Financial Management Lesson Notes

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Financial Management Lesson Notes

  1. 1. FINANCIAL MANAGEMENT Ekrem Tufan [email_address] Anadolu University Open Education Faculty Canakkale Office
  2. 2. What will we learn? <ul><li>An overview of managerial finance </li></ul><ul><li>- What is the finance? </li></ul><ul><li>-Managerial finance in the 1990s </li></ul><ul><li>-The financial manager’s responsibility </li></ul><ul><li>- The goals of the corporation </li></ul>
  3. 3. What will we learn? <ul><li>The financial environment: Markets, institutions </li></ul><ul><li>-The financial markets </li></ul><ul><li>-Financial institutions </li></ul><ul><li>-The stock market </li></ul>
  4. 4. What will we learn? <ul><li>3. F inancial Ratios as a tool of financial analysis </li></ul><ul><li>Profitability Ratios —ability of the firm to earn an adequate return and control costs. </li></ul><ul><li>Asset Utilization Ratios —How efficiently the firm’s assets are being utilized. </li></ul><ul><li>Liquidity Ratios —focus on short term risk management. </li></ul><ul><li>Debt Utilization Ratios —focus on the capital structure and long-term risk management </li></ul>
  5. 5. What will we learn? <ul><li>Risk and rates of return </li></ul><ul><li>-Defining and measuring risk </li></ul><ul><li>-Expected rate of return </li></ul>
  6. 6. What will we learn? <ul><li>4. Strategic long-term investment decisions </li></ul><ul><li>-Generating ideas for capital projects </li></ul><ul><li>-Project classifications </li></ul><ul><li>-Similarities between capital budgeting evaluation techniques </li></ul>
  7. 7. What will we learn? <ul><li>5. Capital budgeting evaluation techniques </li></ul><ul><li>-Payback period method </li></ul><ul><li>-Net present value method </li></ul><ul><li>-Internal rate of return method </li></ul>
  8. 8. What will we learn? <ul><li>6. Practice of NPV and IRR methods </li></ul><ul><li>-Example of NP V </li></ul><ul><li>-Example of IRR </li></ul><ul><li>-Example of sensitivity analysis </li></ul><ul><li>Continuation of examples… </li></ul><ul><li>So on, so far… </li></ul>
  9. 9. What kind of resources can we use when we doing research? <ul><li>All finance books </li></ul><ul><li>All articles about finance </li></ul><ul><li>www.ssrn.com </li></ul><ul><li>www.makalem.com </li></ul><ul><li>www.ceterisparibus.com </li></ul><ul><li>Essentials of Managerial Finance, J. Fred Weston and Eugene Brigham, Harcourt Brace&Company International Edition, 1992. </li></ul><ul><li>Finansal Yönetim, Semih Büker and et all, 2005. ( The main book of our lesson! ) </li></ul>
  10. 10. What is the finance? <ul><li>Money </li></ul><ul><li>Stock exchange </li></ul><ul><li>Banks </li></ul><ul><li>What else? </li></ul><ul><li>How about the companies ? </li></ul><ul><li>Balance sheet </li></ul>
  11. 11. What is the finance? <ul><li>To achieve the goals of company; </li></ul><ul><li>Finding funds from the most suitable sources </li></ul><ul><li>Using them effectively and </li></ul><ul><li>Control the results… </li></ul>
  12. 12. An Overview o f Managerial Finance <ul><li>A Short History of Managerial Finance </li></ul><ul><li>1930s: Liabilities and equity , Great Depression </li></ul><ul><li>1940 and 1950s: Assets, quantitative methods, discounted cash flow methods World War II </li></ul><ul><li>1960 and 1970s: Optimization of assets and liabilities and equity, statistical methods , oil crises </li></ul><ul><li>1980s: Globalization, interest rate and exchange risk , macintosh </li></ul><ul><li>1990s to today: More risk, more computer, new financial instruments and methods , Wall Street </li></ul>
  13. 13. An Overview o f Managerial Finance Board of Directors President Vice President:Sales Vice President:Manufacturing Vice President:Finance Treasurer Controller Credit Manager Inventory Manager Director of Capital Budgeting Cost Accounting Financial Accounting Tax department
