FINANCIAL

MANAGEMENT
 Literature
1. Marsh, Clive (Clive Mark Heath) Financial management
for non-financial managers / Clive Marsh 2012
2. Fundamentals of Financial Management, 12th edition
Eugene F. Brigham, Joel F. Houston, 2009
3. Baker, H. Kent (Harold Kent), Understanding financial
management : a practical guide / H. Kent Baker and Gary
E. Powell.— 1st ed.- 2005
4. Crouhey, M./Galai, D./Mark, R.: The Essentials of Risk
Management, McGraw-Hill, 2014.
5. Richard A. Brealey Principles of corporate finance /
Richard A. Brealey, Stewart C. Myers, Franklin, Allen.—
10th ed., 2011
 Structure
1. Introduction to financial
management
2. The Business and
Financial Environments
3. Time Value of Money
4. Net Present Value
 1. Introduction to financial
management

The purpose of the course of

Financial Management
To understand the financial decision-
making process and to interpret the
impact that financial decisions will
have on value creation.
 1. Introduction to financial
management

Three major decision-making

areas in financial management:

investment

financing

asset
management
 1. Introduction to financial
management
The role of the financial manager
in modern corporation

Until around the first half of the 1900s financial

managers primarily raised funds and managed their firms’
cash positions
In the 1950s, the increasing acceptance of present value
concepts encouraged financial managers to expand their
responsibilities and to become concerned with the
selection of capital investment projects.
 1. Introduction to financial
management
The factors, which influence on the
role of financial manager today:
• heightened corporate competition
• technological change
• volatility in inflation and interest rates,
worldwide economic uncertainty
• fluctuating exchange rates,
• tax law changes
• environmental issues
 1. Introduction to financial
management

What is the Financial management?

Financial management concerns the acquisition,

financing, and management of assets with some
overall goal in mind.

The decision function of can be broken down into

three major areas: the investment, financing, and
asset management decisions.
 1. Introduction to financial
management

The investment
decision
It begins with a determination of the
total amount of assets needed to be held
by the firm.
The financial manager needs to determine the
dollar amount that appears above the double
lines on the left-hand side of the balance sheet
– that is, the size of the firm.
 1. Introduction to financial
management

Financing Decision

Here the financial manager

is concerned with the
makeup of the right-hand
side of the balance sheet.
 1. Introduction to financial
management

Asset Management
Decision
The financial manager is charged with varying degrees of
operating responsibility over existing assets.

These responsibilities require that the financial manager

be more concerned with the management of current
assets than with that of fixed assets.
 1. Introduction to financial
management

The goal of the firm is to

maximize the wealth of the firm’s
present owners.
 1. Introduction to financial
management

Shareholder wealth is represented by the

market price per share of the firm’s common
stock

The idea is that the success of a business

decision should be judged by the effect that it
ultimately has on share price.
 1. Introduction to financial
management

The market price of a firm’s stock

takes into account:
• present and expected future earnings per
share;
• the timing, duration, and risk of these earnings;
• the dividend policy of the firm;
• and other factors that bear on the market price
of the stock.
 1. Introduction to financial
management

Agency Problems
Separation of ownership and
control in the modern
corporation results in
potential conflicts between
owners and managers
 1. Introduction to financial
management

We may think of management as

the AGENTS of the owners.

Shareholders, hoping that the agents will

act in the shareholders’ best interests,
delegate decision-making authority to
them.
 1. Introduction to financial
management

Jensen and Meckling

were the first to develop
A COMPREHENSIVE
THEORY OF THE FIRM
UNDER AGENCY
ARRANGEMENTS
 1. Introduction to financial
management

THE MAIN IDEA OF

THEORY
The principals, in our case the
shareholders, can assure themselves
that the agents (management) will
make optimal decisions only if
appropriate incentives are given and
only if the agents are monitored.
 1. Introduction to financial
management
INCENTIVES INCLUDE
1. stock options
2. bonuses
3. perquisites (“perks,” such
as company automobiles
and expensive (offices)
 1. Introduction to financial
management

MONITORING INCLUDE
• bonding the agent
• systematically reviewing
management perquisites
• auditing financial statements
• and limiting management
decisions
 1. Introduction to financial
management
CORPORATE GOVERNANCE
THREE CATEGORIES OF
INDIVIDUALS
1. the common shareholders, who
elect the board of directors;
2. the company’s board of directors
themselves;
3. the top executive officers led by
the chief executive officer (CEO).
 1. Introduction to financial
management
THE BOARD OF DIRECTORS
• the critical link between shareholders and
managers
• potentially the most effective instrument of
good governance
• the oversight of the company is ultimately their
responsibility.
• the board, when operating properly, is also an
independent check on corporate management to
ensure that management acts in the
shareholders’ best interests.
 1. Introduction to financial
management

BOARDS
review and approve strategy,
significant investments, and acquisitions.

