LECTURE NOTES. ON. FINANCIAL MBA Semester –. II Th C. 4 4 Financial Management--Text and Problems, MY Khan and PK Jain, Tata. McGraw- Hill. Financial Management Full Notes @ Mba Finance - Free download as Word Doc .doc), PDF File .pdf), Text File .txt) or read online for free. Financial. Financial Management is an essential part of the economic and non prepared based on the soundofheaven.info, B.B.A., B.B.M., soundofheaven.info, and M.B.A. syllabus of various.
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Concept based notes. Financial Management. MBA-(II Sem). Prepared by. B.K. Jain. MBA faculty (BISMA). Biyani Institute of science and Management,. Jaipur. LECTURE NOTES. ON. FINANCIAL MANAGEMENT. MBA II SEMESTER (IARE – R16). Prepared by. Dr. J. S. V. GOPALA SARMA, Professor. Department of. Here We Provide the Download Links to MBA 2nd Semester Study Material & Books. You can Check MBA Financial Management Lecture notes pdf, Study Materials & Books. MBA Business Communication Lecture Notes pdf – Download MBA 1st sem Study Materials & Books.
The steps are; 1. This is called exhaustive enumeration. Forward interest rates are usually indicated as with a left subscript indicating the rates start time point and a right one indicating the ending time point. When the effect of company financial decisions upon shareholders portfolios can be undone by the offsetting actions of shareholders, the company financial decision is irrelevant! Cost of debt as a rate to the investment. The relationship is positive in that the higher the systematic risk of j, the higher its expected return.
Explain its significance. How can you classify finance?
How is finance related to other disciplines? What is finance function? State the objectives of the finance function. Explain the significance of finance function. Analyse the various approaches to finance function.
Explain the role of CFO in financial management.
Discuss the support extended by the Board of Directors in managing finance. Explain the scope of the finance function. Elucidate the changing facet of the finance function.
Financial Management books buy Online at Amazon. Khan, P. Text and Problems M. Jain McGraw-Hill Inc. Text, Problems and Cases M. Theory and Practice Product Condition: For more information about the Financial Management, visit our website and you can clarify your doubts via comment box. Leave A Reply Cancel Reply. Save my name, email, and website in this browser for the next time I comment. Notify me of follow-up comments by email. Interest cash flow at time t. Corporate income tax rate.
Interest tax shield cash flow, equal to It x TC. Unleveraged ungeared free cash flow: Market Values Et Market value of the equity of the investment at time t. Dt Market value of the debt of the investment at time t. Vt Market value of the investment at time t. Required return on the debt of the investment.
Cost of debt as a rate to the investment.
Equal to rd x 1-Tc. Overall weighted average return on the capital claims of the investment. Weighted average cost of capital WACC of the investment. All-equity unleveraged ungeared required return on the investment. Module 5 Estimating Cash Flows for Investment Projects - Estimating investment cash flows means that financial managers must keep the following in mind: Inclusion of all corporate cash flows affected by the investment sometimes means that financial analysts must invoke the idea of economic opportunity costs.
Inclusion of all relevant cash flows means that analysts must include cash flows from interactions of the investment with other activities of the corporation. Inclusion of all relevant cash flows also means that analysts must know what things should be omitted from the investments cash flows. An investment should be discontinued if its future cash flows present value is less than the company would obtain by selling or abandoning the project now or later.
Inclusion of all relevant cash flows means that analysts must be very careful that the accounting numbers provided for a project are interpreted correctly. Overhead costs are typically not indicative of the incremental cash flows that a project will require.
Accounting numbers can include non-cash expenses depreciation , and arbitrary activity measures such as floor-space devoted to the manufacture of a product. It is however correct to include as cash outflows the increments to overall corporate expenses caused by the acceptance of the project.
Summary All changes that would be caused in the cash flows of a corporation by its accepting a project must be included in the analysis of the project.
ONLY cash flows are to be included. Module 6 Applications of a Companys Investment Analysis The Payback Period - The number of periods until a projects cash flows accumulate positively to equal its initial outlay. It ignores all cash flows beyond the maximum acceptable payback period. It does not discount the cash flows within the maximum acceptable period, thereby giving equal weight to all of them. This is inconsistent with shareholder opportunity costs.