  14. 14. An Overview o f Managerial Finance <ul><li>The Financial Manager’s Responsibility </li></ul><ul><li>Forecasting and planning </li></ul><ul><li>Major investment and control </li></ul><ul><li>Coordination and control </li></ul><ul><li>Dealing with the financial markets </li></ul>
  15. 15. An Overview o f Managerial Finance <ul><li>The goals of the corporation </li></ul><ul><li>Managerial incentives to maximize shareholder wealth </li></ul><ul><li>Social responsibility </li></ul><ul><li>Stock price maximization and social welfare </li></ul>
  16. 16. Managerial incentives to maximize shareholder wealth <ul><li>Stockholders </li></ul><ul><li>Make the highest money from the company </li></ul><ul><li>Do not want to share theirs company with others. </li></ul><ul><li>Managers </li></ul><ul><li>Having autonomy </li></ul><ul><li>Protect themselves from a hostile takeover or a proxy fight Hostile takeover . doc </li></ul><ul><li>Try to maximize stock prices in reasonable level </li></ul>
  17. 17. Social responsibility <ul><li>Ethical responsibility to provide a safe working environment </li></ul><ul><li>To avoid polluting water and air </li></ul><ul><li>Produce safe products </li></ul><ul><li>But social responsibility has a cost </li></ul><ul><li>If the other firms in its industry do not follow suit, their prices and costs will be lower </li></ul><ul><li>Most investors do not like to buy socially oriented companies shares. </li></ul>
  18. 18. Stock price maximization and social welfare <ul><li>What requires stock price maximization ? </li></ul><ul><li>Efficient, low-cost plants that produce high-quality goods and services at the lowest possible cost </li></ul><ul><li>Development of products that consumers want and need, so the profit motive leads to new technology , to new products, and to new jobs </li></ul>
  19. 19. The Financial Environment: Markets, Institutions <ul><li>The Financial Markets </li></ul><ul><li>Physical asset markets </li></ul><ul><li>Spot markets and futures markets </li></ul><ul><li>Money markets </li></ul><ul><li>Mortgage markets </li></ul><ul><li>World, national, regional and local markets </li></ul><ul><li>Primary markets-secondary markets </li></ul>
  20. 20. Physical asset markets ( Real asset markets ) <ul><li>Wheat, </li></ul><ul><li>autos, </li></ul><ul><li>real estate, </li></ul><ul><li>computers, </li></ul><ul><li>stocks, </li></ul><ul><li>bonds, </li></ul><ul><li>notes, </li></ul><ul><li>mortgages etc. </li></ul>
  21. 21. Spot markets , futures markets, money markets, capital markets <ul><li>In spot and futures markets you can buy and sell assets on the spot delivery or for delivery at some future date, such as six months, or a year in the future. </li></ul><ul><li>Money markets are the markets for debt securities with maturities of less than one year where capital markets for the long term. </li></ul>
  22. 22. World, national, regional and local markets , primary-secondary markets <ul><li>Primary markets, are the markets in which corporations raise new capital. </li></ul><ul><li>Secondary markets, are markets in which existing, already outstanding securities are traded among investors. </li></ul>
  23. 23. The Financial Environment: Markets, Institutions <ul><li>Financial Institutions in Turkey </li></ul><ul><li>Commercial banks </li></ul><ul><li>Pension funds </li></ul><ul><li>Mutual funds </li></ul><ul><li>Life insurance companies </li></ul><ul><li>Stock exchange (ISE) </li></ul><ul><li>Gold exchange (IGE) </li></ul><ul><li>Futures markets (Izmir Futures Market) </li></ul>
  24. 24. The Financial Environment: Markets, Institutions <ul><li>Stock Exchanges </li></ul><ul><li>ISE </li></ul><ul><li>IGE </li></ul><ul><li>Turkish Derivatives Exchange </li></ul><ul><li>Over the counter market </li></ul>