The board also oversees operating plans, capital budgets,

and the company’s financial reports to common
shareholders.
 1. Introduction to financial
management
For example
IN THE UNITED STATES, boards typically
have 10 or 11 members, with the company’s
CEO often serving as chairman of the board.
IN BRITAIN, it is common for the roles of
chairman and CEO to be kept separate, and
this idea is gaining support in the United
States.
 1. Introduction to financial
management
THE CONTROLLER’S
RESPONSIBILITIES
• cost accounting,
• budgets and forecasts,
• internal consumption.
• External financial reporting is provided to
the IRS (Internal Revenue Service) , the
Securities and Exchange Commission
(SEC), and the stockholders.
 1. Introduction to financial
management
THE TREASURER’S
RESPONSIBILITIES
• investment (capital budgeting, pension
management)
• financing (commercial banking and investment
banking relationships
• investor relations, dividend disbursement),
• asset management (cash management, credit
management)
 2.The Business and
Financial Environment
Basic forms of business organization

sole partnerships corporations limited

proprietorships (general and liability
(one owner) limited) companies
(LLCs)
 2.The Business and Financial
Environment

Sole proprietorship
A business form for which there is one owner. This single owner has unlimited
liability for all debts of the firm.

•the oldest form of business organization

•owns the business
•holds title to all its assets
•is personally responsible for all of its debts
•pays no separate income taxes
•can be established with few complications
•little expense
•takes all risks
•has unlimited liability
•difficulty in raising capital
•success of the business is dependent on a single individual
•has certain tax disadvantages
•must pay for a major portion of them from income left over after paying taxes
 2.The Business and Financial
Environment

Partnership
A business form in which two or more individuals act as owners.
In a general partnership all partners have unlimited liability for the debts of the firm
In a limited partnership one or more partners may have limited liability.

•pays no income taxes as a partner

•pay personal income taxes
•a greater amount of capital can be raised
•In a general partnership all partners have
unlimited liability
•limited partners contribute capital and have
liability confined to that amount of capital, but
there is at least one general partner how has
unlimited liability
•only general partner(s) participate in the
operation of the business
•the limited partners are strictly investors
•the limited partners share in the profits or losses
 2.The Business and Financial
Environment

Corporation
A business form legally separate from its owners. Its distinguishing features include
limited liability, easy transfer of ownership, unlimited life, and an ability to raise large
sums of capital.

•an owner’s liability is limited to his or her investment

•personal assets cannot be seized in the settlement of claims
•ownership itself is evidenced by shares of stock
•unlimited life
•easy transfer of ownership through the sale of common stock
•the ability of the corporation to raise capital apart from its owners
•corporate profits are subject to double taxation
•the length of time to incorporate and the red tape involved
•the incorporation fee that must be paid to the state in which the firm is
incorporated
 2.The Business and Financial
Environment

Limited liability company (LLC)

A business form that provides its owners (called “members”) with corporate-style
limited personal liability and the federal-tax treatment of a partnership.

•a hybrid form of business organization

•combines the best aspects of both a corporation and a partnership
•well suited for small and medium-sized firms
•has fewer restrictions and greater flexibility than an older hybrid
business form – the S corporation
•standard corporate characteristics:
•limited liability
•centralized management
•unlimited life
•the ability to transfer ownership interest without prior consent of
the other owners
•often it lacks «unlimited life»
•complete transfer of an ownership interest is usually subject to the
approval of at least a majority of the other LLC members
 2.The Business and Financial
Environment

The Purpose of Financial Markets

Financial assets exist in an economy because the savings of various individuals, corporations,
and governments during a period of time differ from their investment in real assets.

By real assets we mean:

houses buildings equipment inventories durable goods

The interaction of borrowers with lenders determines interest rates.

