1-financial management.ppt
TRANSCRIPT
DR ANJANA RAJU
FINANCIAL FINANCIAL MANAGEMENTMANAGEMENT
DR ANJANA RAJUDR ANJANA RAJU
DR ANJANA RAJU
BASIC CONCEPTSBASIC CONCEPTS
• MEANING AND SCOPE OF FINANCIAL MANAGEMENT
• FORMS OF BUSINESS ORGANISATION
• TIME VALUE OF MONEY• COST OF CAPITAL • VALUATION OF SECURITIES• RISK AND RETURN
DR ANJANA RAJU
BASIC CONCEPTSBASIC CONCEPTS
SECTION I
MEANING AND SCOPE OF
FINANCIAL MANAGEMENT
DR ANJANA RAJU
QUESTION HOURQUESTION HOURWHY A COURSE TITLED
“FINANCE FOR NON- FINANCE EXECUTIVES”?
DR ANJANA RAJU
QUESTION HOURQUESTION HOURWHY A COURSE TITLED
“FINANCE FOR NON- FINANCE EXECUTIVES”?
DR ANJANA RAJU
QUESTION HOURQUESTION HOURWHY NOT PROGRAMS TITLED----
“ PRODUCTION MANAGEMENT FOR NON-PRODUCTION EXECUTIVES”
OR“MARKETING MANAGEMENT FOR
NON- MARKETING EXECUTIVES “
DR ANJANA RAJU
MEANING AND SCOPE OF FINANCIAL MANAGEMENTMEANING AND SCOPE OF FINANCIAL MANAGEMENT
• THE ANSWER IS SIMPLE
COMMON THREAD RUNNING THROUGH ALL DECISIONS TAKEN BY VARIOUS MANAGERS IS
MONEY
DR ANJANA RAJU
MEANING AND SCOPE OF FINANCIAL MANAGEMENTMEANING AND SCOPE OF FINANCIAL MANAGEMENT
R&D MANAGER HAS TO JUSTIFY THE MONEY SPENT ON RESEARCH SPEND
NEW PRODUCT
NEW PROCESSES
REDUCE COSTS AND INCREASE REVENUE
DR ANJANA RAJU
MEANING AND SCOPE OF FINANCIAL MEANING AND SCOPE OF FINANCIAL MANAGEMENTMANAGEMENT
OUTCOME
POSITIVE RESULTS IN RETURN
NOT NEGATIVE RESULTS
DR ANJANA RAJU
MEANING AND SCOPE OF FINANCIAL MEANING AND SCOPE OF FINANCIAL MANAGEMENTMANAGEMENT
MATERIALS MANAGER SHOULD BE AWARE OF INVENTORY
(DIFFERENT ITEMS IN STORES IS NOTHING BUT MONEY IN SHAPE OF INVENTORY)
MAKE PRODUCTIVE USE
DO NOT REACH LOW LEVEL( TO INTERRUPT THE PRODUCTIVE USE)
RIGHT BALANCE BETWEEN TOO MUCH AND TOO LITTLE INVENTORY.
DR ANJANA RAJU
MEANING AND SCOPE OF FINANCIAL MEANING AND SCOPE OF FINANCIAL MANAGEMENTMANAGEMENT
CONCULSION
THIS IS CALLED
“ LIQUIDITY –PROFITABILITY TRADE-OFF”
DR ANJANA RAJU
MEANING AND SCOPE OF FINANCIAL MEANING AND SCOPE OF FINANCIAL MANAGEMENTMANAGEMENT
FINANCIAL MANAGER, AS HIS DESIGNATION IMPLIES
INVOLVED IN ALL FINANCIAL
MATTERS OF THE ORGANISATION
OUTCOME : ALL ACTIVITIES IN THE ORGANISATION HAVE FINANCIAL IMPLICATIONS.
DR ANJANA RAJU
OBJECTIVES OF FINANCIAL OBJECTIVES OF FINANCIAL MANAGEMENTMANAGEMENT
DR ANJANA RAJU
OBJECTIVES OF FINANCIAL MANAGEMENTOBJECTIVES OF FINANCIAL MANAGEMENT
OBJECTIVE SOUGHT TO BE ACHIEVED BY FINANCE MANAGER.
MAKE AVAILABLE THE REQUIRED FUNDS
(AT ACCEPTABLE COST)
FUNDS ARE SUITABLY INVESTED
(IF EVERYTHING GOES ACCORDING TO PLAN)
DR ANJANA RAJU
OBJECTIVES OF FINANCIAL MANAGEMENTOBJECTIVES OF FINANCIAL MANAGEMENT
CONCULSION
GOOD PERFORAMANCE ARE REFLECTED IN THE
PROFITS OF THE FIRM EARNS.
DR ANJANA RAJU
OBJECTIVES OF FINANCIAL OBJECTIVES OF FINANCIAL MANAGEMENTMANAGEMENT
HOW ARE THE PROFITS UTILISED?
- PARTLY DISTRIBUTED AMONG THE OWNERS AS DIVIDEND
- PARTLY RECYCLED INTO OPERATIONS OF FIRMS.
( THE ABOVE PROCESS CONTINUES OVER A PERIOD OF TIME- THE VALUE OF THE FIRM
INCREASES)
DR ANJANA RAJU
OBJECTIVES OF FINANCIAL MANAGEMENTOBJECTIVES OF FINANCIAL MANAGEMENT
- THE FIRM IS ABLE TO GENERATE ATTRACTIVE SURPLUSES FROM SURPLUSES FROM OPERATIONS.