Concern a above is still valid. The Average Accounting Return on Investment AROI - Calculates a rate of return on the investment in each period by dividing expected accounting profits by the net book value of the investments assets. The result is then compared to a minimal acceptable return often an industry or company average. IRR vs. A pattern of sign changes can also product a project that has a totally upward sloping relationship between NPV and IRR.
To correctly accept a project in this case the IRR would have to be less than the hurdle rate. There are various means that can be used to make the IRR come up with a correct answer in a particular situation. The difficulty being that you must know beforehand that you are going to have a problem with the IRR, and what the solution is.
Another situation in which the IRR can cause problems is in multiple-period cash flow investments which require a different discount rate for each cash flow. The cash flows IRR can still be found , but at which hurdle rate is it. The YTM of a security with the same risk and cash flow patterns as the investment would have to be found.
The steps are; 1. Take any two projects out of the group. The investment with the highest net cash flow is the defender, the other the challenger. At each time point, subtract the cash flows of the challenger from those of the defender, the resulting stream are the incremental cash flows. Find the IRR of the incremental cash flows. If the IRR is greater than the appropriate hurdle rate, keep the defender and throw out the challenger and visa versa. Pick the next project out of the group and repeat the process using the winner of step 5 until only one investment remains.
Calculate the IRR of the winner. If it is greater than the hurdle rate, accept it, if not then reject all the projects.
When the incremental cash flows have more than one change of sign across time. When the projects differ in risk or financing, so that they require different hurdle rates. For mutually exclusive events however, CBR is attracted to those investments that have the greatest ratio differences between inflow and outflow present values instead of actual cash or value differences. The Profitability Index - The ratio of the accumulated present values of future cash flows to the present cash flow of an investment.
Capital Rationing The set of methods used to choose a group of projects that will maximise shareholder wealth while having limited funds available is called capital rationing techniques. When having to choose between a few projects, one simply looks at all the possible combinations of investments that lie within the budget and choose the package with the greatest NPV. This is called exhaustive enumeration. When confronted with many projects to choose from, one common method is to calculate the profitability indices for the investments, and to list them in declining order of PI.
Investments are then accepted in order of PI, until the budget has been exhausted. A project may be skipped because its outlay is too large, and the next one having a small enough outlay taken as you work down the list.
The PI technique must be used with some caution in ranking investments when the highest PI projects do not use up the entire budget. Being under capital rationing is an undesirable situation.
This implies that you will be forced to forego investments that would have increased the wealth of shareholders. The existence of high market required rates should not be interpreted as a capital-rationing situation. This is simply a signal that your capital costs are also high.
The capital rationing situation implies that financing beyond the budget constraint carries not a high but an indefinite cost. Investment Inter-relatedness - This is when the acceptance or rejection of one investment affects the expected cash flows on another. Economic Inter-relatedness of Investment Cash-Flows - When dealing with economic relatedness among investment proposals companies must specify all possible combinations of inter-related investments along with their unique cash flows and NPV.
The combination with the highest NPV is chosen. Renewable Investments - When companies must choose among investments in real assets where the life span and cash costs are different for each option the equivalent annual cost technique is used.
The NPV of a single cycle for each asset is found. Divide each NPV by the annuity present value factor for the number of years in each assets replacement cycle at the appropriate discount rate. The result is the constant annuity outlay per period that has the same NPV as the asset. Compare the per-period equivalent annuity outlay for each asset and choose that which has the lowest cost per period. Inflation and Company Investment Decisions - The real rate of return is the difference between the nominal rate and the expected influence of inflation on required rates for some time in the future.
Because there is no way to measure such expectations effects, the real rate is not measurable. If the analysis is performed carefully, the impact of inflation on the investment, and on shareholder wealth, will appear in the NPV. Analysts should always be explicit in requesting inflated future cash flow estimates. For example double-declining balance, or sum-of-the-years digits methods.
The reason for this is that debt contracts promise specific amounts of nominal cash at particular times in the future. If the nominal interest rate that suppliers get at the inception of their investment turns out to be a poor estimate of actual inflation, debt suppliers will achieve a real return different from their initial expectations. Leasing A contractual agreement between an asset owner lessor and a company that will actually operate the asset without owning it lessee The most common type of lease is a financial or capital lease where the lessor is usually in the business of leasing assets.