 2.The Business and Financial
Environment

The Purpose of Financial Markets

The interaction of borrowers with lenders determines interest rates

The purpose of financial markets

in an economy is to allocate savings efficiently to
ultimate users
 2.The Business and Financial
Environment

Financial Markets

Figure illustrates the role of

financial markets and financial
institutions in moving funds from
the savings sector (savings-
surplus units) to the investment
sector (savings-deficit units)
 2.The Business and Financial Environment

A primary Primary and Secondary Markets

market is a
“new issues”
market.
.
Here, In a
funds raised secondar
through the
y market,
sale of new
securities
existing
flow from the securities
ultimate are
savers to the bought
ultimate and sold
investors in
real assets.
2.The Business and Financial
Environment
 2.The Business and Financial Environment

Financial Intermediaries

Financial intermediaries consist of financial institutions:

Financial intermediaries purchase direct (or primary) securities and, in

turn, issue their own indirect (or secondary) securities to the public
 3. Time Value of Money
PRESENT (OR DISCOUNTED) VALUE
1. We all realize that a dollar today is worth
more than a dollar to be received one, two,
or three years from now.
2. Calculating the present value of future cash
flows allows us to place all cash flows on a
current footing so that comparisons can be
made in terms of today’s dollars.
 3. Time Value of Money

PV0 = P0 = FVn /(1 + i ) n

n
= FVn [1/(1 + i ) ]
 3. Time Value of Money
Present value interest factor of $1 at i % for n periods (PVIFi, n)
 3. Time Value of Money

Ordinary Annuity
An annuity is a series of equal
payments or receipts occurring over a
specified number of periods.
In an ordinary annuity, payments or
receipts occur at the end of each
period.
 3. Time Value of Money

FOR EXAMPLE
FIGURE 3.3 SHOWS THE CASH-FLOW
SEQUENCE FOR AN ORDINARY
ANNUITY ON A TIME LINE.
 3. Time Value of Money
Figure 3.4
Time line for calculating the future (compound)
value of an (ordinary) annuity
[periodic receipt = R = $1,000; i = 8%; and n = 3
years]

periodic receipt = R = $1,000; i = 8%; and n =

years]
 3. Time Value of Money

Table 3.5
Future value interest factor of an (ordinary) annuity of $1 per period at i %
for n periods (FVIFAi,n)
 3.Time Value of Money

Annuity Due
In contrast to an ORDINARY
ANNUITY, where payments or
receipts occur at the END OF EACH
PERIOD, an ANNUITY DUE calls
for a series of equal payments
occurring at the BEGINNING OF
EACH PERIOD
3.Time Value of Money
 3.Time Value of Money

Mixed Flows
In practice , we may encounter
a mixed (or uneven) pattern of
cash flows.
 3.Time Value of Money

Mixed Flows
In practice , we may encounter
a mixed (or uneven) pattern of
cash flows.
 3.Time Value of Money

The Magic of Compound Interest

Each year, on your birthday, you invest $2,000 in a
tax-free retirement investment account. By age 65 you
will have accumulated:

From the table, it looks like the time to start saving is now!
 4. Net Present Value
Calculating the Present Value of an Investment
Opportunity
How do you decide whether an investment
opportunity is worth undertaking?
Suppose you own a small company that is
thinking about construction of an office block.
The total cost of buying the land and constructing
the building is $370,000.
A year from now you will be able sell the
building for $420,000.
 4. Net Present Value

Net Present Value

Net present value equals present value minus the
required investment:

In other words, your office development is

worth more than it costs. It makes a net
contribution to value and increases your
wealth.
 4. Net Present Value

The formula for calculating the NPV of

your project can be written as:

C0, the cash flow at time 0 (that is, today) is usually a

negative number.
In other words, C 0 is an investment and therefore a cash
outflow. In our example, C0 $370,000.
 4. Net Present Value
Figure 4.1 Calculation showing the NPV of the office
development.
 4. Net Present Value

Risk and Present Value

Here we can invoke a basic financial
principle: a safe dollar is worth more
than a risky dollar.
The concepts of present value and
the opportunity cost of capital still
make sense for risky investments.
Consider the MAIN IDEA OF THE
NET PRESENT VALUE.

