Amity Business School

Financial
Management
FIBA601
 Topic Amity Business School

• Module I: Introduction
• Module II: Financing Decision
• Module III: Investment Decision-Capital
budgeting &Working Capital
• Module IV: Dividend Decision
• Module V: Valuation Concepts
 Introduction Amity Business School

• Introduction to Financial Environment.

• Financial Market & Instruments.
• Objective of the firm.
• Introduction to Time Value of Money.
• Importance and Relevance of TVM.
• Timeline, PV & FV Calculation
• Techniques used in TVM concept
Compounding & Discounting
 Introduction Amity Business School

• Numerical on Loan Amortization

Schedules, Sinking Fund.
• Numerical on Time Value of Money
• Introduction to the Concept of Risk &
Return.
• Types of Risk. Systematic Risk & Un
systematic Risk
• Calculation of Expected Returns.
• Risk Return Trade off.
• Numerical
 Amity Business School

“Business finance” or “Corporate

finance”
Some important questions that are answered using
finance:
➢ What long-term investments should the firm take
on?

➢ Where will we get the long-term financing to pay

for the investment?

➢ How will we manage the everyday financial

activities of the firm?
 Financial Management Amity Business School

• Financial management refers to that part

of the management activity, which is
concerned with the planning, &
controlling of firm’s financial resources.
• It deals with finding out various sources
for raising funds for the firm.
• Financial management is practiced by
many corporate firms and can be called
Corporation finance or Business Finance
 Financial Management Amity Business School

Decisions
• Capital budgeting
• What long-term investments or projects should the
business take on?

• Capital structure
• How should we pay for our assets?
• Should we use debt or equity?

• Working capital management

• How do we manage the day-to-day finances of the
firm?
 Goal of Financial Amity Business School

Management
What should be the goal of a corporation?
❖ Maximize profit?
Drawbacks
– Profit maximization is a short-term concept.
– Profit maximization does not consider the timing of
returns.
– Profit maximization ignores risk.
 Wealth Maximization Amity Business School

• Financial theory asserts that the wealth

maximization is the single substitute for a stake
holder’s utility.
• When the firm maximizes the shareholder’s wealth,
the individual stakeholders can use this wealth to
maximize his individual utility.
• It means that by maximizing stakeholder’s wealth
the firm is operating consistently toward maximizing
stakeholder’s utility.
• A stake solder’s wealth in the firm is the product of
the numbers of the shares owned, multiplied within
the current stock price per share.
 Amity Business School

Indian Financial System

Non- Organized
Organized
Money lenders
Regulators
Local bankers
Financial Institutions
Traders
Financial Markets
Landlords
Financial services
Pawn brokers
Chit Funds
 Amity Business School

Regulators
• Banks, NBFCs • Capital
,Money market,
market, Forex Venture capital
private equity

RBI SEBI

Forward
market
IRDAI
commission
of India
• Insurance • Derivatives
 Amity Business School

Public sector, Private,

RRBs, Foreign
Banks
Banks, Payment
Banks,SFBs

DFIs (AFC,HFI,AIFIs,
NBFCs
SFCs.SIDCs)

Financial Institutions

Mutual Funds

Insurance
 Amity Business School

Financial
Markets

Money Capital
market Market

Debt Equity
Market Market

Public G-sec Primary Secondary Derivatives

Private debt
sector market market Market Market
 Financial Instruments Amity Business School

• Shares: A share can be defined as “A

fraction part of the capital of the
company which forms the basis of
ownership and interest of a subscriber in
the company”. Precisely, a share is a
small part of the total capital.
• Types of shares: Shares can be
broadly divided into equity shares and
preference shares
 Amity Business School

Types of shares
Equity Shares Preference Shares
Shares which enjoy dividend Shares which enjoy preference
and right to participate in the as regards dividend payment
management of Joint Stock and capital repayment are called
Company are called equity “Preference Shares”.
shares, or, ordinary shares.
They are the owners and real
risk bearers of the company.
 Amity Business School