The Economics of Leasing Advantages Misconceptions Leasing saves money because the lessee does not have to make a large capital outlay to purchase an asset. Lessee debt capacity is higher since they do not need to borrow money to buy the asset.
Leasing allows for higher tax benefits that the alternative of borrowing and purchasing an asset. Information asymmetries exist on certain types of assets, and leasing can serve to lower the costs of such information problems.
There are economies of scale in the management of specialised asset leasing. Evaluating Leases - Cash flows used would include; cost of purchasing, lost depreciation tax shields, lease payments, and lease payment tax shields.
It is important to know what lease rate would allow for a positive NPV when negotiating lease agreements with a lessor. The security market line or SML describes the relationship between risk and return as being positive; the higher the risk, the higher the required return.
Risk and Individuals - To an individual capital supplier, risk is best measured by the standard deviation of rates on return on the entire portfolio of assets or by the extent to which actual outcomes are likely to differ from the mean expected outcome. Unfortunately, studies to date show that the empirical relationship between risk measured as standard deviation of return and the actual level of return earned is not good.
In the s Harry Morowitz was the first to show that company security holders are indeed risk-averse, and require higher returns when the risk is higher. He also showed that the resulting positive relationship between return and standard deviation of return would only be true for the entire portfolio and not for the individual assets within. This is because part of the standard deviation of return for individual assets is diversified away when included in a portfolio with others.
Avg Std Deviation 0. Each cell inside a box describes the probability of a particular set of returns being simultaneously earned by both assets A and B. Probability 0.
An easier method for figuring out risk of a portfolio is using the correlation coefficient. The Market Model and Individual Asset Risk - William Sharpe and John Lentner ascertained the only relevant risk in a market where everyone understands the benefits of diversification is the undiversifiable or systematic risk of an asset. The reason for a minimum level of risk even in a well-diversified portfolio is that there is a common correlation present in all securities, and this limits the amount of diversification possible.
This common factor is called the market factor Riskm. The systematic risk of securities is thus based upon the extent to which their returns are influenced by the market. The actual measure of the undiversifiable risk of a security j is: Deviation of returnj x Correlation of j with the market. A security with low correlation to the market will have much of its risk diversified away when held in a portfolio with other securities, and thus has a low systematic risk.
Also known as the regression coefficient. Provides the same information as the previous systematic risk measure, but scaled to the risk of the market as a whole. For example, a of 1.
The coefficient:. The Market Model or Security Market Line - If the financial market sets securities returns based upon their risks when held in well diversified portfolios, systematic risk will be an appropriate measure of risk for individual assets and securities, and the SML as depicted below will dictate the set of risk-adjusted returns available in the market:.
Above relates the amount of systematic risk inherent in the returns of a security to the return required on that security by the market. The relationship is positive in that the higher the systematic risk of j, the higher its expected return. The SML is located with repect to two important points, the risk-free rate rf and the market portfolios risk-return location m. These investments must over returns in excess of the capital suppliers opportunity costs in order to be acceptable.
Recall that the WACC of any company is in fact an average of the riskadjusted rates of return of the companys various endeavours, including asset types and associated future cash flow expectations.
In order to be acceptable, an investment must offer an expected return in excess of the return depicted on the SML for the investments systematic risk level. This means that good investments would plot above the SML,. However it is below the SML which indicates that it does not offer a return high enough to compensate for its risk.
Investment B has the opposite problem. A company should not generally apply its WACC as an investment criterion. It will only give a correct answer when an investments risk is the same as the average risk of the entire company.
Most companies are aware that projects can differ in risk, and that some adjustment of criterion is advisable. Usually this takes on the form of fixed increments or decrements to the companys average criterion.
Estimating Systematic Risk of Company Investments - To use the SML for estimating required returns the amount of systematic risk size of the coefficient of a project must be specified. There are many ways to do this: If project is of the same risk as the existing company, and its shares are traded on the stock market, one can merely look up the coefficient of the companys shares in one of the financial reporting services that supply such data.
