Learning Module in Financial Management

Learning Module in Financial Management
For Bachelor of Science in Business Administration

1st Semester, School Year 2020-2021
Introduction:
This module aimed to assist, supplement and provide guidance to students in

their learning process and achieving the required learning outcomes of the
course Financial Management. It promotes self-paced, self-contained, and self-
directed learning which still aligned with the target learning competencies
prescribed by the curriculum. This module is expected to be effective when
used in combination of the prescribed textbook, consultation with the faculty
and other means to widen and deepen the students comprehension of each
lesson.
The module is divided into lessons and presented according to the syllabus.
Each lesson has a suggested duration of learning including its pretests and
posttests. The student should be aware of the scheduled term assessment and
therefore should manage the pacing of his/her learning process. Consideration
should also be given to other requirements to be complied which may be time-
based such as scheduled quiz, or scheduled case presentation.
The student is expected to use this module to study and learn the lessons of
the course with an anticipation of a term assessment as form of a confirmation
of the degree of learnings achieved. It is also expected that the student will be
responsible to all the necessary supplemental materials, and other means
needed to fully comprehend the lessons in this module.
Course Outcomes
After completing this course the student must be able to:
LO1. State the university vision and mission, college goals and program’s objectives.
LO2. Describe both the theoretical and practical role of financial management in business
corporations.
LO3. Describe and evaluate the basic features of financial markets
LO4. Identify the basic components of nominal interest rates and use them to make
expected return comparison among assets.
LO5. Explain the trade-off between risk and return
LO6. Compute and apply the value of various financial assets such as annuities, bonds,
and stock to complex cash flow scenarios.
LO7. Examine the financial condition of a given case through proper financial planning and
control process.
LO8. Determine a firm’s weighted average cost of capital
LO9. Examine the given financial statements and create a projected financial statement through
forecasting.
LO10. Compare the different types of inventory management
LO11.Discuss the different sources of short-term financing.
LO12. Distinguish the advantages and disadvantages of short-term financing
LO13. Suggest proper capital budgeting technique to a given case study
LO14. Evaluate the alternative techniques for analysing project opportunities and
budgeting capital
LO15Apply the net present value criterion to complex capital budgeting problems.
Bachelor of Science in Business Administration
Class Orientation
3 hours (Week 1)
Objectives:
• Expectation of teacher from students, including the requirements and
evaluation of requirements
• Expectation of students on course and from teacher
Lesson:
Teacher’s expectation from students
1. Vision and mission of the University
2. Goals of College of Business Administration
3. Objectives of BSBA program
4. Grading system
5. Activities required for projects, recitations and attendance
6. Start from the 1st day of school for the preparation of your career.
7. Other matters
Students’ expectation from course and teacher

Discuss syllabus/module
Selection of class officers
I. Unit Title
Unit 1 - Overview of Financial Management
II. Title of the Lesson

1. Definition of Finance
2. Areas of Finance
3. Roles and Objectives of Financial Management
4. Market Interest Rates
5. Agency Relationships
III. Duration: 6 hrs. (Weeks 2 & 3)
IV. Introduction:
This unit provides the students the overview of finance, basic of finance and
focuses on what business firms should do to achieve their financial goal,
which is to enhance the owner’s wealth. Areas of finance will also discuss
here as well as the roles to be characterized by the financial managers.
Different market interest rates will also be conversed so that the students will
understand on what specific interest rate will be suited for the kind of
business that company will be facing in the future. Agency relationship is
very important to tackle because of their trust to contribute their money,
property and partner industry as well, and in return are expecting to receive
a profit from the business.
V. Objectives:
At the end of the lesson, the students should be able to:

1. Define finance and discuss the 3 areas of finance;
2. Explain why finance should be studied;
3. Understand the different roles and objectives of a finance manager;
4. Understand and apply interest rates in a business scenario
5. Know the importance of agency relationships.
VI. Pretest
True or False. Write your answers on the lines provided for after each
statement.
1. Finance is the application of economic principles to decision making that

involves the allocation of money under conditions of uncertainty.
__________
2. If a market is highly price efficient, it is not extremely difficult for investors

to earn returns that are greater than those expected.
________________
3. Finance is a study on how to raise money and invest it productively.
___________
4. Procurement of funds requires that capital sourcing must be done at the

least cost possible. _____________
5. The field of capital markets and capital markets theory focuses on the
study of financial system, the structure of interest rates and the pricing of
risky assets.
________
Select the best answer to the following statements. Write the letter of
your choice on the space provided for after each statement.
6. Investment management is the specialty area within finance dealing with

the management of individual or institutional funds. ________________
a. Financial management
b. Investment management
c. Capital markets
7. Planning the future development of the business is one of the major roles
of a Finance Manager according to: _____________________
a. Pearson
b. Ross
c. Medina
8. If the debtor receives money today and repays it in a single lump sum at
some other time in the future, it is called ________________
a. Amortized loan
b. Pure discount loan
c. Interest only loan
9. If the creditor allows the debtor to pay interest in each period and to
repay the principal at some point in time, it is called
_________________
a. Amortized loan
b. pure discount loan
c. interest only loan
10. If the debtor requires to repay parts of the loan amount over time and
pays the interest for each period plus fixed amount of the principal, it is
called __________
a. Amortized loan
b. pure discount loan
c. interest only loan
VII. Lesson Proper/Course Methodology
FINANCE DEFINED
Finance is the application of economic principles to decision making that

involves the allocation of money under conditions of uncertainty. Investors
allocate their funds among financial assets in order to accomplish their
objectives, and businesses and governments raise funds by issuing claims
against themselves and then use those funds for operations.
Finance provides the framework for making decisions as to how to get the
funds and what we should do with them once we have them. It is the financial
system that provides the platform by which funds are transferred from those
entities that have funds to those entities that need funds.
Therefore, Finance is:
• Analytical, using statistical, probability, and mathematics to solve

problems.
• Based on economic principles.
• Uses accounting information as inputs to decision-making
• Global in perspective
• The study on how to raise money and invest it productively.
AREAS OF FINANCE
Capital market and capital market theory, financial management, and

investment management are the three Areas of Finance.
Capital Markets and Capital Markets Theory
The field of capital markets and capital markets theory focuses on the study of
financial system, the structure of interest rates and the pricing of risky assets.
The financial system of the economy consists of three components: Financial
markets, 2) Financial intermediaries, and 3) Financial regulators. For this
reason, we often refer to this area as financial markets and institutions.
Several important topics included in this speciality area of finance are the
pricing efficiency of financial markets, the role and investment behaviour of the
players in financial markets, the best way to design and regulate financial
markets, the measurement of risk, and the theory of asset pricing. The pricing
efficiency of the financial markets is critical because it deals with whether
investors can “beat the market.” If a market is highly price efficient, it is
extremely difficult for investors to earn returns that are greater than those
expected for the investment’s level of risk – that is, it is difficult for investors to
beat the market.
In finance, beating the market means outperforming the market by generating

a return of investment beyond what is expected after adjusting for risk and
transaction costs.
The fundamental principle of valuation is that the value of any financial asset is
the present value of the expected cash flows. Thus, the valuation of a financial
asset involves (1) estimating the expected cash flows; (2) determining the
appropriate interest rate or interest rates that should be used to discount the
cash flows; and (3) calculating the present value of the expected cash flows.
Financial Management
Financial management, sometime called business finance or corporate

finance, is the specialty area of finance concerned with financial decision-
making within a business entity. Although financial management is often
referred to as corporate finance, the principles of financial management also
apply to other forms of business and to government entities. Financial
managers are primarily concerned with investment decisions and financing
decisions within business establishments, whether that organization is a sole
proprietorship, a partnership, a limited liability company, a corporation, or a
governmental entity.
Investment Management
Investment management is the specialty area within finance dealing with the
management of individual or institutional funds. Other terms commonly used
to describe this area of finance are asset management, portfolio management,
money management, and wealth management. In industry jargon, an asset
manager “runs money.”
Investment management involves five primary activities.

1) Setting investment objectives starts with a thorough analysis of what the
entity or client wants to accomplish.
2) Given the investment objectives, the investment manager develops
policy guidelines, taking into consideration any client-imposed
investment constraints, legal/regulatory constraints, and tax restrictions.
3) Measuring and evaluating investment performance
4) Establishing an investment policy
5) Selecting specific assets.
THE ROLE AND OBJECTIVE OF FINANCIAL MANAGEMENT
Business finance is both an art and a science. It is concerned with allocating

the financial resources of the company procurement of funds needed; and the
efficient and effective utilization of these funds.
In allocating financial resources, it is important that funds are channelled to

activities that are profitable or costs are minimal. Possible risks are losses
which may arise from decline in revenue, increase in operating costs and
expenses or decline in property value. Procurement of funds requires that
capital sourcing must be done at the least cost possible. This involves
evaluation of the different sources of funds and the costs involved. Sources
available can be short-term and long-term funds. Cost of capital maybe in the
form of financing charges, such as interest, service charges. For capital
contribution of owners, costs are the dividends or shares in profit of the
stockholders. For the efficient utilization, funds must be used for purposes
which they are intended. Unnecessary expenses, unproductive labor, so much
investment in fixed assets may involve inefficiency in utilizing resources.
Effective use of resources require periodic assessment of operations if they are
consistent with the company plans, in attaining its short term and long-term
goals. This needs periodic review of operations to check on developments and
to identify remedial or corrective actions when necessary.
It is unwise to have excessive balance of cash, receivables, inventoried and

other financial resources. The company, in this case, will lose opportunities to
earn on capital tied up or on idle funds. Idle cash may be invested in sort-term
placement. Too much receivables can lead to more collection costs and greater
risk for bad debts. Inventories, beyond what is in demand, may increase
handling and storage costs, or obsolescence. Plant property and equipment,
more than what the company needs gives the company more expenses for
repairs, maintenance and depreciation.
FINANCIAL MANAGER’S RESPONSIBILITY
Financial managers have a major role in a company’s management. This role

is essentially the same in all companies – that is, to acquire the necessary funds
and to ensure that they are used effectively. In some companies, the financial
manage may not be an independent employee, particularly for small companies
where financial management may be done by the secretary or accountant. In
larger companies, this function may be done by executives described as the
financial managers. These are people directly involved in making financial
decisions. Most of the time, the executive responsible for the financial
management of the company is also responsible for its accounting functions.
In large corporations, the owners or stockholders are usually not directly