Equity Shares
Advantages Disadvantages
• The company has no immediate • Equity dividend not tax-
liability to pay it. deductible.
• No fixed dividend obligation. • High cost of equity issue.
• Increases creditworthiness of • Gradual dilution of
business, ceteris paribus.
shareholder’s control over
• No charge created on assets of business.
the business.
• Shareholders control the • Manipulation by a few
company. shareholders.
• Limited liability of the investors. • Dividend at the discretion of
• High dividends. the Directors.
• No collateral security needed. • Very risky investment.
• Increases firm credibility. • Residual claim on
investments.
 Amity Business School

Preference Shares
Advantages Disadvantages
• Fixed dividend. • Not a very high dividend rate.
• First claim on company • No voting rights.
assets. • Dividends paid are not tax-
• Cost of capital is low. deductible.
• No dilution over control. • Non payment of dividend
• No dividend obligation. affects firm
• No redemption liability.
 Amity Business School

DEBENTURES
• When borrowed capital is divided into equal
parts, then, each part is called as a debenture.
• Debenture represents debt. For such debts,
company pays interest at regular intervals.
• It represents borrowed capital and a debenture
holder is the creditor of the company.
• Debenture holder provides loan to the company
and he has nothing to do with the management
of the company
Amity Business School
 Amity Business School

Methods of Raising Finance

• Public Issue of Shares
• Rights Issue of Shares
• Private Placement of Shares
• Issue of Debentures
• Long Term Loans
• Accumulated Earnings (Reserves)
 Amity Business School

Primary Market
• It is the market for new issues
• Fresh capital is raised
• Three modes through which fresh capital
is raised
 Amity Business School

Primary Issue

Private
Public Issue Rights Issue
Placement

Initial Public Private

offering (IPO) Placement

Follow on
Preferential
public offering
allotment
(FPO)

Qualified
Institutions
placement
 Amity Business School

Functions of secondary market

• Liquidity and marketability of outstanding
equity and debt instruments.
• Economic growth through disinvestment and
reinvestment
• Ensure measures to protect investor’s interest
• Help companies to perform better since share
price is a reflection of their performance.
 Stock Exchange Amity Business School

• Stock exchange u/s 2(3) of Securities

Contracts (Regulation) Act, 1956 is
define as ‘ any body of individuals
whether incorporated or not, constituted
for the purpose of assisting , regulating
or controlling the business of buying ,
selling or dealing in securities.’
 Amity Business School

4 tiers of Indian Secondary

markets
✓ Regional Stock Exchanges
✓ The National Stock Exchanges (BSE and NSE)
✓ The Over the counter exchange of India (OTCEI)
✓ The Inter connected Stock exchange of India (ISE)
 Amity Business School

Stock Market Index

• Stock market index is a barometer of market
behaviour.
• It reflects the day to day price fluctuations
• It provides investors information of the average share
price in the market.
• They also act as economic indicators
• It is the aggregate of the market value of the shares
incorporated in the index
 Amity Business School

Major Indices of India

• Sensex
– BSE Sensitivity index
– Launched in 1986
– 30 shares (having large market capitalisation)
– These scrip's or shares are market leaders in their
industry
 Amity Business School

Major Indices of India

• S&P CNX Nifty
– Launched on July 8, 1996
– 50 scrips based on low impact cost, high liquidity
and low market capitalisation
– Weighted average method of averaging is used
where every stock is given a weight in proportion to
its market capitalisation.
 Amity Business School

Other indices
• BSE 200 • CNX nifty junior
• BSE IT Index • Nifty mid cap-50
• BSE Health care Index • IT
• BSE FMCG • Bank
• Small cap • FMCG
• Mid cap
• BSE 100
• BSE 500
 Amity Business School

Time Value of
Money
 Amity Business School

Effects of Compounding
• Simple interest vs. Compound interest

• Suppose you have Rs. 1000 today and

you deposit it with a financial institution,
which pays 10% interest compound
annually, for a period of 2 years.
 Amity Business School

Simple interest Compounded

interest

1st year Principle at the 1000 1000

beginning of the
year

Interest earned 100 100

2nd year Principle at the 1000 1100

beginning of the
year

Interest earned 100 110

Total interest 100+ 100 200 210
earned
 Amity Business School

Basic Definitions
• Present Value – earlier money on a time line

• Future Value – later money on a time line

• Interest rate – “exchange rate” between earlier

money and later money
▪ Discount rate
▪ Cost of capital
▪ Opportunity cost of capital
▪ Required return
 Amity Business School