FOR EXAMPLE, chief financial

officer (CFO) is wondering how to
analyze a proposed $1 million
investment in a new venture called
project X. He asks what you think.
 4. Net Present Value

If we call the cash flows C0, C1 , and so on,

then NPV

We should invest in project X if its NPV is greater than

zero.
 4. Net Present Value
• By calculating the present value of project X,
we are replicating the process by which the
common stock of firm X would be valued in
capital markets.
• The discount rate is the opportunity cost of
investing in the project rather than in the
capital market. In other words, instead of
accepting a project, the firm can always
return the cash to the shareholders and let
them invest it in financial assets.
 4. Net Present Value

• The opportunity cost of taking the project is

the return shareholders could have earned
had they invested the funds on their own.
• When we discount the project’s cash flows
by the expected rate of return on financial
assets, we are measuring how much
investors would be prepared to pay for your
project.
 4. Net Present Value

You can see the trade-off in figure 4.2

 4. Net Present Value

• The opportunity-cost concept makes sense

only if assets of equivalent risk are
compared.
• In general, you should identify financial
assets that have the same risk as your
project, estimate the expected rate of return
on these assets, and use this rate as the
opportunity cost.
 4. Net Present Value
Net Present Value’s Competitors
• These days 75% of firms always, or almost always,
calculate net present value when deciding on investment
projects.
• However, as you can see from Figure 4.3 , NPV is not the
only investment criterion that companies use, and firms
often look at more than one measure of a project’s
attractiveness
• About three-quarters of firms calculate the project’s
internal rate of return (or IRR); that is roughly the same
proportion as use NPV. The IRR rule is a close relative of
NPV and, when used properly, it will give the same answer.
4. Net Present Value
 4. Net Present Value
KEY FEATURES OF THE NET PRESENT VALUE RULE
• First, the NPV rule recognizes that a dollar today is worth more
than a dollar tomorrow, because the dollar today can be invested
to start earning interest immediately. Any investment rule that
does not recognize the time value of money cannot be sensible.
• Second, net present value depends solely on the forecasted cash
flows from the project and the opportunity cost of capital. Any
investment rule that is affected by the manager’s tastes, the
company’s choice of accounting method, the profitability of the
company’s existing business, or the profitability of other
independent projects will lead to bad decisions.
• Third, because present values are all measured in today’s
dollars, you can add them up.
 4. Net Present Value

Whereas payback and return on

book are ad hoc measures,
INTERNAL RATE OF
RETURN has a much more
respectable ancestry and is
recommended in many finance
texts.
 4. Net Present Value

Definition the true rate of

return of an investment that
generates a single payoff after
one period.
 4. Net Present Value

Alternatively, we could write down the

NPV of the investment and find the
discount rate that makes NPV= 0.
 4. Net Present Value

Of course C 1 is the payoff and – C 0 is

the required investment, and so our two
equations say exactly the same thing.
THE DISCOUNT RATE
THAT MAKES NPV = 0
IS ALSO THE RATE OF
RETURN.
 4. Net Present Value
Calculating the IRR
The internal rate of return is defined as
the rate of discount that makes NPV = 0.
So to find the IRR for an investment
project lasting T years, we must solve for
IRR in the following expression:
 4. Net Present Value
Actual calculation of IRR usually involves trial
and error. For example, consider a project that
produces the following flows:
 4. Net Present Value

The internal rate of return is IRR in the

equation.

Let us arbitrarily try a zero discount rate.

In this case NPV is not zero but+ $2,000:
 4. Net Present Value

The NPV is positive; therefore, the IRR must

be greater than zero.
The next step might be to try a discount rate
of 50%. In this case net present value is –
$889:

The NPV is negative; therefore, the IRR must be less than

50%.
 4. Net Present Value
In Figure 4.3 we have plotted the net present values
implied by a range of discount rates
 4. Net Present Value
THE IRR RULE
The internal rate of return rule is to accept an investment
project if the opportunity cost of capital is less than the
internal rate of return. You can see the reasoning behind
this idea if you look again at Figure 4.3.
If the opportunity cost of capital is less than the 28% IRR,
then the project has a positive NPV when discounted at the
opportunity cost of capital.
If it is equal to the IRR, the project has a zero NPV.
And if it is greater than the IRR, the project has a negative
NPV.
 4. Net Present Value

• Therefore, when we compare the opportunity cost of capital

with the IRR on our project, we are effectively asking
whether our project has a positive NPV.
• This is true not only for our example. The rule will give the
same answer as the net present value rule whenever the NPV
of a project is a smoothly declining function of the discount
rate.
• Many firms use internal rate of return as a criterion in
preference to net present value. Although, properly stated,
the two criteria are formally equivalent, the internal rate of
return rule contains several pitfalls.
Thank you for
your attention!