involved in making business decisions, particularly on a day-to-day basis.
Instead, the corporation employs managers to represent the owners’ interests
and make decisions on their behalf. The financial management function is
usually associated with a top officer of the firm, such as the vice president for
finance or some other chief financial officer or CFO.
According to Peirson, the top ten major roles of Financial Managers are:
1. Managing investment in non-current assets through evaluation of
capital projects.
2. Evaluating, obtaining and servicing long-term financial requirements
through borrowing, leasing, retaining funds or issuing stocks and
securities.
3. Distribution of dividends to shareholders.
4. Collection and custody of cash ad payment of bills
5. Managing investments in current assets such as cash, marketable
securities and inventory.
6. Obtaining and servicing short-term finance.
7. Managing risks associated with changes in interest rates and exchange
rates.
8. Assessing the viability of growth through acquisition of other
businesses.
9. Planning the future development of the business
10. Development and implementation of financial policies.
Stephen Ross (p4) identified three decisions made by Financial Managers.
 Capital budgeting. This concerns the planning and managing of the

firm’s long-term investments. The financial manager tries to identify
investment opportunities that are worth more to the firm that the cost
to acquire. Types of investment opportunities depend on the nature
of the firm’s business. Regardless of the specific nature an
opportunity under consideration, financial manager must be
concerned not only with how much cash they expect to receive, but
also with when they expect to receive it and how likely they are to
receive it. Evaluating the size, timing, and risk of future cash flows is
the essence of capital budgeting.
 Capital structuring. This evaluates ways in which the firm obtains

and manages the long-term financing to support its long-term
investments. The firm’s capital structure or financial structure is the
specific mixture of long-term debt and equity the firm uses to finance
is operations. Financial manager’s concerns are: how much should
the firm borrow? And what combination of debt and equity is best?
It determines what part of the pie, or the firm’s cash flow goes to
creditors and what part goes to shareholders. Also, the officer should
decide exactly how and where to raise the money. The expenses
associated with raising long term financials can be considerable, so
different possibilities must be carefully evaluated. Corporations
borrow money from a variety of lenders in different ways, thus
choosing among available creditors and loan types is another
significant factor in financial decisions.
 Working capital management. This refers to the administration of the

firm’s short term assets, including inventory, its short-term liabilities
– such as money owed to suppliers. Managing the firm’s working
capital is a day-to-day activity that ensures that the company has
sufficient resources to continue its operations. Questions and issues
are: how much cash and inventory should be kept on hand? Should
the firm sell on credit? Or borrow on short term and pay cash?
AGENCY RELATIONSHIPS
It has long been recognized that managers may have personal goals that
compete with shareholder wealth maximization. Managers are empowered by
the owners of the firm – the shareholders – to make decisions, and that creates
a potential conflict of interest known as agency theory.
An agency relationship arises whenever one or more individuals, called

principals, hire another individual or organization, called an agent, to perform
some service and delegate decision-making authority to that agent. In financial
management, the primary agency relationships are those between (1)
stockholders and managers and (2) managers and debt holders.
Stockholders versus Managers
A potential agency problem arises whenever the manager of a firm owns less
than 100 percent of the firm’s common stock. If the firm is a proprietorship
managed by its owner, the owner-manager will presumably operate so as to
maximize his or her own welfare, with welfare measured in the form of
increased personal wealth, more leisure, or perquisites. However, if the owner-
manager incorporates and then sells some of the stock to outsiders, a potential
conflict of interest immediately arises. Now the owner-manager may decide to
lead a more relaxed lifestyle and not work as strenuously to maximize
shareholder wealth, because less of this wealth will accrue to him or her. Also,
the owner-manager may decide to consume more perquisites, because some
of those costs will be borne by the outside shareholders. In essence, the fact
that the owner-manager will neither gain all the benefits of the wealth created
by his or her efforts nor bear all the costs of perquisites will increase the
incentive to take actions that are not in the best interests of other shareholders.
In this situation, shareholder wealth maximization could take a back seat to

any number of conflicting managerial goals. By creating a large, rapidly
growing firm, managers
(1) increase their job security, because of hostile takeover is less likely
(2) increase their own power, status, and salaries
(3) create more opportunities for their lower and middle-level managers.
Managers can be encouraged to act in stockholders’ best interests through

incentives that reward them for good performance but punish them for poor
performance. Some specific mechanisms used to motivate managers to act in
shareholders’ best interests include (1) managerial compensation, (2) direct
intervention by shareholders, (3) the threat of firing, and (4) the threat of
takeover.
1) Managerial compensation. Managers obviously must be compensated,

and the structure of the compensation package can and should be
designed to meet two primary objectives (a) to attract and retainable
managers and (b) to align managers’ actions as closely as possible with
the interests of stockholders, who are primarily interested in stock price
maximization. Different companies follow different compensation
practices, but a typical senior executive’s compensation is structured in
three parts. (a) a specified annual salary, which is necessary to meet
living expenses, (b) a bonus paid at the end of the year, which depends
on the company’s profitability during the year; and (c) options to buy
stock, or actual shares of stock, which reward the executive for long-
term performance.
Managers are more likely to focus on maximizing stock prices if they are
themselves large shareholders. Often, companies grant senior managers
performance shares, where the executive receives a number of shares
dependent upon the company’s actual performance and the executive’s
continued service.
2) Direct intervention by shareholders. Years ago most stock was owned

by individuals, but today the majority is owned by institutional investors
such as insurance companies, pension funds, and mutual funds.
Therefore, the institutional money managers have the clout, if they
choose to use it, to exercise considerable influence over most firms’
operations.
3) The threat of firing. Until recently, the probability of a large firm’s

management being ousted by its stockholders was so remote that it
posed little threat. This situation existed because the shares f most firms
were so widely distributed, and management’s control over the voting
mechanism was so strong, that it was almost impossible for dissident
stockholders to get the voters needed to overthrow a management team.
However, as noted above, the situation is changing.
4) The threat of takeovers. Hostile takeovers (when management does not

want the firm to be taken over) are most likely to occur when a firm’s
stock is undervalued relative to its potential because of poor
management. In a hostile takeover, the manages of the acquired firm
are generally managers have a strong incentive to take actions designed
to maximize stock prices. In the words of one company if you want to
keep your job, don’t let your stock sell at a bargain price.
Stockholders (through managers) versus Creditors
In addition to conflicts between stockholders and managers, there can also be

conflicts between creditors and stockholders. Creditors have a claim on part of
the firm’s earnings stream for payment of interest and principal on the debt, and
they have a claim on the firm’s assets in the event of bankruptcy. However,
stockholders have control (through the managers) of decisions that affect the
profitability and risk of the firm. Creditors lend funds at rates that are based on
(1) the riskiness of the firm’s existing assets, (2) expectations concerning the
riskiness of future asset additions, (3) the firm’s existing capital structure (that
is, the amount of debt financing used), and (4) expectations concerning future
capital structure decisions. These are the primary determinants of the riskiness
of a firm’s cash flows, hence the safety of its debt issues.
Now supposed stockholders, acting through management, cause a firm to take

on a large new project that is far riskier than was anticipated by the creditors.
This increased risk will cause the required rate of return on the firm’s debt to
increase, and that will cause the value of the outstanding debt to fall. If the
risky project is successful, all the benefits go to the stockholders, because
creditors’ returns are fixed at the old, low-risk rate. However, if the project is
unsuccessful, the bondholders may have to share in the losses.
Can and should stockholders, through their managers/agents, try to expropriate

wealth from creditors? In general, the answer is no, for unethical behavior is
penalized in the business world. First, creditors attempt to protect themselves
against stockholders by placing restrictive covenants in debt agreements.
Moreover, creditors perceive that a firm’s managers are trying to take
advantage of them, they will either refuse to deal further with the firm or else
will charge a higher-than-normal interest rate to compensate for the risk of
possible exploitation. Thus, firms that deal unfairly with creditors either lose
access to the markets or are saddled with high interest rates and restrictive
covenants, all of which are detrimental to shareholders.
In view of these constraints, it follows that to best serve their shareholders in
the long run, managers must play fairly with creditors. As agents of both
shareholders and creditors, managers must act in a manner that is fairly
balanced between the interests of the two classes of security holders. Similarly,
because of other constraints and sanctions, management actions that would
expropriate wealth from any of the firm’s other stakeholders, including its
employees, customers, suppliers, and community, will ultimately be to the
detriment of its shareholders. In our society, stock price maximization requires
fair treatment for all parties whose economic positions are affected by
managerial decisions.
MARKET INTEREST RATES
Loans and Amortization
Whenever a creditor extends a loan, some provisions have to be made for

repayment of the principal. A loan might be repaid in equal instalments, or it
might be repaid in a single lump sum. The mode of payment of principal and
interest will depend on the agreement of both parties. Basic types of loans are:
pure discount loans, interest-only loans, and amortized loan.
A pure discount loan is the simplest form of loan. The debtor receives money
today and repays a single lump sum at some other time in the future. A one-
year, 10 percent discount loan, for example would require the debtor to repay
Php1.10 in one year for every peso borrowed today. Suppose, a debtor was
able to repay Php25,000 in five years. On the part of the creditor who wants
an interest rate of 12 percent on the loan how much will be lent now? Or what
should be the amount today loan, to get Php25,000 on the fifth year?
This can be a discussion of time value of money, but for this purpose, below is
the illustration.
Present value = Php25,000/1.7623 (refer to Table on Future value at the end

of t periods)
= php14,186
Treasury bills are pure discount loans. If a T-bill promises to repay Php10,000
in 12 months, and the market interests is 7 percent, how much will the bill sell
for in the market?
Present value = 10,000/1.07

= Php9,345.79
Interest-only loan allows the debtor to pay interest in each period and to repay
the principal at some point in time. Notice that a pure discount loan and
interest-only loan are the same that if there is just one period. For example,
with a three-year, 10 percent, interest-only loan of Php10,000, the debtor would
pay Php10,000 x .10 + Php1,000 in interest at the end of the first and second
years. At the end of the third year, the borrower would return the Php10,000
along with another Php1,000 in interest that year.
Amortized loan requires the debtor to repay parts of the loan amount over time.
The debtor pays the interest for each period plus fixed amount. The process
provides loan payments on regular principal reductions. Supposing a business
takes out a Php50,000, five-year loan at 9 percent. The loan agreement calls
for the debtor to pay the interest on the loan balance each year and to reduce
the loan balance each year by Php10,000. Because the loan amortization
declines by Php10,000 each year, it is fully paid in five years.
Year Beginning Principal Interest paid Totally Ending

balance paid payment balance
1 Php50,000 10,000 4,500 14,500 40,000
2 40,000 10,000 3,600 13,600 30,000
3 30,000 10,000 2,700 12,700 20,000
4 20,000 10,000 1,800 11,800 10,000
5 10,000 10,000 900 10,900 0
Total 50,000 13,500 63,500
Notice that in each year, the interest paid is given in the beginning balance
multiplied by the interest rate. Also notice that the beginning balance is given
in the ending balance from the previous year.
The most common way of amortizing a loan is to have the borrower make a
single, fixed payment every period. Almost all consumer loans, like car loans
and mortgages work this way. For example, suppose our five-year, 9 percent
Php50,000 loan amortized this way, the illustration is as follows:
I=PxRxT
Where:
I = interest
P = principal = 50,000
R = rate = 9%
T = time = 5
Interest = 50,000 x 9% x 5
Interest = 22,500
Year Beginning Principal Interest paid Totally Ending