- REFELECTED ON THE STOCK PRICE
( WEALTH INCREASES)
DR ANJANA RAJU
OBJECTIVES OF FINANCIAL MANAGEMENTOBJECTIVES OF FINANCIAL MANAGEMENT
CONCULSION :
OBJECTIVE OF THE FINANCIAL MANAGER IS TO INCREASE OR MAXIMIZE THE WEALTH OF THE OWNERS
- BY INCREASING THE VALUE OF THE FIRM
- REFLECTED IN EPS ( EARNING PER SHARE)
AND MARKET PRICE OF THE SHARE
DR ANJANA RAJU
FUNCTIONS OF FINANCE FUNCTIONS OF FINANCE MANAGERMANAGER
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
A. MOBILIZATION OF FUNDS
B. DEPLOYMENT OF FUNDS
C. CONTROL OVER THE USE OF FUNDS
D. RISK-RETURN TRADE-OFF
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
A. MOBILIZATION OF FUNDS
PLAN FOR FUNDS PLAN TO MOBILISE FROM
VARIOUS SOURCES. DECIDING ON COST OF FUNDS KNOW THE RESTRICTIVE
PROVISIONS ON LOANS
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
A. MOBILIZATION OF FUNDSREAL LIFE EXAMPLE- XYZ LTD KNOWN COMPANY IN COMPUTER
TRAINING, SOFTWARE DEVELOPMENT , INFORMATION SYSTEM UNDERTAKES UPGRADATION
COST OF MODERNIZATION RS 3,578 LAKH GOING TO MOBILISE AS FOLLOWS
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
A. MOBILIZATION OF FUNDS- COST OF MODERNIZATION RS 3,578 LAKH
GOING TO MOBILISE AS FOLLOWS
RS LAKH
PUBLIC ISSUE OF EQUITY SHARES INCLUDING PREMIUMTERM LOAN –ICICILEASING - ICICI - OTHERS DEFERRED PAYMENT GUARANTEEINTERNAL ACCRUALS
1804
130 125 75 991,345_________3,578
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
B.DEPLOYMENT OF FUNDS- ALWAYS MANY COMPETING FOR
ALLOCATION OF FUNDS - VARIOUS DEPARTMENTS - PRODUCTION - MARKETING - PERSONNEL - R&D - TOP MANAGEMENT( FINANCE MANAGER DECIDES ON THE MANNER
OF DEPLOYMENTOF FUNDS TO VARIOUS ASSETS)
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
B.DEPLOYMENT OF FUNDS FINANCE MANAGER APPRAISES THE
PROPOSAL
ALONG WITH FINANCIAL DIMENSIONS
( TO DETERMINE ITS WORTHINESS IN RELATION TO INVESTMENT INVOLVED)
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
B.DEPLOYMENT OF FUNDSCONCULSION
THIS DECISION CALLED THE “INVESTMENT DECISION”
CONSTITUTES ONE OF THE CORE ACTIVITIES OF FINANCE MANAGER.
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
MOBILIZATION OF FUNDS OF XYZ ARE PROPOSED TO BE DEPLOYED AS FOLLOWS AS INDICATED IN PROSPECTUS OF COMPANY.
RS LAKH
BUILDINGSCOMPUTERS & ACCESSORIESPLANT AND MACHINERYINFRASTRUCTURENORMAL CAPITAL EXPENDITUREREPAYMENT OF LOANSINCREASE IN WORKING CAPITAL
985 941 116 213 241 283 799_________3,578
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
C. CONTROL OVER THE USE OF FUNDS
CONTINUOUSLY MONITOR THEIR USE
(PROCUREMENT AND DEPLOYMENT OF FUNDS PROCEEDS ACCORDING TO PLAN)
THIS TASK OF FINANCE MANAGER IS
CALLED FINANCIAL CONTROL.
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGERC. CONTROL OVER THE USE OF FUNDS FINANCE MANAGER --SENDS FREQUENT REPORTS
-- FUNDS REQUIRED AT DIFFERENT POINTS OF TIME.
--- PERFORMANCE OF INDIVIDUAL DEPARTMENTS
( ALL SUCH REPORTS ARE CALLED
” CONTROL REPORTS”)
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
D. RISK-RETURN TRADE-OFFFINANCE MANAGER SEEKS TO
ACHIEVE THE RIGHT BALANCE BETWEEN RISK AND RETURN.
IF FIRMS BORROWERS HEAVILY TO FINANCE
( SURPLUSES GENERATED COULD GO FOR
“ SERVICE OF THE DEBT”)
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
D. RISK-RETURN TRADE-OFF IF THINGS DONOT WORK
ACCORDING TO PLAN
( EXPOSES TO RISK OF SOLVENCY)
DECIDE WHETHER THE OPPORTUNITY IS WORTH MORE THAN ITS COST?
WHETHER ADDITIONAL BURDEN OF DEBT CAN BE SAFELY BORNE?
DR ANJANA RAJU
FUNCTIONS OF FINANCE MANAGERFUNCTIONS OF FINANCE MANAGER
D. RISK-RETURN TRADE-OFF CONCULSION :
DECISION MAKING IN ALL AREAS OF MANAGEMENT INVLOVES BALANCING THE TRADE-OFF BETWEEN RISK AND RETURN
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE INTERFACE BETWEEN FINANCE AND AND
OTHER FUNCTIONSOTHER FUNCTIONS
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSFUNCTIONS
1. MARKETING –FINANCE INTERFACE2. PRODUCTION –FINANCE
INFERFACE3.TOP MANAGEMENT –FINANCE
INTERFACE
o TREASURY OPERATIONSo FOREIGN EXCHANGEo FINANCIAL STRUCTURINGo MAINTAINING SHARE PRICE o ENSURING MANAGEMENT CONTROL.
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSINTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS
1. MARKETING –FINANCE INTERFACE
MARKETING MANAGER SHOULD CLEAR UNDERSTANDING OF
--- CREDIT EXTENTED ---- ANTICIPATION OF SALES ---- COSTS OF MAINTAINING LARGE
INVENTORY. --- FINANCIAL IMPLICATIONS OF
PRICING, PRODUCT PROMOTION AND ADVERTISEMENT , CHOICE OF PRODUCT MIX, AND DISTRIBUTION POLICY.
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSINTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS
2. PRODUCTION –FINANCE INFERFACE
MAKES INVESTMENT IN EQUIPMENT, MATERIAL AND MEN.
USE OF EQUIPMENT IN CONTROL AND USED MOST PRODUCTIVELY..
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSINTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS
2. PRODUCTION –FINANCE INFERFACE
MINIMIZED WORK STOPPAGES AND IDLE TIME.
HOLDING COST AND INCREASE OUTPUT, AS DETERMINED FOR SALE.
MAKE DECISIONS REGARDING MAKE OR BUY OR LEASE.
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSINTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS
3.TOP MANAGEMENT –FINANCE INTERFACE
--OTHER CHALLENGES IN FINANCIAL MANAGEMENT
o TREASURY OPERATIONS
SHORT TERM FUND MUST BE SOPHISTICATED
MAKE SPECULATIVE GAINS BY ANTICIPATING
INTEREST RATE MOVEMENTS.
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSINTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS
3.TOP MANAGEMENT –FINANCE INTERFACE FOREIGN EXCHANGE
WEIGH THE COSTS AND BENEFITS OF TRANSACTING IN FOREIGN EXCHANGE
FUTURE VALUE OF RUPEE HAS BECOME DIFFICULT TO PREDICT.
o
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSINTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS
3.TOP MANAGEMENT –FINANCE INTERFACE o FINANCIAL STRUCTURING
OPTIMUM MIX BETWEEN DEBT AND EQUITY
TAILOR FINANCIAL INSTRUMENTS TO SUIT INVESTORS NEED.
