The document discusses the course of studies for finance which includes capital budgeting, capital structure, dividend policy, and working capital decisions. It lists textbooks on corporate finance and principles of managerial finance. It provides an overview of finance functions in a corporate organization including capital budgeting, financing mix, project evaluation, and maximizing shareholder value. The objective of financial management is to provide an optimal framework for financial decision making.

1. Narain
narain@fms.edu
narain@fms edu

2. Course of studies
AIM: To acquaint with the broad framework of financial
decision making in a business unit
 Th fi
The finance function
f i
 Capital Budgeting
 C it l St t
Capital Structure
 Dividend Policy
 Working Capital Decision
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3. Books for studies
 Brealey & Myers – Principles of Corporate Finance
 Damodaran – Corporate Finance
 Ross, Westerfield & Jordan – Fundamentals of
Corporate Finance
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4. Some more …………
 Gitman – Principles of Managerial Finance
 Van Horne – Financial Management & Policy
 Brigham – Financial Management
 Myers et. al. – Contemporary Financial Management
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5. Some Indian authors …….
 V K Bhalla
 I M Pandey
 Khan & Jain
 P Chandra
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6. Finance?
FINANCE is concerned with the process, institutions,
markets, instruments and services involved in the
markets instruments and services involved in the
transfer of money, among and between, individuals,
businesses and Governments.
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7. Segments of Finance
Financial Process
Financial Institutions
Financial Markets
Financial Instruments
Financial Services
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8. Entities in Finance
Personal Business
Finance Finance
Individuals Businesses
Governments
Public
Finance
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9. Financial Management
Corporate Financial Management is a part of Business
Finance
Financial Management is the study about the decisions
of procuring and judicious use of the financial
resources of the firm with a view to maximise the
wealth of the firm.
f f
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10. Judicious?
Invest in projects that yield a return greater than the minimum acceptable hurdle rate.
The hurdle rate should be higher for riskier projects and should reflect the financing
mix used ‐ either owner’s funds or borrowed money.
i d ih ’ f d b d
Returns on projects should be measured on the basis of cash flows generated, the
timing of these cash flows and both positive & negative side effects of these projects.
Choose a financing mix that maximises the value of the firm and matches the assets
being financed.
If there are not enough investments that earn the hurdle rate, return the cash to the
owners of the firm.
The form of returns – di id d d t k b b k will depend on the
Th f f t dividends and stock buybacks – ill d d th
stockholders’ characteristics.
Objective: Maximise the value of the firm
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11. Corporate Organisation
S T O C K H O L D E R S
elects
Owners Board of Directors
hires
Managers President
(MD/CEO)
VP‐HR VP‐Operations VP‐Finance VP‐Marketing VP‐IT
(CFO)
Treasurer Controller
• Financial planning • Corporate Accounting manger
• g g
Fund raising manager • g g
Financial Accounting manager
• Capital expenditure • Cost Accounting manager
• Credit manager • Tax manager
• Cash manager
• Pension fund manager
• Foreign exchange manager
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12. Roles of finance managers
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13. Career in Managerial Finance
 Financial Analyst
 Capital Expenditures manager
 Project Finance manager
 Cash manager
 Credit Analyst/manager
 Pension Fund manager
 Foreign Exchange manager
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14. Functions of finance manager
o The extent of the functions is determined by:
 Size of organisation
 Big or small
ll
 Nature of business activity
 Manufacturing or non manufacturing
Manufacturing or non‐manufacturing
 Management philosophy
 Reliance on external person
 Degree of specialisation
 Organisational structure
 Vertical or flat
V i l fl
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15. Finance managerial functions
 Provision of capital
 Realistic programmes
 Investor relation
 Market for company’s securities
 Liaison with investment bankers, analysts & major S/hs
 Short term financing
h f
 Adequate sources
 Commercial banks etc
 Banking & Custody
 Banking relations
 C t di f
Custodian of company’s money & securities
’ & iti
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16. Finance managerial functions
 Credit & collection
 Supervising special offers e.g. sales discount, exchange
offer, lease, etc.
ff l t
 Investment
 Making real investments
 Policies for external investments
 Insurance
 Adequate risk coverage
 Planning for control
g
 Establish, coordinate & administer
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17. Finance managerial functions
 Reporting & Interpreting
 Compare with established plans
 Interpret the results to managers owners etc
Interpret the results to managers, owners, etc
 Evaluating & Consulting
 Consult all business segments
g
 Effectiveness of organisational goals
 Tax administration
 Tax policies and procedures
 Government Reporting
 Supervise and coordinate
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18. Finance managerial functions
 Protection of Assets
 Internal control, internal checks and internal audit
coverage
 Economic Appraisal
 Appraise continuously the economic & social forces
 Interpret their impact on business
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19. Objective of Financial
j
Management
 To provide framework for optimum financial decision
making
OOperationally useful criteria to judge business decision
i ll f l i i j d b i d i i
 Provide a normative framework
 Wh t th
What the company should try to achieve/
h ld t t hi /
 May not necessarily is followed in actual practice
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20. Basis criteria of objectives
 Precise and Exact
 As far as possible
 Based on “Bigger the better” principle
 Considers both quantity and quality of benefits
 S bili f b
Stability of benefits over time
fi i
 High probability of occurrence
 Recognises the “Earlier the better” principle
the Earlier the better
 Time value of money
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21. Some competing objectives
Objectives Preciseness Bigger the Quality & Earlier the
better Quality better Rule
Profit
maximisation
Current Ratio
maximisation
EPS
maximisation
a sa o
Share Price
maximisation
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22. Shareholder’s Value
 E (Cash Flowi ) 
Value    
i  (1  k ) i