TVM

Present Future
Value Value

PV of PV of FV of FV of
lump sum annuity lump sum annuity
 Amity Business School

Future Values: Lump sum

FV = PV(1 + r)t
▪ FV = future value
▪ PV = present value
▪ r = period interest rate, expressed as a decimal
▪ t = number of periods

• Future value interest factor(FVIF) = (1 + r)t

 Amity Business School

Numerical (FV of lumpsum)

• If you deposit Rs. 1000 today in a bank

which pays 10% interest compounded
annually, how much will the deposit grow
to after 8 years and 12 years?
 Amity Business School

Given

PV Rs 1000

r 10% pa

n (case 1) 8 yrs

FV ????

FV PV(1+r)^n

1000 (1+.10)^8 =2143.58881

 Amity Business School

Given

PV Rs 1000

r 10% pa

n (case 2) 12 yrs

FV ????

FV PV(1+r)^n

1000 (1+.10)^12 =3138.428

 Amity Business School

Multi Period Compounding

m= 1 (annually)
m =2 (semi - annually)
m = 4 (quarterly)
m= 12 (monthly)
m= 365(daily)
 Amity Business School

Numerical (Multi period

compounding)
• If you deposit Rs. 1000 today in a bank
which pays 12% interest compounded
annually, how much will the deposit grow
to after 8 years if the interest is paid
a) Semi-annually
b) Quarterly
c) Monthly
 Amity Business School

Given

PV Rs 1000

r 12% semi annually m =2

n (case a) 8 yrs

FV ????

FV PV(1+r/m)^n*m

1000 (1+.12/2)^8*2 =2540.3516

 Amity Business School

Given

PV Rs 1000

r 12% quarterly m =4

n (case a) 8 yrs

FV ????

FV PV(1+r/m)^n*m

1000 (1+.12/4)^8*4 =2575.0827

 Amity Business School

Given

PV Rs 1000

r 12% monthly m =12

n (case a) 8 yrs

FV ????

FV PV(1+r/m)^n*m

1000 (1+.12/12)^8*12 =2599.2729

 Amity Business School

TVM Tables
Re do the calculations using TVM table
 Amity Business School

Time Lines
• Show the timing of cash flows. „
• Tick marks occur at the end of periods, so
Time 0 is today; Time 1 is the end of the first
period (year, month, etc.) or the beginning of
the second period
 Amity Business School

Lump sum on time line

Rs 100 lump sum due in 2 years
 Amity Business School

Repeated amount on timeline

Rs 10 repeated at the end of next three years
 Amity Business School

Annuity
• An annuity is a series of level uninterrupted cash flows
occurring at regular intervals.
• Ordinary annuity (or deferred annuity) is a sequence
of uninterrupted, equal cash flows with payments
(receipts) occurring at the end of each period.
• Annuity due is a sequence of uninterrupted, equal
cash flows with payments (receipts) occurring at the
beginning of each period.
• Deferred Annuity (delayed by a period)
• Perpetuity (forever)
 Amity Business School

FV of annuity
[ 𝟏 + 𝒓 𝒏 − 𝟏]
𝑭𝑽 = 𝑨 ∗
𝒓

A = ordinary annuity
FV = future value
r = period interest rate, expressed as a
decimal
n = number of periods
[ 1 + 𝑟 𝑛 − 1]
𝐹𝑉𝐼𝐴𝐹 =
𝑟
 Amity Business School

FV of annuity (multi period

compunding)

𝑟 𝑛∗𝑚
[ 1+ − 1]
FV = A ∗ 𝑚
𝑟
𝑚
 Amity Business School

Numerical (FV of annuity)

You deposit Rs 1000 annually in a bank for

5 years what will be the value of your
deposits if the deposits earn interest of
10% per annum.
 Amity Business School

Given

A Rs 1000

r 10% pa

n 5 yrs

FV ????

FV A[(1+r)^n -1 ]/ r

1000 [( 1+.10)^5-1]/0.10 = 6105.1

Use table to carry out the exercise using FVIAF

 Amity Business School

Applications of FV of annuity
1. Know what lies in store for you
2. How much should you save annually
3. Annual deposit in sinking fund account
4. Finding the interest rate
5. How long should you wait
 Amity Business School

Numerical (Know what lies in

store for you)

• You have decided to deposit RS 30,000

per year in your PPF account for 30
years. What will be the accumulated
value after 30yrs if the interest rate is
8%pa.
 Amity Business School

Given

A Rs 30,000

r 8% pa

n 30 yrs

FV ????