PRICING OF NEW ISSUES.
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSINTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS
3.TOP MANAGEMENT –FINANCE INTERFACE o MAINTAINING SHARE PRICE
IN PREMIUM EQUITY ERA
----- FIRM MUST ENSURE THE SHARE PRICE STAY HEALTHY.
----- DEVISE APPROPRIATE DIVIDEND AND
BONUS POLICIES.
DR ANJANA RAJU
INTERFACE BETWEEN FINANCE AND OTHER FUNCTIONSINTERFACE BETWEEN FINANCE AND OTHER FUNCTIONS
3.TOP MANAGEMENT –FINANCE INTERFACE o ENSURING MANAGEMENT CONTROL.
DONOT EXPOSE COMPANY FOR BEEN
TAKEOVER SUITATION.
DR ANJANA RAJU
SECTION II
FORMS OF BUSINESS ORGANISATION
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
A. SOLE PROPRIETORSHIP
B. PARTNERSHIP
C. COMPANIES
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
A. SOLE PROPRIETORSHIP
OWNED BY SINGLE PERSON
ENJOYS ALL POWERS OF TAKING AND ASSUMING RISK
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
A. SOLE PROPRIETORSHIPADVANTAGES
1. EASY AND INEXPENSIVE TO SET UP
2. FEW GOVT. REGULATIONS
3. NO FIRM TAX.
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
A. SOLE PROPRIETORSHIP
DISAVANTAGES
1. LIFE OF THE FIRM LIMITED TO LIFE OF THE OWNER
2. UNLIMITED PERSONAL LIABILITIES
3.OUTSIDE FUND RAISING NOT POSSIBLE
( LACK OF GROWTH)
4. TAX ON THE INCOME WILL BE VERY HIGH
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
B. PARTNERSHIP BUSINESS OWNED BY TWO OR MORE
PERSONS.
THEY BEAR THE RISK AND REAP THE REWARDS OF BUSINESS
BEINGS THROUGH PARTNERSHIP AGREEMENT OR PARTNERSHIP DEED.
( GOVERNED BY INDIAN PARTNERSHIP ACT, 1923)
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
B. PARTNERSHIPADVANTAGES CAN BE SET UP EASILY AND
INEXPENSIVE
RELATIVETLY FREE FROM GOVT REGULATIONS
EXPERTISE AND EXPERIENCE OF PARTNERS USEFUL TO THE FIRM OPERATIONS
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
B. PARTNERSHIPDISADVANTAGES LIFE OF THE FIRM DEPENDS UPON THE
AGREEMENT (WITHDRAWAL OR DEATH OR DISSOLUTION) CONFLICT BETWEEN PARTNERS
THREATS EXISTENSE OF PARTNERSHIP FIRM
PERSONAL LIABILITY OF THE PARTNES UNLIMITED
ABILITY TO RAISE FUNDS LIMITED
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
C. COMPANIES A GROUP OF PERSONS WORKING
TOGETHER TOWARDS A COMMON OBJECTIVE IS A COMPANY.
TERM “ REGISTER COMPANY “ AS PER SECTION 3(1) (i) OF COMPANIES ACT, 1956.
A COMPANY CAN BE PRIVATE OR PUBLIC COMPANY
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
C. COMPANIES ACCORDING TO SECTION (1) (iii) OF
THE COMPANIES ACT, 1956,
A PRIVATE COMPANY MEANS A COMPANY WHICH HAS A MINIMUM PAID-UP CAPITAL OF ONE LAKH RUPEES OR SUCH HIGHER PAID –UP CAPITAL AS MAY BE PRESCRIBED.
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATIONC. COMPANIES ACCORDING TO SECTION (1) (iii) OF THE COMPANIES ACT, 1956,PRIVATE COMPANY
AND ITS ARTICLE –
RESTRICTS THE RIGHT TO TRANSFER ITS SHARES, IF ANY
LIMIT NO. OF MEMBERS TO FIFTY
PROHIBITS ANY INVITATION TO PUBLIC TO SUBSCRIBE FOR ANY SHARES.
PROHIBITS ANY INVITATION OR ACCEPTANCE OF DEPOSITS FROM PERSONS OTHER THAN MEMBERS.
DR ANJANA RAJU
FORMS OF BUSINESS ORGANISATIONFORMS OF BUSINESS ORGANISATION
C. COMPANIES
ACCORDING TO SECTION (1) (iv) OF THE COMPANIES ACT, 1956,
MININUM PAID-UP CAPITAL OF FIVE LAKH OR
SUCH HIGHER PAID –UP CAPITAL MAY BE PRESCRIBED.
DR ANJANA RAJU
SECTION III
TIME VALUE OF
MONEY
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
BACKGROUND KEEP PACE WITH INCREASING
COMPETITION NEW IDEAS IMPLEMENTED
THROUGH NEW PROJECTS PROJECT ACTIVITY INVLOVES
INVESTING A SUM OF MONEY ANTICIPATION OF BENEFITS
SPREAD OVER A PERIOD OF TIME
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
BACKGROUND QUESTION
HOW DO WE DETERMINE WHETHER THE PROJECT IS FINANCIALLY
VIABLE OR NOT?
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
BACKGROUNDANSWER
SUM OF BENEFITS ACCRUING OVER THE FUTURE PERIOD AND COMPARE THE TOTAL VALUE OF THE BENEFITS WITH THE INITIAL INVESTMENT.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
BACKGROUNDANSWER
AGGREGATE VALUE OF THE BENEFITS EXCEEDS THE INITIAL INVESTMENT, THE PROJECT IS CONSIDERED TO BE FINANCIALLY VIABLE.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
BACKGROUNDOUTCOME APPROACH PRIMA FACIE
APPREARS TO BE SATISFACTORY
(WE HAVE ASSUMED THE IRRESPECTIVE OF TIME WHEN MONEY IS INVESTED OR RECEIVED ,THE VALUE REMAINS THE SAME).
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
BACKGROUND
VALUE OF ONE RUPEE NOW = VALUE OF ONE RUPEE AT THE END OF YEAR 1= VALUE OF ONE RUPEE AT THE END OF YEAR 2 AND SO ON
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
BACKGROUND
ASSUMPTION IS INCORRECT BECAUSE MONEY HAS TIME VALUE.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
WHY SHOULD MONEY HAVE TIME VALUE ?