balance paid payment balance
1 Php72,500 10,000 4,500 14,500 58,000
2 58,000 10,000 4,500 14,500 43,500
3 43,500 10,000 4,500 14,500 29,000
4 29,000 10,000 4,500 14,500 14,500
5 14,500 10,000 4,500 14,500 0
Total 50,000 22,500 72,500 0
VIII. Reflection/Learning Insights
This unit discussed the overview of finance and strategies on what business
firms should do to achieve their financial goal to improve the owner’s wealth.
Included in the discussion were the different areas of finance as well as the roles
to be characterized by the appointed or assigned financial managers in a certain
company.
Agency relationship is very important in the financial management. The owner

or owners of the company should abide by all government rules and regulations
to make the business legally operated. The management should also build a
good relationship with the investors who entrusted their money and property
with the expectation of using this money for business purposes productively and
gaining profit. Good relationship also should be conveyed to other creditors and
suppliers as well as to its customers. Figuring out a good reputation on them
will turn the business operations successfully.
It is further discussed the different interest rates that a company may used. All
businesses are inclined in borrowing money from the outside source due to lack
of funds in developing a new projects or other reasons that a company may
have and resultant to some subsidy. The finance manager should strategized
on the appropriate interest rate and recommend to the owner or owners of the
company.
The students will be given a recitation to evaluate if they understand the

different topics raised on this unit. The students will be given a set of
questions and business scenarios to be analysed.
IX. Post-test:
Identify the following: Write your answers on the lines provided for
after each statement.
1. It is the application of economic principles to decision making that

involves the allocation of money under conditions of uncertainty.
______________
2. This concerns the planning and managing of the firm’s long-term

investments. _______________
3. What is the total interest earned if the principal amount of loan is

135,000 with an 18% for 3 years. ______________
4. What is the annual interest that a debtor should pay for the loan of
360,000 @ 15%. _________________
5. If borrower X granted a pure discount loan of 500,000 at 12% for 3
months on July 6, 2020, how much does borrower X needs to pay at
its maturity date.___________
6. When will be the maturity date of the loan of borrower X as stated on

item no. 5. __________________
7. This evaluates ways in which the firm obtains and manages the long-
term financing to support its long-term investments.
___________________
8. This refers to the administration of the firm’s short term assets,

including inventory, its short term liabilities such as money owed to
suppliers. ______________________
9. It is sometimes called as business finance or corporate finance,

wherein the specialty area concerned with financial decision-making
within a business entity. ________________
10. Its concerned is allocating the financial resources of the company

procurement of funds needed; and the efficient and effective
utilization of these funds. _________________
X. Suggested Readings
Brigham, Eugene F. and Michael C. Ehrhardt. Financial Management Theory

and Practice, 15th ed. Canada: Cengage Learning. 2017
Drake, Pamela Peterson and Frank J. Fabozzi. The Basics of Finance: An

Introduction to Financial Markets, Business Finance and Portfolio
Management. USA: John Wiley and Sons, Inc.
2010.
Medina, Roberto G. Business Finance, 2nd ed. Manila: Rex Book Store, 2015.
Melicher, Edgar A. and Edgar A. Norton. Introduction to Finance Markets,

Investments, and Financial Management. 16th edition. USA: John Wiley and
Sons, Inc. 2017.
Mutya, Ruby F. Basic Business Finance: Management Approach, 2nd ed.

Mandaluyong City: National Book Store, 2015.
Peirson, Grahan, Bron, R. and Howard, P. Essentials of Business Finance.

Austrialia: McGraw- Hill Companies, Inc., 1997.
Ross, Stephen A., Westernfield, R., Jordan, B. Fundamentals of Corporate

Finance, 4th ed. Boston Massachusetts: Iwin McGraw Hill., 1998.
ZLibrary.Asia. Bluesyemre.com. June 6,2020.

I. Unit Title
Unit 2. Risk and Return
II. Title of Lesson

1. Defining Risk
2. Types of Risks
3. Expected Rate of Return
4. Expected Return
III. Duration - 3 hours (week 4)
IV. Introduction
Finance may be defined as the study of procurement and investment of

cash for the drive of enhancing value and wealth. However, engaging
into business is not a guaranteed that a little or initial investment will turn
into a big wealth especially if a person who enters into business was not
able to make his own feasibility study or business plan on a particular
product or services that he wants to manage. Those act of some
capitalists is very risky. Risks are accompanied by all businesses that is
why it may be considered gaming because nobody knows what will
happen in the future. In this unit, it will be discussing the different
terminologies pertaining to risks, understanding each one, and learn how
to manage and how a financial manager makes a final decision to protect
the wealth of the capitalists or investors.
The concept of financial risk and return is an important aspect of a

financial manager’s core responsibilities within a business. Generally,
the more financial risk a business is exposed to, the greater its chances
for a more significant financial return. There are obviously exceptions to
this, as there are many examples of irrational risks that do not come with
correspondingly high returns.
V. Objectives
1. The students should be able to define and understand the

different terminologies pertaining to risks.
2. The students should understand and analyze the different risk

and return of the different business scenarios.
VI. Pre-test:
Identify the following: Write your answers on the lines provided

for at end of each statement.
1. This risk is the possibility of receiving a lesser amount of purchasing

power than was originally invested. __________________
2. The risk that the will have general business problem.

__________________
3. This risk arises from the possibility of an asset that may not be sold
for its market value, given a short notice. __________________
4. This is the risk that the issuing company is unable to make periodic
interest payments or principal repayments on debts.
__________________
5. This is the risk of changes in stock prices in market, described by

volatility and affected by bullish trends. __________________
6. This is the risk of fluctuations in the value of an asset as the interest

rates change. __________________
7. It is a percentage return expected to be earned by an investor during

a set period of time. __________________
8. It is the impact of changes that is system-wide and the portion of

total variability of returns caused by such across the board factors .
__________________
9. It is a percentage return expected to be earned by an investor during

a set period of time. _______________
10. It refers to the costs that will suddenly rise in an entirely

unexpected way, or that some other cost will appear from nowhere
and steal the money we’ve set aside for our expected outlays.
____________________
Defining risks
The term risk is very general. We are all faced with risk in our
everyday lives. In particular, we understand that risk is not
synonymous with the size of a cost or of a loss. These costs are big,
but they are not a threat to our ambitions because they are reasonably
predictable and are already allowed for in our plans.
Risks refer to the costs that will suddenly rise in an entirely

unexpected way, or that some other cost will appear from nowhere
and steal the money we’ve set aside for our expected outlays. The
risk lies in how variable our costs and revenues really are.
Types of Risk:
The types of risks the financial managers must consider are:
1. Business risk - the risk that the company will have general business
problem. This type of risk is mainly dependent upon changes in
demand, input prices and technological obsolescence
2. Liquidity risk - this risk arises from the possibility of an asset that may
not be sold for its market value, given a short notice. It is said to have
a good amount of liquidity risk if an investment must be sold at a high
discount
3. Default risk this is the risk that the issuing company is unable to make
periodic interest payments or principal repayments on debts. Example:
Bonds, debentures and other long-term debts
4. Market risk- this is the risk of changes in stock prices in market,
described by volatility and affected by bullish and bearish trends
5. Interest rate risk this is the risk of fluctuations in the value of an asset
as the interest rates change. If interest rates rise, the price of fixed
income securities like debentures fall and vice versa .
6. Purchasing power risk this risk is the possibility of receiving a lesser
amount of purchasing power than was originally invested
Risk premium
The risk premium refers to the concept that, all else being equal,
greater risk is accompanied by greater returns. This is an important
concept for financial managers hoping to borrow money. Lenders will
look closely at a company to determine how risky they believe the
company is and will base their decision to lend to that company on that
level of risk. Additionally, if the lender does agree to lend money to a
risky business, they will require a greater return in the form of higher
interest rates.
Concept of Risk
A person making an investment expects to get some returns from the

investment in the future. However, as future is uncertain, the future
expected returns too are uncertain. It is the uncertainty associated
with the returns from an investment that introduces a risk into a project.
The expected return is the uncertain future return that a firm expects
to get from its project. The realized return, on the contrary, is the
certain return that a firm has actually earned.
The realized return from the project may not correspond to the
expected return. This possibility of variation of the actual return from
the expected return is termed as risk. Risk is the variability in the
expected return from a project. In other words, it is the degree of
deviation from expected return. Risk is associated with the possibility
that realized returns will be less than the returns that were expected.
So, when realizations correspond to expectations exactly, there would
be no risk.
Elements of Risk
Various components cause the variability in expected returns, which

are known as elements of risk. There are broadly two groups of
elements classified as systematic risk and unsystematic risk.
Systematic risk
Business organizations are part of society that is dynamic. Various

changes occur in a society like economic, political and social system
that have influence on the performance of companies and thereby on
their expected returns. These changes affect all organizations to
varying degrees. Hence the impact of these changes is system-wide
and the portion of total variability of returns caused by such across
the board factors is referred to as systematic risk. These risks are
further subdivided into interest rate risk, market risk, and purchasing
power risk.
Unsystematic Risk
The returns of a company may vary due to certain factors that affect
only that company. Examples of such factors are raw material
scarcity, labour strike, management inefficiency, etc. when the
variability in returns occurs due to such firm-specific factors it is
known as unsystematic risk. The risk is unique or peculiar to a
specific organization and affects it is addition to the systematic risk.
Concept of Return
Return can be defined as the actual income from a project as well as

appreciation in the value of capita. Thus there are two components in
return- the basic component or the periodic cash flows from the
investment, either in the form of interest or dividends; and the change in
the price of the asset, commonly called as the capital gain or loss.
The term yield is often used in connection to return, which refers to the
income component in relation to some price for the asset. The total
return of an asset for the holding period relates to all the cash flows
received by an investor during any designated time period to the amount
of money invested in the asset.
Measurement of Return
Total Return = Cash payments received + Price change in assets over

the period/Purchase price of the asset. In connection with return we use
two terms – realized return and expected or predicted return. Realized
return is the return that was earned by the firm, so it is historic. Expected
or predicted return is the return the firm anticipates to earn from an asset
over some future period.
Concept of Risk and Returns
After investing money in a project a firm wants to get some outcomes

from the project. The outcomes or the benefits that the investment
generates are called returns. Wealth maximization approach is based
on the concept of future value of expected cash flows from a prospective
project.
So, cash flows are nothing but the earnings generated by the project that
we refer to as returns. Since fixture is uncertain, so returns are
associated with some degree of uncertainty. In other words there will be
some variability in generating cash flows, which we call as risk.
Expected rate of return defined
The expected rate of return is a percentage return expected to be earned

by an investor during a set period of time. For example, year, quarter,
or month. In other words, it is a percentage by which the value of
investment is expected to exceed its initial value after a specific period
of time. The expected rate of return can be calculated either as a
weighted average of all possible outcomes or using historical data of
investment performance.
Expected Return
The return on an investment as estimated by an asset pricing model is

calculated by taking the average of the probability distribution of all
possible returns. For example a model might state that an investment
has a 10% chance of a 100% return and a 90% chance of a 50% return.
The expected return is calculated as:
Expected return = 0.1(1) + 0.9(0.5) = 0.55 = 55%
VII. Reflection/Learning Insights
The students should recite on the different questions to be raised in

the class to assess if they understand the topics discussed in this unit.
The student should know how to measure risk, and in order to do that
the risk analyst first looks to classify the key factors that appears likely
to cause volatility in the returns from the position or portfolio under
consideration.
IX. Post-test:
Enumeration:
Enumerate the types of risks

