financial management lectures -vietnamese

7/27/2019 Financial Management Lectures -Vietnamese

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FINANCIAL MANAGEMENT

Professorial Lecturer:

DR. EVANGELINA G. CUSTODIOVP for Administration and Finance


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INTRODUCTION

Organization

(Public orPrivate)

To earn profit;to increase the

value, tosurvive,

to serve orfulfill its social

responsibility

What shall theorganization

produce?Goods or Services

Wah

Productive Resources

(Capital)

Non Human Resources-Tangibles-Intangibles

Human Resources-Internal-External


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HUMAN RESOURCES

EMPLOYEES/ WORKERSSUPPLIERS

BOARD OF DIRECTORS

STOCKHOLDERS/OWNERS

MANAGERS/SUPERVISORS

CREDITORS

COMPETITORS

GOVERNMENT


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NON HUMAN RESOURCES

TANGIBLESINTANGIBLES

FinancialAssets

Real AssetsPatent

Brand

Goodwill

Trademark

Logo-


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TO PRODUCE GOODS ORSERVICES

Organization needs to invest in real or fixedassets or productive capital. The manager ofthe organization must make this decision. Hehas to answer these questions.

What assets to own, or in what assets shouldthe organization invest?

What mix of assets will best facilitate theproduction of goods or services?,

How should the organization invest?

THIS IS AN INVESTMENT DECISION


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AFTER DECIDING WHAT TO INVEST . . .

Organization needs to finance this investment

by acquiring cash. Therefore, the managermust decide again:

What securities to raise,

What mix of credit best meets the objectives

of the organization

Where shall the organization get its fund,

How much money or cash is needed,

THIS IS A FINANCIAL DECISION.


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WHAT IS FINANCIALMANAGEMENT?

The two broad decisions (investment and financialdecisions) are the major responsibility of thefinancial manager.

Financial management is the art and scienceof making the right investment and financialdecisions for the organization.

The concern of Financial Management is themaintenance and creation of economic valueor wealth


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FORMS OF BUSINESSORGANIZATIONS

SOLE OR SINGLE PROPRIETORSHIP- a business owned and managed by a singleindividual

PARTNERSHIP- a business owned by two or more persons

CORPORATION

- a legal entity that functions separateand apart from its owners betterknown as stockholders.


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MAJOR GOALS OF FINANCIAL

MANAGEMENT

1. Maximization of Shareholders Wealth

This is maximization of the market value of the existingshareholders wealth. This is translated bymaximizing the price of the existing common stocks ofa corporation. The market priceof the firms stockreflects the value of the firm as seen by its owners.Shareholders are the legal owners of the firm. This is

a long-term goal. The objective is to have the highestmarket value of common stock. This goal recognizesrisk or uncertainty, timing of returns and considersstockholders return.


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MAJOR GOALS OF FINANCIALMANAGEMENT

2. Maximization of ProfitThis goal stresses the efficient use of

capital resources within a given period of

time. Thisis a short-term goal and itignores risk and timing of returns.

3. Social Responsibility

This is how the business is able toimprove the quality of life in itsenvironment and the economy.


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TEN MAXIMS OF FINANCIALMANAGEMENT

1. The Risk-Return TradeoffWe WontTake on Additional Risk Unless WeExpect to Be Compensated with

Additional Return.

- Investment alternatives have different amount ofrisk and expected returns

- Investors demand higher returns for taking onmore risky projects.


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The Risk-Return Relationship

E

x R

p ee t

c u

t r

e n

d

R i s k

Expected Return for Delaying Consumption

Expected Return for taking on Added Risk


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10 MAXIMS OF FINANCIAL MANAGEMENT

2. The Time Value of Money A DollarReceived Today is Worth More Than aDollar Received in the Future

- Money has a time value associated with it. Adollar received today is worth more than a

dollar received a year from now. It is better toreceive money earlier than later becausemoney received today can earn interest.


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3. Cash -- Not Profit -- is King

- Cash flows, not accounting profits, should beused as a tool for measuring wealth or value.Cash flows are used to measure the benefitsand costs from taking on an investment.

- Cash flows and accounting profits may notoccur together.