CAN BE EMPLOYED PRODUCTIVELY TO GENERATE
REAL RETURNS
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
-- RS 1000 NOW IS MORE VALUABLE THAN RS 1000 AFTER A YEAR
-- WE WILL NOT PART WITH RS 1000 NOW IF WE ASSURED THE SAME RS 1000.
--- WE PART WITH RS 1000 NOW FOR SOMETHING MORE THAN RS 1000.
( THIS IS CALLED “INTEREST” OR THE TIME VALUE FOR MONEY”
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
IF SUM OF --RS 100 INVESTED IN RAW
MATERIAL AND LABOUR
--RESULTS IN FINISHED GOODS WORTH RS 105
--INVESTMENT OF RS 100 EARNED RATE OF RETURN OF 5 PERCENT.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
IN AN INFLATIONARY PERIOD
- A RUPEE TODAY HAS HIGHER PURCHASING THAN A RUPEE IN FUTURE.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
THREE DETERMINANTS COMBINE TO DETERMINE THE RATE OF INTEREST SYMBOLICALLY
REAL RATE OF INTEREST OR RETURN
EXPECTED RATE OF INFLATION
RISK PREMIUMS TO COMPENSATE FOR UNCERTAINTY
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
THREE DETERMINANTS COMBINE TO DETERMINE THE RATE OF INTEREST SYMBOLICALLY
REAL RATE OF INTEREST OR RETURN+ EXPECTED RATE OF INFLATION + RISK PREMIUMS TO COMPENSATE FOR UNCERTAINTY
DR ANJANA RAJU
TWO METHODS OF TIME VALUE
1. COMPOUNDING AND
2. DISCOUNTING
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
TWO METHODS BY WHICH TIME VALUE CAN BE TAKEN
1. COMPOUNDING AND
2. DISCOUNTING
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
ILLUSTRATION PROJECT INVOLVES AN IMMEDIATE
OUTFLOW OF SAY RS 1000. FOLLOWING PATTERN OF INFLOWS YEAR 1 : RS 250 YEAR 2: RS 500 YEAR 3 : RS 750 YEAR 4 : RS 750
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
INITIAL OUTFLOW AND SUBSEQUENT INFLOWS CAN BE REPRESENTED ON A TIME LINE AS GIVEN BELOW:
FIGURE 1
0
Yr 321 4
RS -1000 250 500 750 750
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PROCESS OF COMPOUNDING
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PROCESS OF COMPOUNDINGUNDER THE METHOD OF COMPOUNDING
1. WE FIND FUTURE VALUES (FV) ( of all the cash flows at the end of the time horizon at a
particular rate of return)
2. COMPARING THE FV OF INITIAL OUTFLOW OF RS 1000
( at the end of 4 yrs) WITH
3. SUM OF FV OF YEARLY CASH INFLOWS AT END OF YEAR 4
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FIGURE 2 PROCESS OF COMPOUNDING
0 1 2 3 4
-1000250 500 750
750+
FV(750)
FV(500)
FV(250)
Compared with FV (1000)
+
+
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PROCESS OF DISCOUNTING
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PROCESS OF DISCOUNTING UNDER THE METHOD OF DISCOUNTING
WE RECKON THE TIME VALUE OF
MONEY NOW (i.e AT TIME 0 ON THE TIME LINE)
---WE COMPARE THE INITIAL OUTFLOW WITH THE SUM OF PRESENT (PV) OF THE FUTURE INFLOWS AT THE GIVEN RATE OF INTEREST.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FIGURE 3 PROCESS OF DISCOUNTING
0 1 2 3 4
-1000250 500 750 750
PV(750)
PV(500)
PV(750)
Compared with the sums of
PV (250)
+
+
+
+
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
WE MUST DRAW THE
DISTINCTION BETWEEN
THE CONCEPT OF COMPOUND INTEREST
AND SIMPLE INTEREST.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
ILLUSTRATION
X HAS A SUM OF RS 1000 TO INVEST
THERE ARE TWO SCHEMES --- ONE OFFERING A RATE OF 10%
(COMPOUNDED ANNUALLY) AND---- OTHER OFFERING A SIMPLE RATE OF
10%
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
ILLUSTRATION
WHICH ONE SHOULD HE OPT FOR ASSUMING THAT HE WILL WITHDRAW THE AMOUNT END OF
(A) ONE YEAR (B) TWO YEARS AND (C ) FIVE YEARS?
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
SOLUTION
End of the year
Compound Interest Scheme
Simple Interest Scheme
1 1000+(1000 x 0.10)= 1100
1000+(1000X0.10) =1100
2 1100+(1100 x 0.10)= 1210
1100+(1000x0.10)= 1200
3 1210+(1210 x 0.10)= 1331
1200+(1000x0.10)= 1300
4 1331+(1331 x 0.10)= 1464
1300+(1000x0.10)= 1400
5 1464+(1464 x 0.10)= 1610
1400+(1000x0.10)= 1500
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
RESULT
COMPOUNDED INTEREST SCHEME INTEREST EARNS INTEREST.
UNDER SIMPLE INTEREST SCHEME INTEREST DOES NOT EARN ADDITIONAL INTEREST.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
OUTCOME
WE EMPHASIZE THAT IN FINANCIAL
ANALYSIS WE ALWAYS ASSUME INTEREST TO BE COMPOUNDED
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OF SINGLE FLOW(LUMP SUM)
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY FUTURE VALUE OF SINGLE FLOW(LUMP SUM)
GENERALISED PROCEDURE FOR CALULATING THE FUTURE VALUE(FV) OF SINGLE CASH FLOW COMPOUNDED ANNUALLY IS AS FOLLOWS:
FVn=PV(1+k)n
FVn=Future value of the initial flow n years hence
PV =Initial cash flow
k = Annual rate of interest
n = Life of investment
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OF SINGLE FLOW(LUMP SUM)
ILLUSTRATION
FIXED DEPOSIT SCHEME OF ANDHRA BANK OFFERS THE FOLLOWING INTEREST RATES
AN AMOUNT OF RS 10,000 INVESTED TODAY WILL GROW IN 3 YEARS
PERIOD OF DEPOSIT RATE PER ANNUM
46 DAYS TO 179 DAYS 10.0%
180 DAYS TO < 1YEAR 10.5%
1 YEAR AND ABOVE 11.0%
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OF SINGLE FLOW(LUMP SUM)
SOLUTION
FVn=PV(1+k)n
=10000(1+.11)3
= 10000(1.368) Rs 13,680
PV= Table 1 value of 10,000 for 3yrs is 1.368
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
EFFECTIVE vs
NOMINAL RATE OF INTEREST.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
EFFECTIVE vs NOMINAL RATE OF INTEREST.