FV A[(1+r)^n -1]/ r

30000 [( 1+.08)^30- = 33,98,490

1]/0.08
Use table to carry out the exercise using FVIAF
 Amity Business School

Numerical (How much should you

save annually)

• You want to buy a house after 5 years

when it will expect to cost Rs 2million.
How much should you save annually if
the savings earn a compounded interest
of 12% pa.
 Amity Business School

A ????

r 12% pa

n 5yrs

FV 20,00,000

FV A[(1+r)^n -1]/ r

A FV/ FVIAF FV/{[(1+r)^n -1]/r}

= 2000000/{[1.12^5 - =3,14,812
1]/.12}

Use table to carry out the exercise using FVIAF

 Amity Business School

Numerical (Annual deposit in

sinking fund account)
• Sinking fund: an account established to accumulate
funds for a future obligation

• Alpha Ltd has an obligation to redeem debentures of

Rs 500million bonds 6 years hence. How much should
the company deposit in the sinking fund account
where in it earns an interest of 14% per annum, to
cumulate to Rs 500 million in 6 years time.
 Amity Business School

A ????

r 14% pa

n 6 yrs

FV 50,00,00,000

FV A[(1+r)^n -1]/ r

A FV/ FVIAF FV/{[(1+r)^n -1]/r}

= =5,85,75,445.17
50,00,00,000/{[1.14^6-
1]/.14}

Use table to carry out the exercise using FVIAF

 Amity Business School

Numerical (Finding the interest

rate)

• A finance company advertises that it will

pay a lump sum of Rs 8000 at the end of
6 yrs to an investor who deposits Rs
1000 annually for 6 yrs. What is the
implied rate of return in the offer?
 Amity Business School

A 1000

r ?????

n 6 yrs

FV 8000

FV A[(1+r)^n -1]/ r A* FVIAF

FVIAF FV/A =8000/1000 =8

For n=6 FVIAF = 8.115 at 12% r lies between 11% to

FVIAF = 7.913 at 11% 12%
 Amity Business School

Numerical (How long should you wait)

• You want to take a trip to your friend in

Australia and it will cost Rs 10,00,000
provided things remain unchanged. You
can save Rs 50,000 annually . If your
savings earn an interest of 12% per
annum how long should you wait .
 Amity Business School
A 50000

r 12%pa

n ?????

FV 10,00,000

FV A[(1+r)^n -1]/ r

(1+ r )^n [(FV*r)/A] + 1 (1000000*.12)/50000 + 1=

3.4

n* log (1+r) Log {[(FV*r)/A] + 1} Log(3.4)= 0.5314

n Log {[(FV*r)/A] + 1} / log (1+r) 0.5314/ log (1.12)

= 10.7984 years
 Amity Business School

Doubling Period
• The rule of 72 is a quick way to estimate how
long it will take to double your money:

• # years to double = 72 / R,
• where R is number of percent.
 Amity Business School

Present Value of lumpsum

• PV = FV / (1 + r)t
▪ FV = future value
▪ PV = present value
▪ r = period interest rate, expressed as a
decimal
▪ t = number of periods

• Present value interest factor(PVIF) = 1/(1 + r)t

 Amity Business School

Numerical (PV of lump sum)

• Suppose someone gives you Rs1000 six

year hence. What is the present value of
this amount if the interest rate is 10%?
 Amity Business School

Given

PV ????

r 10% pa

n (case 1) 6 yrs

FV 1000

PV FV / (1+r)^n

1000 /(1+.10)^6 = 564.4739

 Amity Business School

PV of ordinary annuity
[ 1 + 𝑟 𝑛 − 1]
𝑃𝑉 = 𝐴 ∗
𝑟(1 + 𝑟)𝑛

A = ordinary annuity
FV = future value
r = period interest rate, expressed as a decimal
n = number of periods
[ 1 + 𝑟 𝑛 − 1]
𝑃𝑉𝐼𝐴𝐹 =
𝑟(1 + 𝑟)𝑛
 Amity Business School

Numerical (PV of ordinary

annuity)
• You expect to receive Rs 1000 annually
for 3 years at the end of every year.
What is the present value of these
streams of benefits if the discounting
rate is 10%?
 Amity Business School

Given

A Rs 1000

r 10% pa

n 3 yrs

FV ????