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4. Incremental Cash FlowsIts Only WhatChanges That Count

- In making business decisions, we areconcerned with the results of those decisions:

What happens if we say yes versus whathappens if we say no?

- Incremental cash flow is the difference

between the cash flows if the project is takenon versus what the cash flows will be if theproject is not accepted


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5. The Curse of Competitive Markets Why

Its Hard to Find Exceptionally ProfitableProjects

- In competitive markets, extremely large profits

simply cannot exist for very long. Competitionmakes it difficult to find profitable projects butwe have to invest in markets that are notperfectly competitive. Two common ways tomake market less competitive are Product

Differentiation and Creation of CostAdvantage through economies of scale,proprietary technology and monopolisticcontrol of raw materials.


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6. Efficient Capital Markets The Marketsare Quick and the Prices Are Right

Efficient Market A market in which the values ofall assets and securities at any instant in timefully reflect all available public information.

- Stock prices reflect all publicly availableinformation regarding the value of thecompany. Market prices reflect expectedcash flows available to stockholders. Pricesreflect value.


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7. The Agency ProblemManagers WontWork for the Owners Unless Its in TheirBest Interest

Agency problem is a problem resulting fromconflicts of interestbetween the manager(thestockholders agent) and the stockholders(principal).

Align their interest in such a way that what is goodfor shareholders must also be good formanagers.


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8. Taxes Bias Business Decision

In every decision made by the financial manager,the impact of tax is considered.

Tax plays important role in evaluating new projectsand in determining a firms financial structureor mix of debt (liabilities) and equity (ownersinvestment).

Debt financing has cost advantage becauseinterest payments are a tax-deductiveexpense. Paying interest reduces tax.


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9. All Risk is Not Equal Some Risk Can Be

Diversified Away and Some Cannot

Risk is difficult to measure. Risk is the variabilityof possible outcome. There are risks whichcan be controlled and others cannot

Dont put all your eggs in one basket.

Diversification can reduce risk.


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Reducing Risk Through Diversification

20%

0%

10%

R

E

T

U

RN

T I M E

ASSET A

ASSET B

COMBINATION OFASSET A & ASSET B


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10. Ethical Behavior is Doing the Right Thing, andEthical Dilemmas Are Everywhere in Finance

Ethics are standards of conduct or moralbehavior.

Business ethics can be thought of as a

companys attitude and conduct toward itsemployees, customers, community andshareholders.

Beyond the questions of ethics is the question

of social responsibility. Social Responsibilitymeans that a corporation has responsibilitiesto society beyond the maximization ofshareholders wealth.


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Risk-Return Tradeoff

Risk or uncertainty refers to the variability ofexpected returns associated with a giveninvestment.

Let us measure risk and look at therelationships between risk and returns.

Probabilities are used to evaluate the risk

involved in a security.The probability of an event is defined as thechance that the event will occur.It is a

percentage chance of a given outcome.


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MEASURING RISK

The Standard Deviation () is a measure of

dispersion of the probability distribution. Itis commonly used to measure risk.

n

= (ri r)2pii=1


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Steps in calculating risk

To calculate , take the following steps:Step 1. Compute the expected rate of return

( r).

nr = ripi

i=1

where: ri= ithpossible returnpi= probability ofith returnn = number of possiblereturn


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Step 2. Subtract each possible return from r to

obtain a set of deviations (ri r ).

Step 3. Square each deviation, multiply thesquared deviation by the probability ofoccurrence for its return, and sum these

products to obtain the variance(2):n

2= (ri r )2pi

i=1

Step 4. Finally, take the square root of thevariance to obtain the standard deviation ().


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The smaller the standard deviation, the tighter theprobability distribution and, thus, the lower therisk of the investment.

When you compare two investment projects whichhave the same expected returns, you may usestandard deviation to measure absolute risk.

The higher the standard deviation, the higher therisk. But when you compare two projects whichhave different expected returns, use thecoefficient of variation. The coefficient of

variation is computed simply by dividing thestandard deviation for the project by expectedreturn or value: / r. The higher the coefficient,the more risky the project.


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Time Value of Money

This time value of money is another criticalconsideration in financial and investmentdecisions.