1.
2.
3.
4.
5.
6.
True or False. Write your answers on the blank spaces

provided for after each statement.
7. The outcomes or the benefits that the investment

generates are called returns. __________
8. The expected rate of return is a percentage return

expected to be earned by an investor during a set period
of time. ____________________
9. Return can be defined as the actual income from a project

as well as appreciation in the value of capita. _________
10. if the lender does agree to lend money to a risky business,

they will require a greater return in the form of higher
interest rates. ________________
X. Suggested Readings:
.
Brigham, Eugene F. and Michael C. Ehrhardt. Financial
Management Theory and Practice, 15th ed. Canada: Cengage
Learning, 2017.
Crouchy, Micher, Dan Galai, and Robert Mark. The

Essentials of Risk Management. New York: McGraw Hill
Education, 2014.
Drake, Pamela Peterson and Frank J. Fabozzi. The Basics of

Finance: An Introduction to Financial Markets, Business Finance
and Portfolio Management. USA: John Wiley and Sons, Inc.
2010.
Medina, Roberto G. Business Finance, 2nd ed. Manila: Rex Book

Store, 2015.
Melicher, Edgar A. and Edgar A. Norton. Introduction to Finance

Markets, Investments, and Financial Management. 16th edition.
USA: John Wiley and Sons, Inc. 2017.
Mutya, Ruby F. Basic Business Finance: Management Approach,
2nd ed. Mandaluyong City: National Book Store, 2015.
Peirson, Grahan, Bron, R. and Howard, P. Essentials of Business

Finance. Austrialia: McGraw- Hill Companies, Inc., 1997.
Ross, Stephen A., Westernfield, R., Jordan, B. Fundamentals of

Corporate Finance, 4th ed. Boston Massachusetts: Iwin McGraw
Hill., 1998.

I. Unit Title
Unit 3 - Financial Planning and Control Process
II. Title of Lesson

1. Financial Planning and Control Process
2. Cash Budgeting
3. The Break Even Analysis
4. Financial Leverage
III. Duration - 6 hours (week 5 & 6)
IV. Introduction
A strategy is a direction the company intends to take to reach an

objective. Once the company has its strategy, it needs a plan, in
particular the strategic plan, which is the set of actions the company
intends to use to follow its strategy. The investment opportunities that
enable the company to follow its strategy comprise the company’s
investment strategy.
The chief financial officer (CFO), under the supervision of the board of
directors, looks at the company’s investment decisions and considers
how to finance them. Budgeting is mapping out the sources and uses of
funds for future periods. Budgeting requires both economic analysis
(including forecasting) and accounting information. Economic analysis
includes both marketing and production analysis to develop forecasts of
future sales and costs. Accounting techniques are used as a
measurement device. But instead of using accounting to summarize
what has happened, companies use accounting to represent what the
management expects to happen in the future. Therefore, budgeting
involves looking forward into the future.
V. Objectives:
1. At the end of the lesson the students should be able to examine the
financial condition of a given case through proper financial planning
and control process.
2. The students should be able to compute for the break-even point in
a certain project of the company.
VI. Pre-test
A. Define the following
1. Cash budgeting
2. Variable expenses
3. Fixed expenses
4. Long term planning
5. Short term objective
6. Budgeting
7. Budget proposal
8. Budget negotiation
9. Budget revision
10. Budget approval
Financial Planning and Control Process
A company’s strategic plan is a method of achieving the goal of maximizing

shareholders’ wealth. This strategic plan requires both long and short term
financial planning that brings together forecasts of the company’s sales with
financing and investment decision making. Budgets, such as the cash budget
and production budget, are to manage the information used in this planning.
Once these plans are put into effect, the management must compare what
happens with what was planned. Companies use this post auditing to:
 Evaluate the performance of management

 Analyse any deviations of actual results from planned
results
 Evaluate the planning process to determine just how
good it is.
Strategy
A firm analyses external factors to categorize opportunities and threats; it

analyzes internal factors to identify economical or competitive advantages and
weaknesses. When a firm sees how it can match its strengths to market
prospects, it has a strategy that can be applied to the budget. When a budget
exists without consideration of strategy, it usually begins with the prior year’s
budget and misses opportunities to change the direction of the firm, causing
immobility.
Planning
One of the major benefits of budgeting is that it forces the business organization to
examine the future. Expectations must be established for income, expenses,
personnel needs, future growth etc. planning allows for the input of ideas from
multiple sources within the organization, and allows for input from different
viewpoints. The planning process may generate new ideas for the organization’s
direction, or it may provide insight into better ways to achieve goals that have
already been established. The budget process provides a framework to achieve
the goals of the organization. Without the framework of a budget, individual
managers would be improvising decisions without the direction and coordination
provided by a budget. Without a budget, the organization would be operating in a
reactive manner, rather than in a proactive manner.
Monitoring
The budget sets standards, or performance indicators, by which managers can

monitor the organization’s progress in meeting its goals. By comparing the actual
results for a period to the budgeted results for that period, managers can see
whether the organization is on track to achieving its goals. Breaking down the
organization’s master budget to divisional and departmental levels allows each
level of the organization to be evaluated. The organization as a whole may be
meeting its goals while individual divisions and departments are failing. The
difference between the actual results and the expected results is called a variance.
A negative, or unfavorable variance may indicate a need to take corrective action.
Positive, or unfavourable variances can reflect opportunities to make adjustments
to take advantage of the conditions creating the variance, that is, if sales are up,
then perhaps production should be increased.
Long-term Planning
While a strategy is the starting point in achieving organizational goals, a long

term plan is needed to ensure that the strategy is implemented. A long-term
plan is usually a five- to 10-year plan of actions required to achieve the
company’s goals. Planning for the long-term can involve discontinuing certain
operations over time, arranging for equity or debt financing, and allocating
resources gradually to new branches of business. Such major reorganizations
can be accomplished only over a period of time and usually involve the use of
capital budgeting. Capital budgeting is the process of allocating resources to
an entity’s proposed long-term projects. Because buildings, equipment, and
hiring and training staff are all extremely expensive, such allocations must be
made in accordance with strategy.
Short-term Objective
Short-term objectives are the variations in the long-term plan that result from
capital budgeting, the operating results of past periods, and expected future
results caused by the current economic, social, industrial, and technological
environment. These variations are fed into each year’s master budget.
Budget
A budget is operational plan and a control tool for an entity that identifies
the resources and commitments needed to satisfy the entity’s goals
over a period.
Budgeting
Budgeting is undertaking steps involved in preparing a budget. Along

with clear communication of organizational goals, the ideal budget also
contains budgetary controls.
Budgetary control
Without a formal system of control, a budget is little more than a

forecast. Budgetary control is a management process to help ensure
that a budget is achieved by instituting a systematic budget approval
process, by coordinating the efforts of all involved parties and
operations, and by analysing variances from the plan and providing
appropriate feedback to responsible parties. The goals identified in the
budget must be perceived by employees as realistic if those employees
are to be motivated to achieve the goals.
Budget cycle
A budget cycle usually involves the following steps:
1.A budget is created that addresses the entity as a whole as well as

its subunits, and all managers agree to fulfil their part of the budget.
2.The budget is used to test current performance against expectations.
3.variations from the plan are examined, and corrective actions are
taken when possible.
4.feedback is collected, and the plan is revisited and revised if needed.
Reasons for budgeting
There are four main reasons a company creates a budget: planning,

communication, monitoring, and evaluation.
Cash Budgeting
The budgeting process involves putting together the financing and investment
strategy in terms that allow those responsible for the financing of the company
to determine what investments can be made and how these investments should
be financed. In other words, budgeting pulls together decisions regarding
capital budgeting, capital structure, and working capital.
Consider a company whose line of business is operating retail stores. Its store
renovation plan is part of its overall strategy of regaining its share of the retail
market by offering customers better quality and service. Fixing up its stores is
seen as an investment strategy. The company evaluates its renovation plan
using capital budgeting techniques. But the renovation program requires
financing – this is where the capital structure decision comes in. if it needs
more funds, were do they come from? Debt? Equity? Both? And let’s not
forget the working capital decisions. As the company renovates its stores, will
this change its need for cash on hand? Will the renovation affect inventory
needs? If the company expects to increase sales through this program, how
will this affect its investment in accounts receivable? And what about short-
term financing? Will it need more or less short-term financing when it
renovates?
Budgeting Steps
The steps that responsibility centers take in preparing their budgets include the
initial budget proposal, budget negotiation, review and approval and revision.
Budget Proposal
After the CEO decides on the company strategy, a memo or directive is sent to all
line managers or responsibility centers so they can start aligning their budget
process with the strategic plan. With this strategy in mind, each responsibility
center prepares an initial budget, taking both internal and external factors into
account. Internal factors include changes in price, availability, and manufacturing
processes; new products or services, changes in related or intertwined
responsibility centers; and staff changes. External factors include changes in the
economy and the labor market, the price and availability of goods and services.
Budget Negotiation
When the budget proposal is submitted to the committee on budget, the proposal
is to be reviewed, to see if there is consistency with the organization’s strategic
goals, falls within an acceptable range, reviewers also make sure that the budget
is feasible and if fits within its goals then it will then be negotiated and will go to the
next level.
Budget Review and Approval
Budget are to be reviewed again by another set of reviewer which is the budget
committee, where they are responsible to see if there is a consistency in
considering the budget guidelines, short and long term goals, and strategic plans.
Once it is approved by the committee, it is then be submitted to the board of
directors for final approval.
Budget Revision
The firmness of a budget varies from the different organization. Some budgets
must be followed absolutely; others can be revised only under specific situations
while others are subject to a constant or non-stop revision until it meets the
satisfaction of the reviewer.
Breakeven analysis
A break even point is the point where the difference between the sales income
and the variable expenses equals fixed expenses for the period. Variable
expenses are directly proportional to sales income. Examples of these are
materials and manufacturing labor costs; staff commissions based on the sales
made during the period. In these cases, if sales increase or decrease, such
expenses should move in direct proportion to the changes. Fixed expenses
remain constant whatever the sales activity may be. These are not directly
proportional to units of products sold, except for time factor. Examples of these
are insurance for the year; administrative salaries for the month; rent for the
quarter. These expenses are often fixed for the period and the assumption is
that they should remain constant whatever the sales activity maybe. To control
expenses, the rules are.
 Variable expenses should be controlled as a percentage of

activity. In other words, if sales doubles, variable expenses
become twofold, and vice versa.
 Fixed expenses should be controlled as an amount, not as
percentage of sale. They should not move directly with activity.
Just because sales rise or fall this should not necessarily affect
the fixed expenses. They should remain the same.
Assuming the following facts, Company Pithu-Fitu produces item x, where:
Sales price per unit = Php 20.00