In such situations, the coefficient of the other company can be used. This is also valuable when the shares of the investing company are not traded, but those of a similar company are, and the investment is simply a scale change.
If the beginning value is from a company that has borrowed money, the value must be purified before the other adjustments are made. This is done by: To adjust for revenue risk differential, v is multiplied by the ratio of the investments revenue volatility to that of the company: In order to do so, we must know the coefficient for the debt that will be issued for the project as well as the gearing ratio.
With these two items as well as the ungeared coefficient of the project, the equity coefficient can be calculated using: E rm is a function of the risk-free rate and therefore it makes more sense to estimate the difference between E rm and rf. This figure is the historical average market i. Variance rm is the variance standard deviation2 of the market return, and the covariance CF, rm is the covariance coefficient of the CF x variance of the market return of the cash flow with the overall market.
Risk Resolution across Time - A commonly encountered complexity in investment analysis is that the risk of an investment can be foreseen to change as time passes, yet a decision as to whether to undertake the investment must be made now.
Expected payoff is thus: Conclusion If shareholders are already well diversified, diversification at the company level is irrelevant and probably costly to them. Module VIII Company Dividend Policy Since and residual cash not paid as dividends is still owned by shareholders, this retained cash is reinvested in the company on behalf of shareholders.
This dividend decision is thus also a cash-retention or reinvestment decision. Dividend Irrelevancy - The net result of changing a companys dividend is the substitutability of capital gains i. Truly organic for the company: Using above diagram, an increase in dividends would be shown as a widening of the dividend pipe and a narrowing of the retention pipe resulting in a smaller investment amount. To isolate the effect of dividend choices, the companys investment plans must be kept intact as dividends change.
When the effect of company financial decisions upon shareholders portfolios can be undone by the offsetting actions of shareholders, the company financial decision is irrelevant! Dividends and Market Frictions Taxation of Dividends - From the shareholders perspective, it is after-tax dividends that are of interest. The dividend substitute - capital gains, are also potentially liable for taxation.
Transactions Costs of Dividend Payments - Shareholders may prefer one dividend policy to another depending on their preferences for consuming wealth across time and the costs they would pay to achieve the desired consumption pattern. Flotation Costs Companies themselves incur costs in raising money from capital markets when they pay dividends so high as to require new shares to be issued.
Combined Frictions - The net bias in most cases is against the payment of dividends. Dividend Clienteles: Irrelevancy II - Differing groups of shareholders have become known as clienteles in finance. The interpretation is that they comprise groups that would be willing to pay extra to get the type of dividend policy that is best suited to their own tax and consumption proclivity.
Other Considerations in Dividend Policy Dividends and Signaling - It is in the interests of both managers and shareholders to have share prices reflect new information good or bad as quickly as possible. Dividends and Share Repurchase - Share repurchases are nothing more than a cash dividend to shareholders.
Share repurchases on the open market also show sings of signal attempts that receive a positive response from holders. This is a transaction wherein a company offers to repurchase only particular shares usually held by potential buyers. The repurchase price is at a significant premium over the market price. Module IX - Company Capital Structure A companys capital structure is the extent to which it is financed with each of its capital sources debt and equity.
Capital Structure, Risk and Capital Costs - Debt is not cheaper than equity since the assurance of debt increases the attendant returns required on equity often called the implicit cost of borrowing. Capital Structure Irrelevancy I: Financial markets will ensure this. Shares of any company must sell for just what it would otherwise cost to acquire the same future cash flow expectations. Arbitrage and Prices A Digression - Arbitrage is a transaction wherein an instantaneous risk-free profit is realized.
Capital Structure and Company Values without taxes - The below illustrates the behavior of the required rates of return and overall capital cost of the company; it alters the companys capital structure. Capital Structure Decisions and Taxes - Companies are taxed by the government on the amount of income or profit that they make. Summation of Capital Structure relevance with Taxes - Operating cash flows that a company produces are transformed by the taxation system before they can be claimed by capital suppliers.
This transformation is different depending on the capital structure of the company. Notice that the companys cost of capital WACC steadily declines as the company substitutes debt for equity in its capital structure. A companys cost of capital is therefore lower the higher its proportion of debt.