FV A[(1+r)^n -1]/ [r(1+r)^n]

1000 [( 1+.1)^3-1]/[0.1*(1+.1)^3] = 2486.8

Use table to carry out the exercise using FVIAF

 Amity Business School

PV of annuity due
1+𝑟 𝑛−1
𝑃𝑉 = 𝐴 ∗ 𝑛
∗ (1 + 𝑟)
𝑟 1+𝑟

A = ordinary annuity
FV = future value
r = period interest rate, expressed as a decimal
n = number of periods
 Amity Business School

Numerical (PV of annuity due)

• You expect to receive Rs 1000 annually

for 3 years at the beginning of every
year. What is the present value of these
streams of benefits if the discounting
rate is 10%?
 Amity Business School

Given

A Rs 1000

r 10% pa

n 3 yrs

FV ????

FV A[(1+r)^n -1]/ [r(1+r)^n]*(1+r) A*PVIAF*(1+r)

1000 [( 1+.1)^3- = 2735.48

1]/[0.1*(1+.1)^3]*(1+.1)
Use table to carry out the exercise using FVIAF
 Amity Business School

PV of annuity (multi period)

𝑟 𝑛∗𝑚
[ 1+ − 1]
PV = A ∗ 𝑚
𝑟 𝑟 𝑛∗𝑚
1+
𝑚 𝑚
 Amity Business School

Applications of PV of annuity
1. How much can you borrow
2. Period of Loan amortization & Loan
Amortization Schedule
3. Determining periodic withdrawals
 Amity Business School

Numerical (How much can you

borrow)

• You can afford to pay Rs 1,00,000 per

year for 5 years towards a new car. The
finance company offers a interest rate of
10%pa . How much can you borrow to
buy a car?
 Amity Business School

Given

A Rs 100000

r 10% pa

n 5 yrs

FV ????

FV A[(1+r)^n -1]/ [r(1+r)^n]

100000 [( 1+.1)^5-1]/[0.1*(1+.1)^5] = 379078.6769

Use table to carry out the exercise using FVIAF

 Amity Business School

Numerical (Period of Loan amortization &

Loan Amortization Schedule

• You want to borrow Rs 50,00,000 to buy a flat

.You approach a housing finance company.
The company charges an interest of 10% pa.
You take the loan for a period of 5 years. What
is the installment you pay per annum and
prepare the loan amortization schedule.
 Amity Business School

Given

PV Rs 500000

r 10% pa

n 5 yrs

A ????

PV A[(1+r)^n -1]/ [r(1+r)^n]

A PV/ {[(1+r)^n -1]/ [r(1+r)^n]} PV/ PVIAF

500000/{ [( 1+.1)^5- = 1318987.404

1]/[0.1*(1+.1)^5]}
 Amity Business School

Principal outstanding
at the beginning of Principal Principal outstanding at
Year year Installment Interest repaid the end of year

(steps) I II III = 0.10* I IV = II - III V = 1- IV

1 5000000 1318987 500000 818987 4181013

2 4181013 1318987 418101.3 900885.7 3280127.3

3 3280127.3 1318987 328012.73 990974.3 2289153.03

4 2289153.03 1318987 228915.303 1090072 1199081.333

5 1199081.333 1318987 119908.1333 1199079 2.4663

 Amity Business School

Numerical (Determining periodic

withdrawals)

• Mr Raghav deposits Rs 3,00,000 on

retirement in a bank which pays 10%
interest . How much can be withdrawn
annually for a period of 10 years?
 Amity Business School

Given

PV Rs 300000

r 10% pa

n 10 yrs

A ????

