decisions
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Profit maximization criteria Ambiguity Timing of benefits
Quality of benefits
Timing of benefits:
A alternative is better than B alternative in terms of profitMenu
Time Alternative A (tk in lakh) Alternative B (tk in lakh)
Period 1 50 ---
Period 2 100 100
Period 3 50 100
Total 200 200
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Profit maximization criteria Quality of benefits:
Obviously alternative A is better than alternative Bin terms of risks and uncertainty
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State of economy Alternative A (tk in lakh) Alternative B (tk in lakh)
Recession(Period 1) 9 ---
Normal (Period 2) 10 10Boom(Period 3) 11 20
Total 30 30
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Wealth maximization criteria
Risk-return relationship
Return=risk free rate+ risk premium
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Expected Return
Risk Premium
Risk-free Return
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Time value of money
Chapter 2
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Time value of money means that the
value of a unit of money is different in
different time period
There are two techniques for doing this
- compounding technique
- discounting technique
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Rationale
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Shortcut formula:
A= P(1+i)n
Where,A= end amount, P= principal, i= interest rate
n= number of yearsMenu
Annual compoundingYear 1 2 3
Beginning amount 1000 1500 1102.50
Interest rate 0.05 0.05 0.05
Amount of interest 50 52.50 55.125Beginning principal 1000 1050 1102.50
Ending principal 1050 1102.50 1157.625
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Semi-AnnualMeans that there are two compounding periods in a year
Shortcut formula:
A= P(1+i/2)2n
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Year 6 months 1 year 18 months 2 years
Beginning amount 1000.00 1030.00 1060.90 1092.73
Interest rate 0.03 0.03 0.03 0.03
Amount of interes 30.00 30.90 31.83 32.78
Beginning principal 1000.00 1030.00 1060.90 1092.73
Ending principa 1030.00 1060.90 1192.73 1125.51
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Quarterly compounding Quarterly compounding means thatthere are four compounding periods
within the year
In these cases the rate of interest in
each compounding period will be 1.5%
that is (1/4 of 6 per cent)
Shortcut formula:
A= P( 1+i/4)4n
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Graphic illustration of
compounding values0 1 2 3 4 5
500 1000 1500 2000 2500.00
2100.00
1654.50
1158.00
608.00
8020.50
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Present value or discounting
technique Present value is the current value of a
future amount
Discounting is determining the present
value of a future amount
Mathematical formulation:
P = A { 1/(1+i)n }
Shortcut formula: P= A ( PVIF)
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Series of cash flows
Mixed stream: is a stream of cash flows
that reflects no particular pattern
Formula:
P=