Unit 1

Concept, scope and objectives of finance

The first chapter is the introduction of what exactly finance is and its applications in the
daily lives of individuals. The concept, scope, objective of finance are thoroughly explained.

Concept:
Financial management is that managerial activity which is concerned with the planning and
controlling of the firm’s financial resources.

Scope:
Finance is one of the pillars of any firm in any industry. Without handling the finances, there
is no way the company can function properly!

Objectives:
The functions of raising funds, investing them in assets to shareholders are respectively
known as financing decision, investment decision and dividend decision. A firm attempts to
balance cash inflows and outflows while performing these functions.

Profit maximization vs. Wealth maximization

This concept is the base of every firm. The company can choose either of the two and work
towards achieving their respective goals
Profit maximization: Profit maximization is considered as the goal of financial management.
In this approach actions that increase the profits should be undertaken and the actions that
decrease the profits are avoided.
Wealth Maximization: Wealth maximization is one of the modern approaches, which
involves latest innovations and improvements in the field of the business concern. The term
wealth means shareholder wealth or the wealth of the persons those who are involved in
the business concern. 

Functions of Finance Manager in Modern Age and Agency Problem

In modern enterprises, financial managers occupy key positions. He or she is one of the
members of the top management team. The finance manager is responsible for shaping the
fortunes of the enterprise, and is involved in the most vital decision of the allocation of
capital.

Fundamental Valuation Concept:

The Time value of money
The time value of money means that worth of a Rupee received today is different from the
worth of a Rupee to be received in future. In this there were three things to learn – future
value, present value and annuity capital.

Risk and Return Analysis

Risk and return concepts are basic to the understanding of the valuation of assets or
securities. Return on a security consists of two parts given with equation:
Return = Dividend yield + Capital gain rate;
D1 P 1−P 0
R= +
P0 P0
The expected rate of return on a security is the sum of the products of possible rates of
return and their probabilities. Thus:
n
E(R) = R1P1 + R2P2 + … + RnPn = ∑ RiPi
k=0

Types of Risk Variance & Standard Deviation Risk-Return Trade off

Variance (σ2) or standard deviation (σ) is a measure of the risk of returns on a security.
Companies like Larsen & Toubro, Dr Reddy’s, Dr Lal Pathlab’s are some of the few
companies with a stable financial structure, making them the best companies for investors
to invest in.

Unit 2
Long-term sources of finance
There are a lot of ways in which a company can earn for a long time period. Below listed are
the securities that help a company to raise the required capital for its functioning.

Preference shares
A share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary
share dividends. Most preference shares have a fixed dividend, while common stocks generally do
not.

Tata Capital and L & T Finance Holding are two best companies while looking to buy preference
shares.

Debentures
The definition of a debenture is a long-term bond issued by a company, or an unsecured loan that a
company issues without a pledge of assets. The best debentures to look for is from Muthoot Finance
Ltd, IIFL Finance Ltd. 

Term Loans
A term loan is a loan from a bank for a specific amount that has a specified repayment schedule and
either a fixed or floating interest rate. A term loan is often appropriate for an established small
business with sound financial statements.

The best banks from where you can get term loans are HDFC bank, IDFC bank and many more!

Functions of Money Market & Capital market

1. Money Markets (meet the working capital needs of a productive unit with short-
term instruments)
2. Capital Markets (serves the long-term needs of the corporate through Shares,
Debentures…)
Money Markets and Capital Markets differ in the period of maturity of Financial Assets
issued in these two markets.

Private Placement of shares/bonds

The private placement involves issue of securities, debt or equity, to selected subscribers,
such as banks, FIs, MFs and high net worth individuals. It is arranged through a
merchant/investment banker, who acts as an agent of the issuer and brings together the
issuer and the investor(s). Since these securities are allotted to a few sophisticated and
experienced investors, the stringent public disclosure regulations and registration
requirements are relaxed. The Companies Act, 1956, states that an offer of securities to
more than 50 persons is deemed to be public issue.