Capital Structure Irrelevancy II: Taxes - Merton Miller has argued that as more and more borrowing is undertaken by companies in economies with progressive personal taxes, the interest rates necessary to sell bonds to high personal-tax investors will cause the benefits of company borrowing to disappear.
Capital Structure and Agency Problems - Agency deals with situations where the decision-making authority of a principal i. For example, some debt claims carry a convertibility provision; this means that under certain conditions, at the option of the lender, a bond can be exchanged for common shares. Default and Agency Costs - The true costs of bankruptcy or financial distress are: The costs involved in pursuing the legal process of realigning the claims on the assets of the company from those specified in the original borrowing contract.
The implicit and opportunity costs incurred in this effort relative to what would have happened had the company financed instead by equity capital. Other Agency Considerations - Perk consumption beyond the point where management productivity is efficiently enhanced.
Making the Company Borrowing Decision - No quantitative method. This though should be qualified; a practitioner must very careful to judge the net tax benefits of borrowing. This is more of a rule of thumb than a thought out, validated notion. This rule probably works due to agency costs risk is likely to make agency costs higher. Book Values and Borrowing - Practitioners argue book values should be used for measuring the extent of company borrowing while academic types argue that market values are the correct measure.
They are a good measure of the extent to which values will not be upset by financial distress when the company is engaged in borrowing. Techniques of Deciding upon Company Capital Structure 1. Examine what companies in similar lines of business have decided about the amounts they will borrow.
Financial planning a detailed examination of the companys future cashflow expectations including those associated with the borrowing alternatives under consideration so as to decide upon the best choice of financing method.
Suggestions for Deciding about Capital Structure 1. The company should use simulation to attempt to forecast its cash flows and financial statements across the foreseeable future under the various alternative proposals for financing. If similarities indicate a significant chance of coming into conflict with covenants of borrowing contracts in ways that would damage the operational aspects of the firm borrowing should be avoided. If simulations show that tax benefits of borrowing simply replace other tax benefits there is little reason to borrow.
If a companys value is largely based in tangible assets, more borrowing is sustainable. Industry gearing ratios are useful to see what other companies have been able to sustain.
If potential lenders fear company action to the detriment of bondholders, the company should attach covenants to the bonds to alleviate some of that concern i. There are also reasons why a company may choose to avoid new equity issuance i.
Once a tentative conclusion has been made, see if the result would be inconsistent with the capital structures of other companies in the same line of business. If so, it should be determined whether this is an improvement over the usual practice or a signal that something has been left out of the analysis. Module X Working Capital Management Working capital is the set of balance sheet items that would be included under current assets and current liabilities.
Includes the assets if cash, marketable securities, accounts receivable debtors , and inventories; the liabilities of accounts payable creditors , short-term borrowings, and other liabilities coming due within one year. Risk, Return, and Term on Investments - The nature of short-term finance is that it tends to be risky in the sense of requiring the firm to frequently renew the principal amounts of financing outstanding; this could become a problem during hard times.
In situations where companies find themselves with unforeseen reductions in the need for financing, short-term finance is dispensed with reversed quickly at the end of its term. Combining Risk and Rates of Return on Assets and Financing - Companies currently face the decision as to the best term structure of assets and financing. An old rule of thumb is to finance short-term assets with shortterm liabilities and long-term with long-term.
This is called maturity matching. Management of Short-term Assets and Financing - Rather than considering the desirability of each specific short-term asset, managers adopt policies governing the firms investment within each type. Optimisation and Short-term Investment - Management techniques attempt to balance costs and benefits in such a way as to produce the highest net benefit or equivalently the lowest net cost of investing in short-term assets.
Management of Cash Balances - As indicated above cash and near cash assets interest earning bank deposits and short-term marketable securities confer the liquidity benefit to companies investing in them. Transaction balances reality that debts must eventually be paid in cash. Compensating balances cash amounts contractually left on deposit with banks. The optimising of cash replenishment amounts in this situation is solved by: In such a situation the best a manager can do is specify a probability distribution of potential cash balance changes.
The solution is as follows:. Management of Receivables - Companies usually find it necessary to hold accounts receivable and inventory stocks.