 It involves precise estimation of benefits:
 Cash Flow
 Higher cash flow will accumulate the value of the firm
h h fl ll l h l f h f
 Bigger the better
RRecognises the time of receipt of cash flows
i th ti f i t f h fl
 Earlier the better
 Considers both quantity & quality of cash flows
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23. Maximisation of Share Price
 Corporate mangers should strive to achieve
maximisation of value of the firm
 Fi i l d b h i
Firm includes both investors & lenders
& l d
 Lenders can protect themselves contractually
 M i i th l f th
Maximise the value of the owners for whom it is being
f h it i b i
operated
 Share price is an observable & real measure of owners’
Share price is an observable & real measure of owners
value, if not perfect measure
 Market may make a mistake in its assessment of
shareholders’ value
h h ld ’ l
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24. Value Addition
 Value added is the market price of the output of an
enterprise less the price of the goods and services
acquired by transfer from other firms
 This is the total pie that can be divided among the
various contributors
 Employees, owners, creditors and governments
 Thus, it includes –
,
 Wages, rent, interest, taxes, dividends and retentions
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25. I & i i
Income concepts & recipients
 Value added
V l dd d
 Employees, owners, creditors & governments
 Enterprise net income
 Stockholders, bondholders & governments
 Net income to investors
 Stockholders & long term debt‐holders
 Net income to shareholders
 Stockholders (preferred & equity)
 Net income to residual equity holders
 Equity shareholders
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26. Economic Value Added
 Popular measure to determine whether an investment,
proposed or existing, positively contributes to the
owner s wealth
owner’s wealth
 Used in AT&T, Coca‐Cola, Quacker Oats, etc.
 EVA= Operating Profit After Tax – Cost of funds used
to finance an investment
 Positive EVA: increases S/Hs value
/
 Numerous accounting & financial issues involved
 Relatively simple & strongly linked to owner’s wealth
y p gy
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27. Market Value Added
 Most directly related by the EVA
 Definitive and reliable measure of wealth creation
 Equals difference between the market value of the firm
and the capital contributed by the shareholders and
lenders
 In fact, is the cumulative amount by which a company
has enhanced or diminished shareholders value
has enhanced or diminished shareholders’ value
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28. Stakeholders Vs. Shareholders
 Employees, creditors, suppliers, customers, regulators,
governments and others having direct economic link
with the firm.
with the firm
 Stakeholders focuses firm – avoiding actions
detrimental to stakeholders
 Does not alters the goal of value/wealth maximisation
 A part of Governance and Social Responsibility
p p y
 Minimise stakeholder turnover, conflict and litigation
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29. Agency issue
 Goal of the finance manager is the maximisation of the
wealth of the owners of the firm
M
Management can be viewed as agents of the owners
b i d f h
 Owners hires the management
 Gives the decision making authority to manage the firm
for owner’s benefits
 In practice, managers concerned with their own
p , g
benefits
 E.g. personal wealth, job security, lifestyle, fringe
benefits, etc.
b f
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30. Agency issue
 Manager’s personal goals may make managers reluctant
or unwilling to take more than moderate risk if they
perceive it to be in conflict with their personal goals
 The result of such a “satisfying approach” is
 A compromise between satisfaction & maximisation
 less than the maximum return & potential loss of wealth
for the owners
 The resolution is‐
A. Market Forces
B. Agency costs
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31. A: Market Forces
1. Institutional Investors:
 E.g. Insurance companies, Mutual Funds, Pension
Funds, etc.
F d t
 Holds large blocks of a firm’s stocks
 They actively uses their votes to oust under performing
managers and replace them with more competent
managers
 Also communicate with the companies and exert
pressure on management to perform or be fired
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32. A: Market Forces
2. Hostile Takeovers
 Acquisition of a firm (the target) by another firm or
group (the acquirer) that is not supported by
(th i ) th t i t t d b
management
 Typically occurs when the acquirer feels that the target
yp y q g
firm is being poorly managed, and as a result, is
undervalued in the market place
 AAttempt techniques available to defend against hostile
h i il bl d f d i h il
takeovers, its constant threat motivates mgt. to act in
the best interest of firm’s owners
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33. B: Agency Costs
 Incurred to respond to potential market forces by
preventing or minimising agency problems and
contributing to the maximisation of owner’s wealth
owner s
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34. Types of Agency Costs
1. Monitoring expenditures‐
 Payment for audit & control
2. Bonding expenditures‐
 Payment to third party to obtain a fidelity bond
3. O
Opportunity costs‐
i
 Loss of profit due to the longer response time of the
complex organisational structure
4. Structuring expenditures‐
 Results from structuring managerial compensation to
g g p
correspond with stock price maximisation
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35. Types of structuring expenses
1. Incentive Plans‐
 To tie management compensation with share price
 E.g. Stock Options‐ allow manager to purchase stock
 Is been criticised as positive effort may be
accompanied by the negative market
2. Performance Plans‐
a. Cash bonuses
Cas bo uses
b. Performance shares
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