Finding the Future Values CompoundingA dollar received today is worth more than

a dollar to be received tomorrow because

of the interest it can earn from putting it ina savings account or placing it in aninvestment account. Compoundinginterest means that interest earns interest.


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Time line:

P at time o 1 2 3 F at time n

P F1 F2 F3 Fn

Let us define: Fn= future value or the amount of money at theend of yearn

P = principali = annual interest raten = number of years

Then,

F1 = the amount of money at the end of year 1

= principal and interest= P + i P t= P(1+i)


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F2= the amount of money at the end of year 2

= F1(1+i)= P(1+i) (1+i)= P(1+i)2

The future value of an investmentcompounded annually at rate iforn years

isFn= P(1+i)

n

If (1+i)n = FVIFi,n

then Fn = P(FVIFi,n)where FVIFi,n is the future value interest factor

for $1. Table of Compound Interest of $1

Example: You place $100 in a savings


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Example: You place $100 in a savingsaccount earning 8% interest compoundedannually. How much money will you have

in the account the end of 4 years?

Fn= P(1+i)n = P(FVIFi,n)

F4= $100(1+.08)4 = $100(FVIF8%,4)

F4= $100(1.03605) = $136.05

At the end of 4 years, at 8% interest rate,your $100 today will be $136.05.

Fi di P V l Di i


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Finding Present Value Discounting

Present values is the present worth of futuresums of money. The process ofcalculating present values or discounting,is actually the opposite of compounding or

finding the future value. In connection withpresent value calculations, the interestrate iis called discount rate.

Lets recall this formula of compounding

Fn= P(1+i); from this we can derive P


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Therefore,

Fn 1

P= =

Fn(1 + i)n (1 + i)n

if 1/(1+i)n = PVIFi,n

then P = Fn(PVIFi,n)

where PVIFi,n

represents the present valueinterest factor for $1.

Example: You are given an opportunity to receive


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Example: You are given an opportunity to receive$10,000 six years from now. If you can earn10% on your investments, what is the most youshould pay for this opportunity. To answer this

question, you must compute the present value of$10,000 to be received 6 years from now at a10% rate of discount. F6is $10,000, i is 10%,which is 0.1, and n is 6 years. PVIF10%,6 is

0.5645.

$10,000 1

P= = $10,000(1 + .1)6 (1 + .1)6

= $10,000 (0.5645) = $5,645


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This means that at 10% interest on yourinvestment, you could be indifferent to thechoice between $5,645 now or $10,000

six years from now since the amounts aretime equivalent. In other words, youcould invest $5,645 today at 10% and

have $10,000 in 6 years.

If series of payments or receipts of a fixed

amount for a specified number of periodsare expected, future value and presentvalue can be calculated using the formulafor an annuity.


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Annuity is a series of payments or receipts of afixed amount for a specified number of periods

For future value of an annuity:

Fn= A (FVIFAi,n)For present value of an annuity:

Pn= A (PVIFAi,n)Where A = the amount of an annuity

FVIFAi,n represents the future value interest factorfor an n-year annuity compounded at ipercent.

PVIFAi,n represents the appropriate value for thepresent value interest factor for a $1 annuitydiscounted at ipercent forn years.


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Example: Future value of an annuity

You wish to know the sum of money youwill have in your savings account at theend of 6 years by depositing $100 at the

end of each year for the next 6 years. Theannual interest rate is 8%. The FVIFA8,6is 7.336. Therefore,

F6 = $100 (7.336) = $733.60


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Example: Future value of an annuity

You wish to know the sum of money you

will have in your savings account at theend of 6 years by depositing $100 at theend of each year for the next 6 years. The

annual interest rate is 8%. The FVIFA8%,6is 7.336. Therefore,

F6 = $100 (7.336) = $733.60


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Example: Present value of an annuity

Your father will retire at age 65 andexpects to live to age 75. At the rate of10%, calculate the amount your fathermust have available at age 65 in order toreceive $10,000 annually from retirementuntil death. A=$10,000, i= 10%,PVIFA10,10) = 6.1446

Pn = A(PVIFAi,n) = $10,000 (6.1446)

= $61,446


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Capital Budgeting

Capital Budgeting is the process of makinglong-term planning decisions forinvestments.