Role & Functions of Regulator/Intermediaries

The SEBI Act 1992 constituted the SEBI to take control over capital issues and other activities
(i.e. regulation of Primary Market), by repealing the Capital Issues Control Act, 1947 and to
provide a number of guidelines in order to regulate the Primary Market. Further, Ministry of
Finance transferred most of the powers under Securities Contracts (Regulations) Act, 1956
to SEBI.

Unit 3
Concept of Gross Working Capital & Net Working Capital
Working Capital is the amount of funds which a company must have to finance its day-to-
day operations.
A great example is the GODREJ INDUSTRIES has a Working Capital of 8.94 B. This is much higher than
that of the Industrials sector and significantly higher than that of the Conglomerates industry.
The working capital for all India stocks is notably lower than that of the firm.

Net WC
Difference between current assets and current liabilities. Represents, the extent to which CA
are financed by long-term funds.

Various Approaches to WC Management Factors affecting working

Capital requirement
Management of cash:
Cash management is concerned with the managing of:
– cash flows into and out of the firm
– cash flows within the firm
– cash balances held by the firm at a point of time by financing deficit or investing surplus
cash

Motives of Holding Cash

Some firms may also maintain cash for taking advantages of speculative changes in prices of
input and output.
• The transactions motive
• The precautionary motive (to meet contingencies in the future)
• The speculative motive

Inventory Management:
Levels of Inventory
An effective inventory management
• Ensure a continuous supply of raw materials, to facilitate uninterrupted production
• Maintain sufficient stocks of raw materials in periods of short supply and anticipate price
changes
• Maintain sufficient finished goods inventory for smooth sales operation, and efficient
customer service
• Minimize the carrying cost and time
• Control investment in inventories and keep it at an optimum level
Credit Policy
The objective of credit policy is to promote sales up to that point where profit is maximized.
To achieve this basic goal, the firm should manage its credit policy in an effective manner to
expand its sales, regulate and control the credit and its management costs, and maintain
debtors at an optimum level.

Unit 4
Cost of equity share
The cost of equity capital, may be defined as the minimum rate of return that the firm must
earn on the equity financed portion of an investment project in order to leave unchanged
the market price of the shares (or net proceeds of the sale).

Preference share
kp = D/Po = Dividend/Net amount realized

Debentures
For the issuing firm, the cost of debt is:
 the rate of return required by investors
 adjusted for flotation costs (any costs associated with issuing new bonds), and
 adjusted for taxes

Capital Budgeting:
Non-Discounting and Discounting
1. Non-discounted Cash Flow Criteria
 Payback Period (PB)
 Discounted Payback Period (DPB)
 Accounting Rate of Return (ARR)
2. Discounted Cash Flow (DCF) Criteria
 Net Present Value (NPV)
 Internal Rate of Return (IRR)
 Profitability Index (PI)
Nestlé group through training and internal consulting has been a long and important process that has
increased the number of managers accustomed to quantitative decision making and established new
reporting protocols imposing the use of MS models.

NPV, IRR and PI Project selection in Capital Rationing

NPV:
The rate at which NPV becomes Zero – so search Trial and error method

IRR:
The rate at which the total PV of all Cash inflow equals the initial outlays
NPV is Positive – Apply higher rate if discount to reach that point where NPV become zero
that will be your IRR

Analysis
Risk can be defined as variability of returns of an investment. Risk arises in investment
evaluation because we cannot make any correct prediction about the cash flow sequence
since the future events on which they depend are uncertain. Risk can be measured by using
statistical techniques to measure the variability. Standard deviation, variance or coefficient
variation can be used to measure risk.

Complex Investment Decisions:

Analysis of risk and uncertainty
Methods
The different methods of analysis of risk and uncertainty. All these suit well for different
types of industries. Every company has the liberty to choose the method that suits them the
best. The different types of methods are:
 Adjusted Rate
 Probability
 Sensitivity Analysis
 Decision Tree Analysis

Unit 5
Capital Structure:
The fifth and final unit explains the different approaches that can be taken to make capital
structure decisions. There are a lot of approaches and one can choose the approach which
works for them.
The different approaches include:
 NI
 NOI
 Traditional Approach
 Modigliani Miller Approach

Another topic that was covered is the retained earnings and theories of dividend decisions.
These also include a lot of models like:
 Walter’s model
 Gordon’s Model
 Modigliani Miller model