Variable cost per unit = 12.00
Profit contribution per unit = 8.00
If fixed expenses for the year is Php900,000, break-even point is calculated as

follows:
BEP = Php900,000/Ph8.00 = 112,500 units
Therefore, the sales value is Php2,250,000 (112,500 units x Php20.00 per unit)
Financial Leverage
Most companies are financed through either debt or equity. Equity financing
comes from shareholders, the owners of the company. These shareholders
share in the earnings of the company in an amount proportional to their
investment. Debt financing comes from lending institutions, and, while the
borrowing company must pay regular interest payments to its lender, it does
not need to share earnings with the lender. For this reason, accompany can
use debt rather than additional equity to finance its operations and magnify the
profits with respect to the current equity investment. At the same time, losses
are also magnified through this financial leverage. This is the fundamental
risk/return consideration in the makeup of a company’s financing.
A strategy is the direction a company takes to meet its objective, whereas a

strategic plan is how a company intends to go in that direction. For
management, a strategic investment plan includes policies to seek out
possible assets. A strategic plan also includes resource allocation. If a
company requires more capital, the timing, amount, and type of capital
comprise elements of company’s financial strategic plan. These things
must be planned to implement the strategy. Financial planning allocates a
company’s resources to achieve its investment objectives.
IX. Post test
ANALYZE THE FOLLOWING:
Alhambra manufacturing company selling price for Product A is Php2.0 per unit
and profit contribution per unit is php0.80, calculate the following:
1. If fixed expense is 125,000 during the year, what is the break-

even point of the Product A?
2. What is its sales value ?
3. Numbered the following groups according to pattern discussed

on how to approve the company’s budget.
( ) a. board of directors
( ) b. top management
( ) c. budget committee
( ) d. middle and lower management
4. Identify at least 4 component budgets of a financial budget

________________
________________
________________
________________
X. Suggested Readings


Management. USA: John Wiley and Sons, Inc. 2010.
Sons, Inc. 2017.




I. Unit Title
Unit 4: Analysis of Financial Statement

1. The Basic Financial Statements
2. Analysis of Financial Statements
3. Financial Ratios
4. Classes of Financial Ratios
III. Duration: 6 Hrs (week 7 & 8)
IV. Introduction
The firm’s financial condition is the primary concern of various stakeholders

consisting of the stockholders, the suppliers and creditors, the government,
the public, and manpower or employees of the firm. Financial statements
are summaries of the operating, financing, and investment of a business.
Financial statements should provide information useful to both investors and
creditors in making credit, investment, and other business decisions. And
this usefulness means that investors and creditors can use these
statements to predict, compare, and evaluate the amount, timing, and
uncertainty of future cash flows expected to result from those earnings.
It is in this purpose that a financial analysis should be done for the right and
timely decision making for the company.
V. Objectives:
At the end of the lesson, the students are expected to:
1. Recall the different parts of assets, liabilities, and equity;

2. analyze the financial statement using the single-period analysis and
comparative or trend analysis.
3. Know and understand the classes of financial ratios
VI. Pretest
Enumeration.
A. What are the components of financial statement?

1.
2.
3.
4.
B. What groups are interested in the state of finances of a firm?
(Give at least 7 groups)
5.
6.
7.
8.
9.
10.
11.
C. What are the classes of financial ratio?
12.
13.
14.
15.
Financial Statement Reports
Financial statements are summaries of the operating, financing, and investment

activities of a business. Financial statements should provide information useful
to both investors and creditors in making credit, investment, and other business
decisions. And this usefulness means that investors and creditors can use
these statements to predict, compare, and evaluate the amount, timing, and
uncertainty of future cash flows expected to result from those earnings.
The Basic Financial Statements
The basic financial statements are the balance sheet, the income statement,
the statement of cash flow, and the statement of shareholders’ equity. The
balance sheet is a report of what the company has – assets, debt, and equity
as of the end of the quarter or year, and the income statement is a report of
what the company earned during h fiscal period. The statement of cash flows
is a report of the cash flows of the company over the fiscal period, whereas the
statement of shareholders’ equity is a reconciliation of the shareholders’ equity
from one fiscal year end to another.
The Balance Sheet
The balance sheet is a report of the assets, liabilities, and equity of a company
at a point in time, generally at the end of a fiscal quarter or fiscal year. Assets
are resources of the business enterprise, which are comprised of current or
long-lived assets. How did the company finance these resources? It did so
with liabilities and equity. Liabilities are obligations of the business enterprise
that must be repaid at a future point in time, whereas equity is the ownership
interest of the business enterprise. The relation between assets, liabilities and
equity is simple, as reflected in the balance of what is owned and how it is
financed, referred to as the accounting identity.
ASSETS = LIABILITIES + EQUITY
Assets
Assets are anything that the company owns that has a value. These assets
may have a physical in existence or not. Examples of physical assets include
inventory items held for sale, office furniture, and production equipment. If an
asset does not have a physical existence, we refer to it as an intangible asset,
such as a trademark or a patent. You cannot see or touch an intangible asset,
but it still contributes value to the company.
Assets may also be current or long-term, depending on how fast the company
would be able to convert them into cash. Assets are generally reported in the
balance sheet in order of liquidity, with the most liquid asset listed first and the
least liquid listed last.
The most liquid assets of the company are the current assets. Current assets
are assets that can be turned into cash in one operating cycle or one year,
whichever is longer. This constraints with the noncurrent assets, which cannot
be liquidated quickly.
Liabilities
Liabilities may be interest-bearing, such as bond issue or noninterest bearing,

such as amounts due to suppliers.
In the balance sheet, liabilities are presented in order of their due date and are
often presented in two categories, current liabilities and long-term liabilities.
Current liabilities are obligations due within one year or one operating cycle
(whichever is longer). Current liabilities may consist of: accounts payable,
wages and salaries payable, current portion of long-term indebtedness, and
short term bank loans.
Long-term liabilities are obligations that are due beyond one year. There are
different types of long term liabilities, including: notes payables and bonds,
capital leases, asset retirement liability, deferred taxes.
Equity
The equity of a company is the ownership interest. The book value of equity,
which for a corporation is often referred to as shareholders’ equity or
stockholders’ equity, is basically the amount that investors paid the company
for their ownership interest, plus any earnings (or less any losses), and minus
any distributions to owners. For corporation,
Equity is the amount that investors paid the corporation for the stock when it
was initially sold, plus or minus any earnings or losses, less any dividends paid.
Shareholders equity is the carrying or book value of the ownership of a

company. Shareholders’ equity is comprised of: par value, additional paid-in-
capital, retained earnings, accumulated comprehensive income or loss.
The Income Statement
The income statement is a summary of operating performance over a period of

time. We start with the revenue of the company over a period of time and then
subtract the costs and expenses related to that revenue. The bottom line of
the income statement consists of the owners’ earnings for the period. To arrive
at this “bottom line”, we need to compare revenues and expenses.
Analysis of Financial Statements
The purpose of financial analysis is to diagnose the current and past financial
condition of the firm to give some clues about its future condition. The output
of financial analysis is a useful tool in decision-making.
Financial analysis is the process of interpreting the past, present, and future
financial condition of the company.
Types of analysis
In the analysis of the financial standing of the firm, procedures may be

categorized as follows
1. Single-period analysis; and

2. Comparative or trend analysis.
Single-Period Analysis
Single-period analysis refers to comparison and measurements based upon the

financial data of a single-period. It reveals financial position and relationship
as of a given point or period of time.
Ratios, percentages, and other analytical techniques disclose the financial

positions and results of operations of the firm at the end of the current period.
Examples of the single-period analysis are the current and the equity ratios.
Comparative or Trend Analysis
The comparative or trend analysis compares and measures items on the

financial statements of two or more fiscal periods. The improvement or lack of
improvement in financial position and in the results of operation is determined.
Financial Ratios
A very useful method in financial analysis is the use of financial ratios. The
relation of one part of the financial statement to another is expressed through
financial ratios. The net profit, for instance, may be measured in relation to
gross sales.
Financial ratio defined
Financial ratio may be defined as a relationship between two quantities on a

firm’s financial statement or statements, which is derived by dividing one
quantity by another.
Functions of financial ratios
Financial ratios serve the following purposes:
1. As a starting point for detailed financial analysis;

2. To help diagnose a situation;
3. To monitor performance;
4. To help plan forward; and
5. To reduce the amount of data to workable form and to make the data
more meaningful.
Classes of financial ratios
Financial ratios may be classified as follows:
1. Liquidity;
2. Activity;
3. Profitability; and
4. Solvency.
LIQUIDITY RATIO
Liquidity refers to the ability of the firm to pay its bills on time or to meet its
current obligations. Ratios which are used to measure this ability of the firm
are called liquidity ratios.
The amount of short-term financial obligations of the firm can be found in the
current liabilities section of the balance sheet. The ability of the firm to cover
its obligations is determined by the amount of cash and marketable securities
the firm has, as well as the amount of funds tied up in its receivables and
inventory accounts. As soon as the outstanding accounts are collected, the
receivables account will release cash. As soon as the inventory is sold and the
credit sales are collected, funds will be released. It is for such reason that cash
and near-cash items indicated in the balance sheet are known as liquid assets,
and they are viewed as resources which cover the short-term financial
obligations of the firm.
Those classified as liquidity ratios are the following:
1. Current ratio;
2. Acid test ratio;
3. Sales to receivable ratio;
4. Sales to inventory ratio; and
5. Inventory to net working capital ratio.
Exhibit 1
Illustrative Balance Sheet
ABC CORPORATION
Balance Sheet
As of December 31, 2015 and 2016
2015 2016
Current Assets:
Cash php82,700,000 php110,900,000
Accounts receivable (net) 92,600,000 146,200,000
Inventories 88,800,000 129,500,000
Prepaid expenses 2,800,000 6,200,000
Advances from customers 5,300,000 2,800,000
Total current assets 272,200,000 395,600,000
Property, plant and equipment 215,200,000 283,400,000
Less: accumulated depreciation 101,200,000 119,600,000
Net property, plant and equipment 114,000,000 163,800,000
Other assets 3,100,000 4,200,000
TOTAL ASSETS php389,300,000 php563,600,000
Liabilities and net worth