FOR EXAMPLE NOMINAL RATE OF INTEREST IS 10 PERCENT PER
ANNUM
WHEN COMPOUNDING IS DONE SEMI-ANNUALLY ( THE PRINCIPAL AMOUNT GROWS AT RATE OF 10.25%
P.A)
o 10.25 % IS CALLED AS EFFECTIVE INTEREST
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
GENERAL RELATIONSHIP BETWEEN THE EFFECTIVE AND NOMINAL RATES OF INTEREST IS AS FOLLOWS:
r=(1+k )m-1 m
WHERE
r= Effective rate of interest k= Nominal rate of interest m=Frequency of compounding per
year
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PROBLEMFIND OUT EFFECTIVE RATE OF INTEREST IF THE NOMINAL RATE OF INTEREST IS 12 PERCENT
AND IS QUARTERLY COMPOUNDED EFFECTIVE RATE OF INTEREST
r=(1+k )m-1 m
r=(1+0.12 )4-1 4
=(1=0.03) 4-1= 1.126-1
=0.126= 12.6% P.A
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OF MULTIPLE FLOWS
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OF MULTIPLE FLOWS SUPPOSE WE INVEST RS 1,000 NOW
(BEGINNING OF YEAR 1)
RS 2,000 AT BEGINNING OF YEAR 2
RS 3,000 AT THE BEGINNING OF YEAR 3
HOW MUCH WILL THESE FLOWS ACCUMULATE TO AT THE END OF YEAR 3
( AT THE RATE OF 12 PERCENT PER ANNUM?)
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FIGURE 4 COMPOUNDING PROCESS OF MULTIPLE FLOWS
0
1 2 3
1000 2000 3000ACCUMULATION
FV(3000)
FV(2000)
FV(1000)
+
+
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEYFUTURE VALUE OF MULTIPLE FLOWS TO DETERMINE THE ACCUMULATED SUM AT
THE END OF YEAR 3
WE HAVE TO JUST ADD FUTURE COMPOUNDED VALUES OF RS 1,000, RS 2,000 AND RS 3,000 RESPECTIVELY
FV (Rs 1,000)+FV(Rs 2,000)+ FV( Rs 3,000)
AT k =0.12, THE ABOVE SUM IS EQUAL TO
1,000 x FVIF(12,3)+2,000 x FVIF(12,3) 3,000x FVIF (12,3)
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEYFUTURE VALUE OF MULTIPLE FLOWS
RS{(1,000 x1.405)+(2,000 x 1.254)
+(3,000x1.120)}
=RS 7,273 NOTE : ABOVE PROCESS TEDIOUS IF WE
HAVE TO DETERMINE ACCUMULATION OF MULTIPLE FLOWS OVER A LONGER PERIOD OF TIME
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEYFUTURE VALUE OF MULTIPLE FLOWS
FOR EXAMPLE
ACCUMULATION OF A RECURRING DEPOSIT OF RS 100 PER MONTH FRO 60 MONTHS AT RATE OF 1 PERCENT PER MONTH
( SHORT CUT METHOD CAN BE EMPLOYED
PROVIDED THE FLOWS ARE EQUAL)
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OFANNUITY
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OFANNUITY
ANNUITY IS THE TERM USED TO DESCIBE A SERIES OF PERIODIC FLOWS OF EQUAL AMOUNTS
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OFANNUITY
TERMS TO UNDERSTAND IF EQUAL AMOUNTS OF CASH FLOWS
OCCUR AT THE END OF EACH PERIOD OVER THE SPECIFIED TIME HORIZON, THEN THIS STREAM OF CASH FLOWS IS DEFINED AS A REGULAR ANNUITY OR DEFERRED ANNUITY.
WHEN CASH FLOWS OCCUR AT BEGINNING OF EACH PERIOD THE ANNUITY IS KNOWN AS AN ANNUITY DUE
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
FUTURE VALUE OFANNUITY
THE FUTURE VALUE OF REGULAR ANNUITY FOR THE A PERIOD OF n YEARS AT THE RATE OF INTEREST “k” IS GIVEN BY FORMULA
FVAn =A(1+k)n-1+ A (1+k)n-2+ A (1+k)n-3 +…+ A
WHICH REDUCES TO
FVAn =A[ (1+k)n – 1 ] k
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEYFUTURE VALUE OFANNUITY
WHICH REDUCES TO
FVAn =A[ (1+k)n – 1 ] k
WHERE A= AMOUNT DEPOSITED /INVESTED AT
THE END OF EVERY YEAR FOR n YEARS k= RATE OF INTEREST (EXPRESSED IN
DECIMALS) n= TIME HORIZON
FVAn = ACCUMULATION AT THE END OF n YEARS
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEYFUTURE VALUE OFANNUITY
DO ILLUSTRATION 7 AND 8
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PRESENT VALUE
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PRESENT VALUE BACKGROUND
THIS APPROACH CAN DETERMINE THE PRESENT VALUE OF FUTURE CASH FLOW OR A STREAM OF FUTURE CASH FLOWS
COMMONLY FOLLOWED APPROACH FOR EVALUATING FINANCIAL VIABILITY OF PROJECTS
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PRESENT VALUE
1. PRESENT VALUE OF SINGLE FLOW
2. PRESENT VALUE OF UNEVEN MULTIPLE FLOWS
3. PRESENT VALUE OF AN ANNUITY
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PRESENT VALUE
1. PRESENT VALUE OF SINGLE FLOW
IF WE INVEST RS 1,000 TODAY AT 10% P.A FOR PERIOD OF 5 YEARS
PV= FVn
(1+k)n
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEYPRESENT VALUE OF SINGLE FLOW IF WE INVEST RS 1,000 TODAY AT 10% P.A FOR
PERIOD OF 5 YEARS
PV= FVn
(1+k)n
RS 1,000 x FVIF(10,5) =RS 1,000x1.611= RS 1,611 AT END OF 5 YEARS
THE SUM OF RS 1,611 IS CALLED THE ACCUMULATION OF RS 1,000 FOR GIVEN VALUES OF “k” AND “n”
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEYPRESENT VALUE OF SINGLE FLOW
DO ILLUSTRATION 9 AND 10
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
2. PRESENT VALUE OF UNEVEN MULTIPLE FLOWS
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY2. PRESENT VALUE OF UNEVEN MULTIPLE FLOWS SUPPOSE A PROJECT INVOLVES AN INITIAL