Some methods of evaluating investmentprojects are:

Payback period

Net Present ValueInternal Rate of Return

Profitability Index (benefit/cost ratio)


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Payback period. The payback period measures the lengthof time required to recover the amount of initialinvestment. It is computer by dividing the initialinvestment by the cash inflows through increased

revenues or cost savings.Example: Assume: Cost of Investment $18,000

Annual cash savings $3,000Then, the payback period (PBP) is:

Initial Investment Cost $18,000PBP = =Increased Revenues or Lost Savings

$3,000

PBP = 6 years

Decision Rule: Choose the project with the shorterpayback period. The shorter the payback period, theless risky the project, and the greater the liquidity.

Net Present Val e (NPV) is the e cess of the present al e


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Net Present Value (NPV) is the excess of the present value(PV) of cash inflows generated by the project over theamount of the initial investment ( I ):

NPV = PV I

The present value of future cash flows is just discounting.

Decision Rule: If NPV is positive, accept the project.Otherwise, reject it.

Example: Consider the following investment:Initial Investment $12,950

Estimated life 10 yearsAnnual cash inflows $ 3,000Required Rate of Return 12%


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PV = Annual cash inflows (PVIFAi,n)

PV = $3,000(PVIFA 12,10)

= $3,000 (5.6502)= $16,950

NPV = PV - I

NPV = $16,950 - $12,950

= $4,000

Since the NPV of the investment is positive,the investment should be accepted.

I t l R t f R t (IRR) i d fi d t


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Internal Rate of Return (IRR) is defined atthe rate of interest that equates InitialInvestment (I) with the Present Value

(PV) of future cash inflows. In otherwords, at IRR,

I = PV or NPV = 0

Decision Rule: Accept the project if the

IRR exceeds the required rated of return(RRR) or the cost of capital. Otherwise,reject it.

Using the same data:


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I = $12,950, PV = $3,000(PVIFA?,10)

I = PV

2,950 = $3,000 (PVIFA?,10)

$12,950/$3,000 = (PVIFA?,10)

(PVIFA?,10) = 4.317

4.317 stands somewhere between 18% and20% in the 10-year line of PVIFA table. Byinterpolation, IRR is 19.17%.

Since IRR of 19.17% is greater than the costof capital of 12%, accept the investment.

f ( f /C )


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Profitability Index (Benefit/Cost Ratio) is theratio of the total PV of future cash inflows

to the initial investment, that is, PV/I.If the profitability index is greater than 1,

then accept the project.

This is used as a means of ranking projectsin descending order of attractiveness.


PV/I = $16,950/$12,950 = 1.31Since the project generates $1.31 foreach dollar invested, accept the project.


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Financial Decisions

1. Short-term financingfinancing that will be

repaid in 1 year or less. It may be used tomeet seasonal and temporaryfluctuations in acompanys funds positions as well as to meetpermanent needs of the business. It may be

used to provide extra net working capital,finance current assets, or provide interim(temporary) financing for a long-term project.Examples: trade credit, bank loans, bankers

acceptance, finance company loans,commercial papers, receivable financing andinventory financing

2 L t d bt fi i fi i th t


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2. Long-term debt financing financing thatwill be repaid in more than one year.Sources of long-term debt financing

include mortgages (notes payable thathave as collateral real assets) and bonds(certificate indicating that a company has

borrowed a given sum of money that itagrees to repay it a future date).

3. Equity financing is financing throughissuance of preferred and commonstocks.

I h i h f fi i h f


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In choosing the type of financing, the cost ofcapital is a critical consideration.

Cost of capital is defined as the rate of returnthat is necessary to maintain the market value ofthe firm (price of the firms stock).

The cost of capital is computed as a weightedaverage of the various capital components,which are debt, preferred stock, common stockand retained earnings (right-hand side of thebalance sheet).


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Always remember the techniques inchoosing the right investment. The

investment must earn a return more thanits cost, and be guided by the ten maximsof financial management in making

financial and investment decisions.

SALAMAT PO

financial management lectures -vietnamese

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