PV A[(1+r)^n -1]/ [r(1+r)^n]

A PV/ {[(1+r)^n -1]/ [r(1+r)^n]} PV/ PVIAF

300000/{ [( 1+.1)^10- = 48,820

1]/[0.1*(1+.1)^10]}
 Amity Business School

PV of growing annuity
1+𝑔 𝑛
[1 − 𝑛 ]
1+𝑟
𝑃𝑉 = 𝐴 ∗ 1 + 𝑔 ∗
𝑟−𝑔

A = ordinary annuity
FV = future value
r = period interest rate, expressed as a decimal
n = number of periods
g = growth rate
Note r> g
 Amity Business School

Numerical (PV of growing annuity)

• Alpha ltd receives cash flow of

Rs50lakhs in first year and it is expected
to grow at 10% every year till 5 years . If
the discount rate is 12% what is the
present value of this amount.
 Amity Business School

Given

A Rs 50lakhs

r 12% pa g= 10%

n 5 yrs

PV ????

𝑛
PV 1+𝑔
[1 − 𝑛 ]
1+𝑟
𝑃𝑉 = 𝐴 ∗ 1 + 𝑔 ∗
𝑟−𝑔

= 241.2294
 Amity Business School

PV of growing perpetuity

𝐴
𝑃𝑉 =
𝑟−𝑔
A = ordinary annuity
PV = present value
r = period interest rate, expressed as a decimal
 Amity Business School

Numerical (PV of perpetuity)

• Find the present value of a perpetuity of

Rs 1000 if the interest rate is equal to
10%
 Amity Business School

Given

A Rs 1000

r 10%

n forever

PV ????

PV 𝐴
𝑃𝑉 =
𝑟

=1000/ .1 10000
 Amity Business School

PV of perpetuity
𝐴
𝑃𝑉 =
𝑟

A = ordinary annuity
PV = present value
r = period interest rate, expressed as a decimal
g = growth rate
Note r> g
 Amity Business School

Numerical (PV of growing perpetuity)

• An office generates a rental of Rs

3,00,000 in the next year which is
expected to grow by 5% every year
indefinitely. If the discount rate is 10%
what is the present value of the stream.
 Amity Business School

Given

A Rs 300000

r 10% g= 5%

n forever

PV ????

PV 𝐴
𝑃𝑉 =
𝑟−𝑔

=300000/( .1-.05) 6000000

 Amity Business School

Effective Annual Rate(EAR)

𝐴𝑃𝑅 𝑚
𝐸𝐴𝑅 = ( 1 + ) −1
𝑚

EAR = effective annual rate

m = frequency of compounding in a year
APR = annual percentage rate
 Amity Business School

Numerical (EAR)

• Bank offers stated rate as 12% annual

interest. What will be the EAR when
compounding is done
– Semi annually
– Quarterly
– Monthly
 Amity Business School

Given

APR 12%

EAR 𝐴𝑃𝑅 𝑚
𝐸𝐴𝑅 = ( 1 + ) −1
𝑚
m=2 EAR =(1+.12/2)^2-1 =0.1236

m=4 EAR =(1+.12/4)^4-1 =0.1255

m= 12 EAR =(1+.12/12)^12-1 =0.1268

 Amity Business School

Numerical (Combined)
• As a winner of a competition you can choose any of
the following prizes
i. Rs 5,00,000 now
ii. Rs 10,00,000 at the end of 6 yrs.
iii. Rs 60,000 forever
iv. Rs 1,00,000 per year for 10 years
v. Rs 35,000 next year and rising thereafter by 5%
every year forvever
If interest rate is 10% which prize will you choose and
why ?
 Amity Business School

Given

PV 500000
 Amity Business School

Given

FV 10,00,000

r 10%

n 6 yrs.

PV 𝐹𝑉
𝑃𝑉 =
(1 + 𝑟)𝑛
= 10,00,000/(1.1)^6

= 5,64,473.9301
 Amity Business School

Given

A 60,000

r 10%

n forever

PV ????

PV 𝐴
𝑃𝑉 =
𝑟

=60000/.1 6,00,000
 Amity Business School

Given

A Rs 100000

r 10% pa

n 10 yrs

PV ????

PV [ 1 + 𝑟 𝑛 − 1]
𝑃𝑉 = 𝐴 ∗
𝑟(1 + 𝑟)𝑛

A =6,14,456.7106
 Amity Business School

Given

A 35,000

r 10% pa g= 5%

n forever

PV ????

PV 𝐴
𝑃𝑉 =
𝑟−𝑔

= 7,00,000