INVESTMENT OF RS 10 LAKH AND GENERATES NET INFLOWS AS FOLLOWS
END OF THE YEAR- 1 RS 2 LAKH 2 RS 4 LAKH 3 RS 6 LAKH
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY2. PRESENT VALUE OF UNEVEN MULTIPLE FLOWS QUESTION TO BE ANSWERED
1. WHAT IS THE PRESENT VALUE OF THE FUTURE CASH FLOWS?
ANSWER : WE HAVE TO DETERMINE THE RELEVANT RATE OF INTEREST
NOTE: RELEVANT RATE OF INTEREST WILL BE THE COST OF FUNDS INVESTED
ASSUMPTION : WE ASSUME COST IS 12%P.A( THEN WE CAN NOW DETERMINE PRESENT
VALUES OF CASH FLOWS USING THE TWO-STEP PROCEDURE)
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
2. PRESENT VALUE OF UNEVEN MULTIPLE FLOWS
STEP 1 EVALUATE THE PRESENT VALUE OF CASH FLOW
INDEPENDENTLY
YEAR
CASHFLOW (RS IN LAKHS
PRESENT VALUE (RS.IN LAKH)
1 2 2 x PVIF(12,1)=2 x0.893 = 1.79
2 4 4 x PVIF(12,2)=4 x0.797 = 3.19
3 6 6 x PVIF(12,3)=6 x0.712 = 4.27
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
2. PRESENT VALUE OF UNEVEN MULTIPLE FLOWS
STEP 2 AGGREGATE THE PRESENT VALUES
OBTAINED IN STEP 1( TO DETERMINE THE PV OF CASHFLOWS STREAM)
CASHFLOW OF RS(1.79+3.19+4.27)=RS 9.25 LAKH.
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
2. PRESENT VALUE OF UNEVEN MULTIPLE FLOWS
WHEN PROJECT IS VIABLE
IF PRESENT VALUE OF CASHFLOWS INFLOWS EXCEEDS THE PRESENT VALUE OF CASH OUTFLOW
IN THE ABOVE ILLUSTRATION THE PROJECT IS NOT VIABLE
CASH INFLOWS RS 9.25 LAKH CASHOUTFLOWS RS 10 LAKHS (INITIAL INVESTMENT)
DIFFERENCE OF RS 0.75 LAKHS IS CALLED NET PRESENT VALUE
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
PRESENT VALUE
3. PRESENT VALUE OF AN ANNUITY
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
3. PRESENT VALUE OF AN ANNUITY PVIFA ( PRESENT VALUE INTEREST FACTOR ANNUITY)
PRESENT VALUE OF AN ANNUITY “A” RECEIVABLE AT THE END OF EVERY YEAR FOR THE PERIOD OF n YEARS AT RATE OF INTEREST k IS EQUAL TO
PVAn = A + A + A +… A (1+k) (1+k)2 (1+k)3 (1+k)n
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
3. PRESENT VALUE OF AN ANNUITY WHICH REDUCES TO
PVA n = A x [ (1+k)n -1 ]
k(1+k)n
THE EXPRESSION IS CALLED
PVIFA ( PRESENT VALUE INTEREST FACTOR ANNUITY)
DR ANJANA RAJU
TIME VALUE FOR MONEYTIME VALUE FOR MONEY
3. PRESENT VALUE OF AN ANNUITY PVIFA ( PRESENT VALUE INTEREST FACTOR ANNUITY)
REPRESENTS THE VALUE OF REGULAR ANNUITY OF RE 1 FOR GIVEN VALUES OF k AND n.
DO ILLUSTRATION 11 AND 12
DR ANJANA RAJU
SECTION IV
COST OF CAPITAL
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
MEANING OF COST OF CAPITAL
COST ASSOCIATED WITH PRINCIPAL SOURCES OF LONG –TERM FINANCE
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
MEANING OF COST OF CAPITAL
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITALMEANING OF COST OF CAPITAL
WHAT IS COSTS THE COMPANY TO RAISE FINANCE THROUGH VARIOUS SOURCES?
COST OF DIFFERENT FINANCIAL RESOURCES THAT THE COMPANY USES IS TERMED AS ITS COST OF CAPITAL.
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITALFOR EXAMPLE
TOTAL CAPITAL BASE OF RS 500 LAKHS
IN THE RATIO OF 1:1 OF DEBT-EQUITY
250 LAKHS EACH OF DEBT AND EQUITY
IF POST –TAX COSTS OF DEBTS AND EQUITY ARE 7% AND 18% RESPECTIVELY.
COST OF CAPITAL TO THE COMPANY WILL BE EQUAL TO WEIGHTED AVERAGE COST
250 x 7% 250 x 18% = 12.5% 500 500
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST ASSOCIATED WITH PRINCIPAL SOURCES OF LONG –TERM FINANCE
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST ASSOCIATED WITH PRINCIPAL SOURCES OF LONG –TERM FINANCE
COST OF
DEBENTURES
TERM LOANS
EQUITY CAPITAL
RETAINED EARNINGS
EXTERNAL EQUITY
DR ANJANA RAJU
COST OF DEBENTURES
DR ANJANA RAJU
COST OF DEBENTURESCOST OF DEBENTURESCOST OF DEBENTURES DEFINED AS
THE DISCOUNTED RATE WHICH EQUATES THE NET PROCEEDS FROM ISSUE OF DEBENTURES TO
THE EXPECTED CASH FLOWS IN THE FORM OF INTEREST AND PRINCIPAL REPAYMENTS.
n P=∑ I (1+t) + F t=1 (1+kd)t (1+kd)n
DR ANJANA RAJU
COST OF DEBENTURESCOST OF DEBENTURES
COST OF DEBENTURES DEFINED AS
n P=∑ I (1+t) + F t=1 (1+kd)t (1+kd)n
WHERE
kd = POST –TAX COST OF DEBENTURES CAPITAL I = ANNUAL INTEREST PAYMENT PER DEBENTURE CAPITAL T= CORPORATE TAX RATE F= REDEMPTION PRICE PER DEBENTURE P=NET AMOUNT REALIZED PER DEBENTURES AND n= MATURITY PERIOD
DR ANJANA RAJU
COST OF DEBENTURES COST OF DEBENTURES
COST OF DEBENTURES DEFINED AS
n P=∑ I (1+t) + F t=1 (1+kd)t (1+kd)n
WHERE
kd = POST –TAX COST OF DEBENTURES CAPITAL I = ANNUAL INTEREST PAYMENT PER DEBENTURE CAPITAL T= CORPORATE TAX RATE F= REDEMPTION PRICE PER DEBENTURE P=NET AMOUNT REALIZED PER DEBENTURES AND n= MATURITY PERIOD
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST OF DEBENTURES DEFINED AS
INTEREST PAYMENT (I) IS MULTIPLIED BY THE FACTOR (1-t)
( because interest on debt is tax-deductible expenses)
ONLY POST –TAX COSTS ARE CONSIDERED.