  25. 25. The Financial Environment: Markets, Institutions <ul><li>Istanbul Stock Exchange </li></ul><ul><li>1985 December Inauguration of the Istanbul Stock Exchange under the Chairmanship of Mr. Muharrem KARSLI </li></ul><ul><li>1986 January Commencement of stock trading at the Cagaloglu building on January 3, 1986 </li></ul><ul><li>1991 June Initiation of the Bonds and Bills Market and commencement of Outright Purchases and Sales Transactions </li></ul><ul><li>1997 August launch of the Repo/ Reverse Repo Market </li></ul><ul><li>2005 January ISE Derivatives Market is closed permanently as of January 28, 2005 </li></ul>
  26. 26. The Financial Environment: Markets, Institutions <ul><li>Istanbul Gold Exchange </li></ul><ul><li>26 July 1995 Inauguration of the IGE </li></ul><ul><li>15 August 1997 establishment of the Futures and Options Market </li></ul>
  27. 27. The Financial Environment: Markets, Institutions <ul><li>Turkish Derivatives Exchange (TURKDEX) </li></ul><ul><li>04 July 2002, establishment of the Turkish Derivatives Exchange </li></ul><ul><li>04 February 2005, transactions started officially </li></ul>
  28. 28. Risk And Rates Of Return <ul><li>Defining and measuring risk </li></ul><ul><li>Expected Rate of Return </li></ul><ul><li>Measuring Risk: The Standard Deviation </li></ul><ul><li>Measuring Risk: Coefficient of Variation </li></ul>
  29. 29. Risk And Rates Of Return <ul><li>What is the risk in finance? </li></ul><ul><li>Risk is the financial uncertainty that the actual return on an investment will be different from the expected return. </li></ul><ul><li>The exposure to loss of investment as a result of changes in business conditions, domestic or foreign economies, investment markets, interest rates, relative currency rates, or inflation. </li></ul>
  30. 30. Expected Rate of Return <ul><li>Calculation of Expected Rates of Return: </li></ul><ul><li>Payoff Matrix </li></ul><ul><li>Expected Rate of Return.xls </li></ul>
  31. 31. Expected Rate of Return <ul><li>The weights are the probabilities, and the weighted average is the expected rate of return, </li></ul><ul><li>Expected rate of return= </li></ul>
  32. 32. Expected Rate of Return
  33. 33. Measuring Risk: Standard Deviation <ul><li>XU1002002-12. xls </li></ul>
  34. 34. Coefficient of Variation as a Risk Measure <ul><li>Coefficient of variation (CV), standard deviation divided by the expected return </li></ul>
  35. 35. Strategic Long-Term Investment Decisions <ul><li>Generating ideas for capital projects </li></ul><ul><li>Who creates the capital budgeting projects? </li></ul><ul><li>Do we need to be an entrepreneur? </li></ul><ul><li>Two questions for testing being entrepreneur </li></ul><ul><li>( CV and address book ) </li></ul>
  36. 36. Strategic Long-Term Investment Decisions <ul><li>Project classifications </li></ul><ul><li>Replacement: Maintenance of business </li></ul><ul><li>Replacement: Cost reduction </li></ul><ul><li>Expansion of existing products or markets </li></ul><ul><li>Expansion into new products or markets </li></ul><ul><li>Safety and/or environmental projects </li></ul><ul><li>Other </li></ul>
  37. 37. Project classifications <ul><li>Replacement: Maintenance of business </li></ul><ul><li>One category consists of expenditures to replace worn-out or damaged equipment used in the production of profitable products. </li></ul><ul><li>Should we continue to produce these products or services? </li></ul><ul><li>Should we continue to use our existing production processes? </li></ul>
  38. 38. Project classifications <ul><li>Replacement: Cost reduction </li></ul><ul><li>This category includes expenditures to replace serviceable but obsolete equipment. </li></ul><ul><li>The purpose here is to lower the costs of labor, materials, or other inputs such as electricity. </li></ul>