Current liabilities
Accounts payable php43,400,000 Php62,900,000
Accrued income tax 36,700,000 44,000,000
Accrued pension and profit 27,100,000 38,400,000
sharing
Other accruals 21,900,000 21,200,000
Current portion of long-term debt 2,100,000
Total current liabilities 131,200,000 176,500,000
Debenture (9% due 2026 94,000,000
Other long-term debt 7,800,000 4,100,000
Deferred income tax 5,200,000 7,600,000
Common stock (Php1.00 par) 10,100,000 10,200,000
Paid-in surplus 25,100,000 27,200,000
Earned surplus 209,900,000 244,000,000
p
TOTAL LIABILITIES AND NET php389,300,000 Php563,600,000
WORTH
Exhibit 2
Illustrative Income Statement
ABC CORPORATION
Income Statement
For the year ended December 31, 2015 and 2016
2015 2016
Net Sales php655,100,000 php872,700,000

Cost of Goods and services 460,900,000 616,100,000
Gross Profit 194,200,000 256,600,000
Selling, General and Administrative 98,300,000 125,200,000
Expenses
Employee Profit Sharing and Retirement 26,900,000 38,700,000
Operating Profit 69,000,000 92,700,000
Other Income 1,100,000 1,800,000
Interest Paid 1,000,000 7,400,000
Provision for Income Taxes 31,800,000 40,100,000
Net Profit Php37,300,000 Php47,000,000
Current Ratio. This ratio indicates the margin of safety by which a firm can
meet its obligations falling due within the year from such assets easily
convertible into cash within the year. It may be derived with the use of the
following formula:
Current ratio = current assets/current liabilities
Substituting data from the illustrative balance sheet (exhibit 1), the current ratio
for 2016 is computed as follows:
395,600,000/176,500,000 = 2.24
It is widely believed that the current ratio of the firm is satisfactory when it is 2
or better.
Acid test ratio. The acid test ratio, also called quick ratio, is the ratio of cash
assets to current liabilities. It is calculated by deducting inventories from current
assets and dividing the remainder by current liabilities. The formula for the acid
test ratio will then appear as follows:
Acid test or quick ratio = current assets-inventory/current liabilities
Substituting data from the illustrative balance sheet (exhibit 1), the acid test
ratio for 2016 is computed as follows:
395,600,000-129,500,000/176,500,000 =1.5
The result of 1.5 indicates that the more liquid assets of the firm is more than
enough to cover its current liabilities. The acid test is a more stringent test of
shorter, debt-paying capacity than the current ratio because it excludes
inventory.
Sales to Receivable ratio. The ratio may be computed in two ways:
1. In terms of annual turnover; and

2. In terms of collection period
The formula used for computing annual turnover and collection period are as
follows:
Annual turnover = annual net sales/account receivables
872,700,000/146,200,000 = 6 times
When sales to receivables ratio is computed in terms of collection period, what

is determined is the average length of time for which credit is being extended
by the business to its customers. It is calculated with the use of the following
formula.
360 days________
Collection period =
Sales account receivables
Substituting data from exhibits 1 and 2, the collection period is:
360 days
Collection period =
872,700,000/146,200,000
Collection period = 60 days

Sales to inventory ratio. This ratio is a measure of inventory turnover. Firms
with excessive inventories will show a low ratio. The formula is as follows:
Annual receipts from sales________

Sales to inventory ratio =
Inventory at the end of the year
Substituting data from exhibits 1 and 2, the sales to inventory ratio is derived
as follows
Sales to inventory
872,700,000
Ratio =
129,500,000
= 6.73 times
Inventory to networking capital ratio. This ratio shows the proportion of net
current assets tied up in inventory, indicating the potential loss to the company
in the event of a decline in inventory values. It is calculated by dividing net
working capital into inventory figure. Since the net working capital is defined
as current assets minus current liabilities, the inventory to net working capital
ratio would appear as follows:
inventory______________
Inventory to net working capital ratio =
Current assets – current liabilities
Subtituting data from exhibit 1, the ratio would be derived as follows:
Inventory to net
129,500,000
working capital ratio =
395,000,600 – 176,500,000
= 0.59
ACTIVITY RATIOS
Ratios that are used to measure how effectively the firm employs the resources
at its command are called activity ratios.
Four types of ratios are classified as activity ratios. These are the following:
1. Sales to receivable ratio;

2. Sales to inventory ratio;
3. Inventory to net working capital ratio; and
4. Sales to net worth ratio.
It will be noticed that the first three types of activity ratios are also classified as
liquidity ratios. Since they were previously presented, only the last type of
will be discussed.
Sales to Net Worth ratio. The ratio of net sales to owner’s equity represents
the turnover of owner’s equity. The formula used is as follows:
net sales of owners’ equity_______

Sales to net worth ratio =
Tangible owners’ equity
872,700,000_______
Sales to net worth ratio =
281,400,000
Sales to net worth ratio = 3.10 times
PROFITABILITY RATIOS
Probability ratios are those which measure management’s effectiveness as

shown by the returns generated on sales and investment. Ratios indicating
profitability consist of the following:

2. Profit to net sales;
3. Profit to net worth; and
4. Profit to assets.
Since the sales to inventory ratio is also classified under the liquidity and activity
ratios, only the last three ratios on profitability will be discussed.
Profit to net sales. This ratio, also called profit margin on sales, is computed by
dividing net income after taxes by sales. The result is the profit margin expressed
in percentage. Using data from exhibit 2, the profit margin for 2016 is computed
as follows:
Profit margin = net income/sales
= 47,000,000/572,700,000
= 5%
Profit to net worth. This ratio, also referred to as return on net worth ratio,
measures the rate of return on the owner’s investment. Using figures provided
under exhibits 1 and 2, the formula and computation are provided as follows:
Return on net worth = Net income

Net worth
Return on net worth = 47,000,000/281,400,000
Return on net worth = 16%
Profit to assets. This ratio is also called return on total assets ratio. It measures
the return on total investment in the firm. It is computed as follows:
Return on total assets = net income/total assets

= php47,000,000/php563,600,000
= 8%
SOLVENCY RATIOS
Solvency ratios refer to those which measure the ability of the firm to pay its
debt eventually, if it is not paid on time. The solvency ratios include the
following:
1. Current ratio;
3. Inventory to net working capital ratio;
4. debt to net worth ratio;
5. net worth to fixed assets ratio; and
6. sales to net worth ratio.
Debt to net worth ratio. This ratio shows the relative proportion of debt to equity.
In effect, it measures the debt exposure of the firm. The formula and sample
calculation are as follows:
Total debt
Debt to net worth ratio =
Net worth
Debt to net worth ratio = 282,200,000

281,400.000
Debt to net worth ratio = 100%
Net worth to fixed assets. This ratio indicates to what extent fixed assets have
been financed by the contribution of the stockholders. Using exhibit 1 as a
basis, the ratio is calculated with the use of a formulas follows:
Net worth to fixed assets = net worth/fixed assets
= 281,400,000/163,800,000
= 171%
COMPARATIVE RATIO ANALYSIS
Financial ratios may be made more useful by comparing them to the financial
ratios of other firms in the industry. If the firm’s ratio is different from that of the
industry, the cause of the deviation should be investigated.
Comparisons may be made either with those of selected firms or with averages
for the industry. The data that will be used in the comparisons may be gathered
from annual surveys, such as those made for the top 1,000 Philippine
corporations. In addition, the publication requirements imposed on financial
intermediaries also provide the analyst with ready materials. Banks, insurance
companies, and financing firms, for instance, are required by the government to
have their financial statements published in the newspapers. Otherwise, the
Securities and Exchange Commission is a very useful source of financial data
relating to registered firms.
Financial analysis is a way by which various groups would know the financial
condition of the firm. This is determined through single-period or comparative
analysis.
A useful method in financial analysis is the use of financial ratios. The

relationship between two quantities on a firm’s financial statement is determined
through this method.
Financial ratios are classified as either (1) liquidity; (2) activity; (3) profitability;
or (4) solvency.
Liquidity ratios are used to determine the ability of the firm to meet the resources
at its command.
Activity ratios are used to measure how effectively the firm employs the
resources at its command.
Profitability ratios are which measure management’s effectiveness.
Solvency ratios are used to measure the ability of the firm to pay its debt
eventually, if it is not paid on time.
Financial ratios may be made more useful by comparing them with those of
other firm’s ratios.
IX. Post-test:
Statement Analysis Write your answer on the space provided before each
item.
Write Statement a Statement b

A TRUE TRUE
B TRUE FALSE
C FALSE TRUE
D FALSE FALSE
___________ 1. Statement of Cash Flow

a) Describes sources and uses of funds
b) Presents assets, liabilities, and equity
____________ 2. Statement of Changes in Owner’s Equity

a) Beginning capital
b) Ending capital
___________ 3. Statement of Income

a) Presents record of sales
b) Presents record of expenses
___________ 4. Statement of Financial Condition

a) Presents assets, liabilities, equity
b) Presents sales and expenses
___________ 5. Current ratio

a) Current assets – inventory
b) Current sales
___________ 6. Accounts receivable turnover

a) Annual cash sales
b) Accounts receivables
___________ 7. Quick assets
a) Cash
b) Accounts receivables
___________ 8. Profit to net sales

a) Net income
b) Sales
__________ 9. Net worth to fixed assets

a) Net worth
b) Fixed assets
___________10. Single period analysis

a) Comparison
b) measurements


Management. USA: John Wiley and Sons, Inc. 2010.

Sons, Inc. 2017.



Midterm Examination – (Week 9)

I. Unit Title
Unit 5: Cost of Capital

1. Cost of Capital
2. Weighted Average Cost of Capital
3. Cost of Borrowing
4. Cost of Debt
5. Cost of Equity
III. Duration: 6 Hours, Week 10-11
IV. Introduction:
Financing Activity would include borrowing money or taking loans from a

financial institution. The said resources of fund would carry some cost in order
to acquire it from the lender and the said cost is known as the “cost of capital”.
Simply stated, cost of capital is the cost incurred in order to raise needed fund
for business operations. The said cost is also referred to as financing cost
(interest rate) the company pays when securing a loan. Business firms normally
define their own “cost of capital” in one of two ways:
Firstly, cost of capital” simply refers to the financing cost the needs to
be paid when borrowing funds, either by securing a loan or by selling bonds or
equity financing and this comes in the form of annual interest rate, such as 5%,
or 10%. Secondly, it it refers to investment decision making, cost of capital may
be referred to as the rate of return that can be earned on such investment.
V. Objectives:
At the end of this lesson, the students are expected to:

1. Recognize the meaning of cost capital;
2. Explain and discuss the cost of borrowing, debt and equity; and
3. Illustrate cost of capital through the use of weighted average cost of
capital and capital asset pricing models.
.
VI. Pretest
Practical exercise/question:
1. What is the cost of capital?
2. What is the purpose of computing weighted average cost of capital?
3. What is borrowing cost?
4. What is cost of debt?
5. What is cost of equity?
Write your answer here:

Weighted Average Cost of Capital (WACC)
What Is a Weighted Average cost of Capital?