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST OF DEBENTURES
I(1-t) + (F-P) (1-t)
n kd = ____________________ F+P 2
ILLUSTRATION 1
DR ANJANA RAJU
COST OF TERM LOANS
DR ANJANA RAJU
COST OF TERM LOANS
SIMPLY EQUAL TO THE INTEREST RATE
MULTIPLIED BY (1-Tax rate)
INTEREST RATE APPLICABLE TO NEW TERM LOAN.
INTEREST IS TAX DEDUCTIBLE
COST OF CAPITALCOST OF CAPITAL
DR ANJANA RAJU
COST OF TERM LOANS
Kt= I (1-t)
where I = Interest rate t= tax rate
COST OF CAPITALCOST OF CAPITAL
DR ANJANA RAJU
COST OF PREFERNCE SHARE (KP)
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST OF PREFERNCE SHARE (KP)
D+ F-P n
kp= ___________
F+P 2
kp = cost of preference capital D = PREFERENCE DIVIDEND PER SHARE PAYABLE ANNUALLY
F= REDEMPTION PRICE P= NET AMOUNT REALISED PER SHARE AND n= MATURITY PERIOD
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST OF PREFERNCE SHARE (KP)
ILLUSTRATION 2
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITALCOST ASSOCIATED WITH PRINCIPAL SOURCES OF
LONG –TERM FINANCE
COST EQUITY CAPITAL
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST OF EQUITY CAPITAL
n
kp=
∑ Dt
t=1 (1+ ke)t
pe =PRICE PER EQUITY SHARE
Dt= EXPECTED DIVIDEND PER SHARE AT THE END OF YEAR ONE, AND
Ke = RATE OF RETURN REQUIRED BY EQUITY SHAREHOLDERS
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST OF EQUITY CAPITAL ASSUMING A CONSTANT GROWTH RATE IN
DIVIDENDS.
Ke = D1 + g Pe
D1 AND g ARE KNOWN IF THE CURRENT MARKET PRICE OF THE SHARE IS GIVEN
DO ILLUSTRATION 3
DR ANJANA RAJU
COST OF RETAINED EARNINGS
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL COST OF RETAINED EARNING AND COST OF EXTERNAL EQUITY
EARNINGS OF THE FIRM CAN BE REINVESTED OR
PAIDED AS DIVIDEND TO SHAREHOLDERS
INCASE EARNINGS ARE RETAINED THEN SHAREHOLDERS DEMAND COMPENSATION
COST OF RETAINED EARNING LESSER COSTLY THEN NEW ISSUE COST( NO FLOATING COST)
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITAL
COST OF EXTERNAL EQUITY
ke= D1+g
P0(1-f)
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITALCOST OF EXTERNAL EQUITY
ke=cost of external equity
D1= Dividend expected at the end of year 1
P0 = current market price per share
g= constant growth rate applicable to dividends
f= floatation costs as a percentage of current market price
DR ANJANA RAJU
COST OF CAPITALCOST OF CAPITALCOST OF EXTERNAL EQUITY
K’e = ke/(1-f)
Ke = rate of return required by equity investors
K’e= cost of external equity
f =flotation costs as a percentage of current market price
DO ILLUSTRATION 5
DR ANJANA RAJU
SECTION V
VALUATION OF SECURITIES
DR ANJANA RAJU
VALUATION OF SECURITIES
o VALUATION CONCEPT
o BOND VALUATION
o EQUITY VALUATION
DR ANJANA RAJU
VALUATION OF SECURITIESVALUATION OF SECURITIESo VALUATION CONCEPT
BOOK VALUE IS AN ACCOUNTING CONCEPT
ASSETS RECORDED AT HISTORICAL COSTS
BOOK VALUE OF DEBT IS STATED AT OUTSTANDING AMOUNT.
DR ANJANA RAJU
VALUATION OF SECURITIESVALUATION OF SECURITIESo VALUATION CONCEPT
REPLACEMENT VALUE : AMT SPEND TO REPLACE THE EXISTING ASSET IN CURRENT CONDITION
LIQUIDATION VALUE: AMOUNT REALISED IF THE ASSET IS SOLD AFTER HAVING TERMINATING ITS BUSINESS.
DR ANJANA RAJU
VALUATION OF SECURITIESVALUATION OF SECURITIESo VALUATION CONCEPT
GOING CONCERN VALUE: AMOUNT REALISED IF BUSINESSN IS SOLD AS AN OPEARTING ONE.
MARKET VALUE: THE CURRENT PRICE AT WHICH THE ASSET OR SECURITY IS BEING SOLD OR BROUGHT.
DR ANJANA RAJU
VALUATION OF SECURITIESVALUATION OF SECURITIESo VALUATION OF BOND
BONDS ARE NEGOTIABLE PROMISSORY NOTES USED BY
INDIVIDUALS,BUSINESS FIRMS,GOVERNMENTS,GOVERNMENT AGENCIES.
DR ANJANA RAJU
VALUATION OF SECURITIESVALUATION OF SECURITIESo VALUATION OF BOND
PRIVATE SECTOR ISSUE SECURED OR UNSECURED BONDS.
RATE OF INTEREST IS FIXED AND KNOWN
REDEEMABLE AFTER A SPECIFIC PERIOD
EXPECTED CASHFLOW CONSISTS OF ANNUAL INTEREST PAYMENTS PLUS PRINCIPAL.
DR ANJANA RAJU
BOND – RELATED TERMS
DR ANJANA RAJU
BOND – RELATED TERMSBOND – RELATED TERMSFACE VALUE
COUPON RATE OF INTEREST
MATURITY
REDEMPTION VALUE
MARKET VALUE
DR ANJANA RAJU
BOND – RELATED TERMSBOND – RELATED TERMS
FACE VALUE
VALUE STATED ON THE FACE OF THE BOND AND IS ALSO KNOW AS PAR VALUE
DR ANJANA RAJU
BOND – RELATED TERMSBOND – RELATED TERMS
FACE VALUE
REPRESENTS THE AMOUNT OF BORROWING BY FIRM
( WHICH IT SPECIFIES TO REPAY AFTER A SPECIFIC
PERIOD)
ISSUED AT RS 100 OR RS 1000
DR ANJANA RAJU
BOND – RELATED TERMSBOND – RELATED TERMS
COUPON RATE OF INTEREST
CARRIES A SPECIFIC RATE OF INTEREST WHICH IS CALLED THE COUPON RATE
INTEREST PAID ON THE BOND IS TAX DEDUCTIBLE.