  39. 39. Project classifications <ul><li>Expansion of existing products or markets </li></ul><ul><li>Expenditures to increase output of existing products, or to expand outlets or distribution facilities in markets now being served are included here. </li></ul>
  40. 40. Project classifications <ul><li>Expansion into new products or markets </li></ul><ul><li>These are expenditures necessary to produce a new product or to expand into a geographic area not currently being served. </li></ul>
  41. 41. Project classifications <ul><li>Safety and/or environmental projects </li></ul><ul><li>Expenditures necessary to comply with government orders, labor agreements, or insurance policy terms fall into this category. </li></ul>
  42. 42. Project classifications <ul><li>Other project investments </li></ul><ul><li>This catch all includes office buildings, parking lots, executive aircraft, and so on. </li></ul>
  43. 43. Strategic Long-Term Investment Decisions <ul><li>Similarities between capital budgeting evaluation techniques </li></ul><ul><li>Project cost </li></ul><ul><li>Expected cash flows estimation </li></ul><ul><li>Estimation of project riskiness </li></ul><ul><li>Cost of capital decision </li></ul><ul><li>Measurement of present value of cash inflows </li></ul><ul><li>Present value of the expected cash inflows and required outlay </li></ul>
  44. 44. Capital Budgeting Evaluation Techniques <ul><li>Payback Period </li></ul><ul><li>Net Present Value (NPV) </li></ul><ul><li>Internal Rate of Return (IRR) </li></ul><ul><li>Sensitivity Analysis </li></ul>
  45. 45. Capital Budgeting Evaluation Techniques <ul><li>Payback period </li></ul><ul><li>Project S : </li></ul><ul><li>Net Cash Flow </li></ul><ul><li>Cumulative NCF </li></ul>
  46. 46. Payback period <ul><li>Project (S) </li></ul><ul><li> Uncovered cost at start of year </li></ul><ul><li>Payback=Year before full recovery + </li></ul><ul><li>Cash flow during year </li></ul><ul><li> 100 </li></ul><ul><li>Payback Period (S)= 2 + = 2,333 Years </li></ul><ul><li> 300 </li></ul>
  47. 47. Capital Budgeting Evaluation Techniques <ul><li>Payback period </li></ul><ul><li>Project L : </li></ul><ul><li>Net Cash Flow </li></ul><ul><li>Cumulative NCF </li></ul>
  48. 48. Payback period <ul><li>Project (L) </li></ul>200 Payback Period ( L )= 3 + = 3 ,333 Years 6 00
  49. 49. Capital Budgeting Evaluation Techniques <ul><li>Net Present Value (NPV) </li></ul>
  50. 50. Capital Budgeting Evaluation Techniques <ul><li>Internal rate of return (IRR) </li></ul><ul><li>The IRR is defined as that discount rate which equates the present value of a project’s expected cash inflows to the present value of its expected costs. </li></ul>
  51. 51. Capital Budgeting Evaluation Techniques <ul><li>Internal rate of return (IRR) </li></ul>
  52. 52. Net Present Value (NPV) <ul><li>To implement this method, it should be proceeded as follows: </li></ul><ul><li>Find the present value of investment and its future cash flows with discounting at the project’s cost of capital </li></ul><ul><li>Sum discounted investment and cash flows </li></ul><ul><li>If the NPV is positive then we accept the project. If we have to choose a project among the alternate projects, we should take into consider the highest NPV </li></ul>
  53. 53. Example of NPV and IRR <ul><li>Small Scale Flower Cultivation Project </li></ul><ul><li>This project h as written by Weitz Center experts for an area in India. </li></ul><ul><li>The project covers an area about one acre. The aim is producing and selling flowers. Project’s cost will be covered by a bank loan. All cost and sale data have been collected and realised that target sales could be achieved. Cost benefit analysis Flower . xls </li></ul>

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