A Weighted Average Cost of Capital is the arithmetic average (mean) capital
costs that weighs the contribution of each capital source by the proportion of
total funding it provides.” Weighted average cost of capital usually appears as
an annual percentage. Calculating WACC is a matter of summing the capital
cost components, multiplying each by its appropriate weight. For example, in
simplest terms:
WACC = (Proportion of total funding that is equity funding) x (cost of equity) +

(proportion of total funding that is debt funding) x (cost of debt) x (1-corporate
tax rate)
To illustrate, a firm has determined its cost of each source of capital and optimal
capital structure, which is composed of the following sources and target market
value proportions:
Source of Capital Target Market After Tax Cost WACC (TMP x

Proportions (TMP) (ATC) ATC)
Long term debt 40% 6% 2.40%
Preferred Stock 10% 11% 1.10%
Common Stock 50% 15% 7.5%
Total 100% 11.00%
It will be noted based on the above illustration that WACC is simply computed
by multiplying the total market proportion to the after tax cost. Thus, the WACC
for the given example is 11%.
Cost of Borrowing
Cost of Borrowing refers to the total amount a debtor pays to secure a loan and
use funds, including the finance costs, account maintenance, loan origination,
and other loan related expenses.
When a debtor repays a loan over time, the following equation holds:
Total Payments = Repayment of loan principal + cost of Borrowing
Cost of borrowing may include for instance, interest payments, and (in some
cases) loan origination fees, loan amount maintenance fees, borrower
insurance fees, and still other fees. As an example, consider a loan with the
following properties:
Loan Properties:
Amount to borrow (loan principle): 100,000.00
Annual Interest rate 6.0%
Amortization time 10 years
Payment frequency monthly
Annual Borrower Insurance P 25
Such a loan calls for 120 monthly payments of P1,110.21. Therefore, the
borrower who makes all payments on schedule ends up repaying a total of
120x1,110.21 or P133,225. The borrower will also pay P200 for loan
origination, P600 in account maintenance fees (120xP5), and P250 in borrower
insurance. The cost of borrowing, therefore, calculates as:
Cost of Borrowing calculation

Total repayments P133,225.20
Less: principal repaid (100,000.00)
Total interest payments 33,225.20
Loan Origination fee 200.00
Account maintenance 600.00
Borrower insurance fees 250.00
Total cost of borrowing P34,255.20
Cost of Debt
Cost of Debt is the overall average rate an organization pays on all its
obligations.
Theses typically consist of bonds and bank loans. “cost of Debt” usually
appears as an annual percentage.
For a company with marginal income tax rate of 30% and before tax cost of
debt of 6%, the after tax cost of debt is as follows:
After –tax cost of debt+ (Before tax cost of debt) x (1 – marginal tax rate)
=(0.06) x (1.00 -0.30)
=(0.06) x (0.70)
=0.042 or 4.20%
As with the cost of capital, cost of debt tends to be higher for companies with
lower credit ratings – companies that the bond market considers riskier or more
speculative. Whereas, cost of capital is the rate the company must pay now to
raise more funds, cost of debt is the cost the company is paying to carry all debt
it has acquired.
Cost of debt becomes a concern for stockholders, bondholders, and potential
investors for high leverage companies (i.e. companies where debt financing is
large relative to owner’s equity.) High leverage is riskier and less profitable in a
weak company when the company’s ability to service a massive debt load may
be questionable.
The cost of debt may also weigh in management decisions regarding asset
acquisitions or other investments bought with borrowed funds. The additional
cost of debt in such cases reduces the value if investment tools such as return
to in investment or internal rate of return (IRR).
Cost of Equity
Cost of equity (COE) is part of a company’s capital structure. COE

measures the returns demanded by stock market investors who will bear the
risks of ownership. COE usually appears as annual percentage.
One approach to calculating cost of equity refers to equity

appreciation and divided growth.
Cost of Equity = (Next year’s dividend per share + Equity appreciation per
share)
Current market value of stock) + Dividend growth
For example, consider a stock whose current market value is P8.00, paying an
annual dividend of P0.20 per share. If those conditions held for next year, the
investor’s return would be simply 0.20/8.00, or 2.5%. When the investor requires a
return of, say 5%, one or two terms of the above equation must change:
1. If the stock price appreciates 0.0 to 8.20, the investor would experience a
5% return: (0.20 dividend + 0.0 stock appreciation)/ 8.00 current value of
stock).
2. When, instead, the company doubles the dividend (dividend growth) to
0.40, while the stock price remains at 8.00, the investor also experiences a
5% return.
Calculating cost of Equity from the Capital Asset Pricing Model (CAPM)
Cost of equity = (Market risk premium) x ( Equity beta) + Risk – less rate
Consider a situation where the following holds for one company’s stock:
Grande Company Common Shares
Market Risk Premium 4.0%
Equity beta fort his stock: 0.60
Risk – free rate P1,800.00
Using these CAPM data and the formula above, Cost of Equity is as follows:
Cost of Equity = (4.0%) x (0.60) +5.0% =7.4%

In the CAPM, beta is a measure of the stock’s historical borrowing usually price
changes compared to changes in the market as a whole. A beta of 0 indicates the
stock tends to rise or fall independently from the market. A negative beta means a
stock tends to rise when the market falls, and the stock tends to fall while the
market rises. A positive beta means the stock tends to rise and fall with the
market.
Recitation will be used to provide for students’ insights on the lesson

presented, sample questions will be:
1. What can you say about the use of Capital Asset Pricing Model?
2. Considering the use of Weighted Average cost of Capital, does it

reflects the average future costs of funds over the long run?
3. Can financial/business have benefited from the use of cost of equity?
IX. Post-test
SELF ASSESSMENT [10 points]: True or False
________1. Using the Capital Asset Pricing model, the cost common stock
equity is the return required by investors as compensation for the firm’s non-
diversifiable risk.
________2. Use of the Capital Asset Pricing Model in measuring the cost of
common stock equity differs from the constant growth valuation model in that it
directly considers the firm’s risk as reflected by beta.
________3. The capital asset pricing model describes the relationship between
the required return, or the cost of common stock equity capital, and the non-
systematic risk or the firms as measured by beta coefficient.
________4. The cost of common stock equity is the rate at which investors
discount the expected dividends of the firm.
________5. The cost of common stock equity may be estimated by using the
capital asset pricing model.
________6. The weighted average cost that reflects the interrelationship of
financing decisions can be obtained by weighing the cost of each source of
financing by its target proportion in the firm’s capital structure.
________7. In computing the weighted average cost of capital, the historic
weights are either book value or market value weights based on actual capital
structure proportions.
________8. The weighted average cost of capital reflects the expected average
future cost of funds over the long run.
________9. Since retained earnings is a more expensive source of financing
than debt and preferred stock, the weighted average cost of capital will fall once
retained earnings have been exhausted.
________10. A firm may face increases in the weighted average cost of capital
either when retained earnings have been exhausted or due to increases in debt,
preferred stock, and common equity costs as additional new funds are required.
TASK TO-DO [80 POINTS]:
Below are the given scenarios Provide for your evaluation after you have done
give your analysis to the following independent cases (20 points)
1. What is the approximate before tax cost of debt for a 15 year, 10 percent, P
1,000 par value bond selling at P950?
2. What is the approximate before tax cost of debt for a 10 year, 8 percent,
P1,000 par value bond selling at P 1,150?
Submission should be done before moving to the next unit or until instructed.
KEY TAKEAWAYS:
1. Cost of capital is part of company’s structure.
2. Weighted average cost of capital is a matter of summing the capital cost
of components, multiplying each by its appropriate weight.
Ariel Dizon Pineda, Basic Financial Management,2019.
I. Unit Title
Unit 6: Bonds and Stocks Valuation

1. Concepts of Bonds
2. Concepts of Stocks
3. Common Stock Valuation Models
III. Duration: 6 Hours, Week 12-13
IV. Introduction:
Bonds, defined
Most people would always ask what really is the meaning of
bonds. How bonds become a source of financing? Simply stated, bonds are a
source of financing in the form of debt or borrowing. When a business issues a
bond, the money received is then considered a loan and needs to be paid over
a period of time. Like any other form of financial borrowing or debts, bonds
would entail periodic interest to be paid to the lenders.
Bonds are commonly issued by the government and corporations
commonly in order to raise needed funds or capital. The government would
require funds in order to finance the building of various infrastructure projects
such as roads, schools, dams and many more. On the other hand, the
corporations, would use bonds to expand their business or raise capital to
undertake profitable projects. Large companies and even the government
would require huge amount of money that financial institutions like bank would
not be able to provide.
V. Objectives:
At the end of this lesson, the students are expected to:

1. Explain the meaning of bonds and stocks;
2. Identify the difference between bonds and stocks;
3. Discuss common stock valuation models;
4. Recognized the importance of bonds and stocks in financial
management; and
5. Solve problems related to bonds and stock valuation.
.
VI. Pretest
Practical exercise/question:
a. What is the meaning of bonds?
b. Discuss what is face value? Maturity value? Coupon rate?
c. Discuss the advantages and disadvantages of bond investment?
d. How does investing in bonds affect the economy?
e. What are the commonly known type of stocks? Discuss each.
f. Discuss the dividend discount method.
g. Discuss the discounted cash flow method.
h. Discuss the concept of preferred stock valuation.
Write your answer here:
Bonds are commonly issued by the government and corporations

commonly in order to raise needed funds or capital. The government would
require funds in order to finance the building of various infrastructure
projects such as roads, schools, dams and many more.
Advantages and Disadvantages of Bonds