DR ANJANA RAJU
BOND – RELATED TERMSBOND – RELATED TERMS
MATURITY
ISSUED FOR SPECIFIC PERIOD
TYPICALLY CORPORATE BONDS HAVE MATURITY PERIOD 7-10 YEARS.
GOVERNMENT BONDS UPTO 20-25 YEARS
DR ANJANA RAJU
BOND – RELATED TERMSBOND – RELATED TERMS
REDEMPTION VALUE
VALUE THE BONDHOLDER GETS ON MATURITY IS CALLED REDEMPTION VALUE.
A BOND MAY BE REDEMMED AT PAR , AT PREMIUM (MORE THAN PAR) OR AT A DISCOUNT(LESS THAN PAR VALUE)
DR ANJANA RAJU
BOND – RELATED TERMSBOND – RELATED TERMS
MARKET VALUE
BOND TRADED IN STOCK EXCHANGE
PRICE AT WHICH IT IS BROUGHT
MARKET VALUE MAY BE DIFFERENT FROM PAR VALUE OR REDEMPTION VALUE
DR ANJANA RAJU
VALUATION OF SECURITIESVALUATION OF SECURITIES
o CONVERTIBLE DEBENTURES
CONVERTIBLE PARTLY OR FULLY INTO EQUITY SHARES
DR ANJANA RAJU
VALUATION OF SECURITIESVALUATION OF SECURITIES
EQUITY VALUATION
INTRINSIC VALUE IS THE VALUE OF A STOCK WHICH IS
JUSTIFIED BY ASSETS , EARNING, DIVIDEND, DEFINITE PROSPECTS AND THE FACTOR OF THE MGT OF THE ISSUING COMPANY.
DR ANJANA RAJU
VALUATION OF SECURITIESVALUATION OF SECURITIES
WHAT ARE MAJOR COMPONENTS OF INTRINSIC VALUE ?
1. EARNING POWER AND PROFITABILITY OF THE MGT IN EMPLOYMENT OF ASSETS.
2. DIVIDENDS PAID AND ABILITY TO PAY IN FUTURE.
3. ESTIMATES OF THE GROWTH OF EARNINGS
DR ANJANA RAJU
SECTION VI
RISK AND RETURN
DR ANJANA RAJU
RISK AND RETURNRISK AND RETURN1. CONCEPTS OF RISK AND RETURN
2. THE COMPONENTS OF RETURN
3. RELATION BETWEEN RISK AND EXPECTED RATE OF RETURN
5. SOURCES OF RISK
DR ANJANA RAJU
RISK AND RETURNRISK AND RETURN WHAT IS THE IMPORTANCE OF RETURNS IN
ANY INVESTMENT DECISION?
ENABLES INVESTORS TO COMPARE ALTERNATIVE IN TERMS OF WHAT THEY HAVE TO OFFER THE INVESTOR .
MEASUREMENT OF HISTORICAL (PAST) RETURNS.
ESTIMATION OF FUTURE RETURNS
DR ANJANA RAJU
RISK AND RETURNRISK AND RETURN
TWO TYPES OF RETURNS
REALISED OR HISTORICAL RETURNS
EXPECTED RETURN
DR ANJANA RAJU
RISK AND RETURNRISK AND RETURN
TYPES OF RETURNS
DR ANJANA RAJU
RISK AND RETURNRISK AND RETURN
TWO TYPES OF RETURNS
REALISED OR HISTORICAL RETURNSThe rate of return on an investment can be calculated
as follows:(Amount received – Amount invested)
Return = ________________________
Amount invested
For example, if $1,000 is invested and $1,100 is returned after one year, the rate of return for this investment is: ($1,100 - $1,000) / $1,000 = 10%.
DR ANJANA RAJU
RISK AND RETURNRISK AND RETURN
TWO TYPES OF RETURNS
EXPECTED RETURN
RETURN FROM AN ASSET THAT INVESTOR ANTICIPATE OR EXPECT TO EARN OVER SOME FUTURE PERIOD.
EXPECTED RETURN IS SUBJECT TO UNCERTAINTY OR RISK,AND MAY OR MAY NOT OCCUR.
DR ANJANA RAJU
THE COMPONENTS OF RETURNTHE COMPONENTS OF RETURN
DR ANJANA RAJU
THE COMPONENTS OF RETURNTHE COMPONENTS OF RETURN
RETURN IS BASICALLY MADE UP OF TWO COMPONENTS.
1. PERIODIC CASH RECEIPT OR INCOME ON INVESTMENT.
(IN FORM OF DIVIDEND, INTEREST ETC)
TERM YIELD IS OFTEN USED IN CONNECTION COMPONENT OF RETURN
FOR EXAMPLE 10% BOND AT PURCHASE PRICE OF RS 900 IS 11.11%
DR ANJANA RAJU
THE COMPONENTS OF RETURNTHE COMPONENTS OF RETURN
2. APPRECIATION (DEPRECIATION) IN THE ASSET, IS REFFERED TO AS CAPITAL GAIN (LOSS)
MANY INVESTORS HAVE CAPITAL GAINS AS THEIR PRIMARY OBJECTIVE AND EXPECT THIS COMPONENT TO BE LARGER THAN THE INCOME COMPONENT.
DR ANJANA RAJU
RISKRISK
DR ANJANA RAJU
RISKRISK
BACKGROUND
RISK AND RETURN GO HAND IN HAND IN INVESTMENTS AND FINANCE.
ONE CANNOT TALK ABOUT RETURNS WITHOUT TALKING ABOUT RISK
DR ANJANA RAJU
RISKRISK
CONCULSION
INVESTMENT DECISIONS ALWAYS INVOLVE A TRADE –OFF BETWEEN RISK AND RETURN.
DR ANJANA RAJU
RISKRISK
RISK DEFINED AS
THE CHANCE THAT THE ACTUAL OUTCOME FROM AN INVESTMENT WILL DIFFER FROM THE EXPECTED OUTCOME
DR ANJANA RAJU
SOURCES OF RISKSOURCES OF RISKFACTORS WHICH MAKE ANY FINANCIAL
ASSET RISKY
1. INTEREST RATE RISK- 2. MARKET RISK3. INFLATION RISK4. BUSINESS RISK 5. FINANCIAL RISK6. LIQUIDITY RISK