Bonds become an attractive source of financing because of the
following advantages:
1. Investor will receive regular income through interest earned
from the bonds over a period of time.
2. Full amount of investment will be received by the investor on
the maturity date of the bond.
3. Profit can be generated from the bonds if it can be sold on a
higher price compared to the amount when it was bought.
However, certain precautions need to be exercised as
investing in bond also have some disadvantages such as:
1. Since bond investment normally covers a long period of

time like 5 or 10 years, the interest received might not be
even enough to cover inflation, thus instead of gaining
profit it might even result a loss.
2. The risk of companies not being able to return the money
to investors. This could happen if the money borrowed is
not put into profitable projects.
Any bond investor must consult an experienced fund manager

to choose or pick the best selection of bonds.
Effect on Bonds in the Economy
At the time of recession or when the economic conditions decline,

the government may opt to issue bonds in order to generate enough funds
for its projects. A bond investment during this period might be attractive as
the government may offer better interest rates to attract the general public
or individual investor to buy the bonds.
On another side, if the stocks market is on a decline stage,

corporation will use or sell bonds in order to attract investors and raise the
needed funds to sustain business operations. Investors will not be attracted
to bonds if the stock market or investment offers better rates and return.
Concept of Stocks
Stocks, defined
Corporation normally raise funds by selling stocks. But what do
we really mean by stocks and how it becomes source of financing or raising
corporate capital requirement? Acquisition or buying stocks from a
corporate entity would allow an investor to own part of business firm.
Corporation would sell control of the company in the form of stocks to
investors or stockholders to raise or acquire funds to sustain or expand
business operations.
Most commonly types of stocks are common and preferred

stocks. Common or ordinary stocks give the owner to exercise voting rights
in corporate decisions while preferred stockholders don’t. However,
preferred shareholders are legally entitled to receive a certain level of
dividend payments before any dividends can be issued to other
shareholders. A convertible preferred stocks refers to a type of stock that
has option to be converted into a fixed number of common shares, usually
any time after a predetermined date.
Advantages and Disadvantages of Stocks
One may wonder on what the disadvantages in investing in stocks

are and among them are:
1. Contribution to economic growth – When company performance results

to profit, it affects the growth of the economy. In the same way that if the
economy grows, it generates enough purchasing power which allows
people to have enough money to spend and thus results to businesses
to grow and generate profits.
2. Beats inflation – Dividends received from stocks range from 10% - 12%
which are normally higher to an average inflation rate that ranges
between 3%-5%
3. Accessibility – Stocks can be bought in capital market through broker, a
financial planner, or online.
4. Return on Investment – Investors would normally buy stocks when the
prices are low and later sell when the prices are high. Thus, aside from
the dividends received from stocks, they can also generate profit when
investors resell them at the most appropriate time.
5. Liquidity and conversion to cash – Stocks may be sold at any given time
as it does not carry a maturity date.
But an investor my also consider some disadvantages of owning stocks.
1. Investment Risk – When a company performs poorly, stock price will

decrease and thus investor is at risk of losing on the investment
made.
2. Priority for payment - When the company goes bankrupt,
stockholders will receive payment only after all third party creditors
have been paid.
3. Time requirement – Time is needed to do research, read FS and
annual reports, follow company’s developments in the news and
monitor the stock market in order to arrive to a decision on which
company to buy stocks.
4. Stock prices volatility – Depending on the individual intention, this
could result to some emotional high since stocks’ prices have a
tendency to ho high or low.
5. You compete against professionals. Institutional investors and
traders have more time and knowledge to invest. Find out how to
gain an advantage as an individual investor.
Common Stock Valuation Models
Common stock valuation can be either through absolute and relative

valuation models.
Under absolute valuation, the focus will be on dividends, cash flow and growth
rate of a single. Relative valuation models involve calculating multiple ratios,
such as price to earnings multiple, and comparing them to the multiples of
other comparable firms. The focus in this lesson will be the absolute valuation
methods since it is most commonly used by most companies.
Absolute Valuation Model

1. Dividend Discount Method (DDM)
One of the most basic absolute valuation model is the “dividend discount
method” which determine the worthiness of the business based on the
dividends paid to shareholders. This model is used since dividends
represent the actual cash flows going to the shareholder, thus valuing the
present value of these cash flows should give you a value for how much
shares should be worth. Under this model, the dividends should be actually
paid. Companies that pay stable and predictable dividends are the best
suited to use this type valuation method.
To illustrate, let us take the dividends and earnings of ADP company below
(in Philippine Peso)
2012 2013 2014 2015 2016 2017

Dividend 0.50 0.53 0.55 0.58 0.61 0.64
per share
Earnings 4.00 4.20 4.41 4.63 4.86 5.11
per share
Based on the illustration above, it can be observed that the earnings per
share and dividends grow at an average rate of 5% which implies that the
firm’s dividend is consistent with its earnings trend which makes it stable
and predictable. Thus, under this scenario, the company is fit to use the
dividend discount method.
2. Discounted Cash Flow Method (DCF)

Under the discounted cash flow method, it suited for companies that
don’t pay a dividend or payment is irregular. The DCF method uses a firm’s
discounted future cash flows to determine the value of the firm.
The DCF model uses the free cash flows which are forecast for five
to ten years, and then a terminal value is calculated for all of the cash flows
beyond the forecast period. The company should have a predictable positive
free cash flows to be able to use this method.
Let us illustrate this method using the given example (in Philippine
Peso):
2012 2013 2014 2015 2016 2017

Operating 438 789 1462 890 2565 510
cash flow
Capital 785 995 1132 1256 2235 1546
Expenditures
Free cash -347 -206 330 -366 330 -1036
flow
Based on the example, the business shows an increasing positive operating

cash flows but the high capital expenditures indicate that the firm is putting
back a lot of its cash into business to support its operation. As such the result
is negative free cash flows for four of the six years which makes it difficult
(nearly impossible) to predict future cash flows. Thus, in order to use the DCF
method most effectively, the target company should generally have stable,
positive and predictable free cash flows which is shown in the illustration
below:
2012 2013 2014 2015 2016 2017

Operating 438 789 1462 890 2565 510
cash flow
Capital 385 715 1355 745 2365 245
expenditures
Free cash 53 74 107 145 200 265
flow
Percentage 39.62% 44.59% 35.51% 37.93% 32.50%
of increase
Average % 38.03%
There is no perfect valuation method as it changes for every situation, but

it is necessary to know the company characteristics in order to determine the
valuation method that best suits the situation.
Preferred Stock Valuation
The nature of preferred stocks is that it pays a fixed amount of dividend

and this can be used to calculate the value by discounting each of these
payments to the present day. Taking all the dividend payments and calculate
the sum of the present value into perpetuity, then the value of stock can be
determined.
Let us illustrate by looking t ADP Company that pays a 25 centavo-
dividend every month with a required rate of return of 6% per year. To
calculate for the expected stock value of the stock, P0.25/0.005=P50. The
discount rate of 6% was divided by 1 to get 0.005.
V= D1 +D2_+D3 +….Dn___
1+r (1+r)2 (1+r)3 (1 + r)n
Where:
V = the value
D1= the dividend next period
r = the required rate of return
Considerations
If the company earnings are not adequate, it might result to cut off
in the payment of preferred stock dividends. This risk of a cut payment needs
to be accounted for. This risk increases as the dividend payment compared to
earnings gets higher.
Preferred shares do not have the voting rights such as those given
to common shares. For investors who have large amount of shares, this
seems to be valuable feature to individuals as compared to the average
investor who looks at this voting right do not much value. This feature is
needed in evaluating preferred shares marketability.
Preferred shares possess similar characteristics with that of the

bond in terms of valuation. This means the value will also move inversely with
interest rates. When the interest rate goes up, the value of the preferred
shares will go down, holding everything else constant.
Recitation will be used to provide for students’ insights on the lesson

presented, sample questions will be:
a. What can you say about the use of Discounted Cash Flow Method?
b. How does investing in bonds affect the economy?
c. Discuss the concept of preferred stock valuation
IX. Post-test
SELF ASSESSMENT [10 points]: True or False
________1. A type of long term financing used by both corporations and

government entities is common stock.
________2. The return expected from an asset is fully defined by its discount
rate.
________3. The key inputs to the valuation process include returns, discount
rate, and risk.
________4. In the valuation process, the higher the risk, the greater the
required return.
________5. Bonds are a series of short term debt instruments.
________6. When a company performs poorly, stock price will decrease and
thus investor is at risk of losing on the investment made.
________7. When the company goes bankrupt, stockholders will receive
payment only after all third party creditors had been paid.
________8. Institutional investors and traders have more time and knowledge
to invest.
________ 9. Corporation normally raise funds by selling stocks.
________10. Investor will receive regular income through the interest earned
form the bonds over a period of time.
Ariel Dizon Pineda, Basic Financial Management, 2019.

Learning Module in Financial Management

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Learning Module in Financial Management

For Bachelor of Science in Business Administration

This module aimed to assist, supplement and provide guidance to students in

Students’ expectation from course and teacher

Unit 1 - Overview of Financial Management

II. Title of the Lesson

III. Duration: 6 hrs. (Weeks 2 & 3)

At the end of the lesson, the students should be able to:

1. Finance is the application of economic principles to decision making that

2. If a market is highly price efficient, it is not extremely difficult for investors

4. Procurement of funds requires that capital sourcing must be done at the

6. Investment management is the specialty area within finance dealing with

Finance is the application of economic principles to decision making that

Therefore, Finance is:

• Analytical, using statistical, probability, and mathematics to solve

Capital market and capital market theory, financial management, and

Capital Markets and Capital Markets Theory

In finance, beating the market means outperforming the market by generating

Financial management, sometime called business finance or corporate

Investment management involves five primary activities.

THE ROLE AND OBJECTIVE OF FINANCIAL MANAGEMENT

Business finance is both an art and a science. It is concerned with allocating

In allocating financial resources, it is important that funds are channelled to

It is unwise to have excessive balance of cash, receivables, inventoried and

FINANCIAL MANAGER’S RESPONSIBILITY

Financial managers have a major role in a company’s management. This role

In large corporations, the owners or stockholders are usually not directly

Stephen Ross (p4) identified three decisions made by Financial Managers.

 Capital budgeting. This concerns the planning and managing of the

 Capital structuring. This evaluates ways in which the firm obtains

 Working capital management. This refers to the administration of the

An agency relationship arises whenever one or more individuals, called

In this situation, shareholder wealth maximization could take a back seat to

Managers can be encouraged to act in stockholders’ best interests through

1) Managerial compensation. Managers obviously must be compensated,

2) Direct intervention by shareholders. Years ago most stock was owned

3) The threat of firing. Until recently, the probability of a large firm’s

4) The threat of takeovers. Hostile takeovers (when management does not

Stockholders (through managers) versus Creditors

In addition to conflicts between stockholders and managers, there can also be

Now supposed stockholders, acting through management, cause a firm to take

Can and should stockholders, through their managers/agents, try to expropriate

MARKET INTEREST RATES

Loans and Amortization

Whenever a creditor extends a loan, some provisions have to be made for

Present value = Php25,000/1.7623 (refer to Table on Future value at the end

Present value = 10,000/1.07

Year Beginning Principal Interest paid Totally Ending

Year Beginning Principal Interest paid Totally Ending

Agency relationship is very important in the financial management. The owner

The students will be given a recitation to evaluate if they understand the

1. It is the application of economic principles to decision making that

2. This concerns the planning and managing of the firm’s long-term

3. What is the total interest earned if the principal amount of loan is

6. When will be the maturity date of the loan of borrower X as stated on

8. This refers to the administration of the firm’s short term assets,

9. It is sometimes called as business finance or corporate finance,

10. Its concerned is allocating the financial resources of the company

Brigham, Eugene F. and Michael C. Ehrhardt. Financial Management Theory