LECTURE NO 1

INTRO TO FINANCIAL
MANAGEMENT
 LECTURE OUTLINES
 FM Defined
 Three Main Decisions
 Investment Decision
 Financing Decision
 Assets Management Decision

 Introduction To TVM.
 Concept of TVM
 Time Lines
 Future Value
 Present Value
LECTURE OUTLINES
 Multiple Cash Flows
Present Value of UCFs
Future Value of UCFs
 Computation of n & I
 Rule of “72”
 Special Thanks
 THE FINANCIAL MANAGEMENT
 What is Financial Management?
“It manages Three Things” Or
“It Covers three aspects” Or
“Financial Management is concerned with
three decisions; acquisition, financing &
management of asset keeping in mind
some/ overall organizational goal in
mind ”
 THE FINANCIAL MANAGEMENT
 Financial Management

 Investment Financing Assets Mgt:

 Decisions Decisions Decisions
OR OR OR
 Capital Capital Working
 Budgeting Structure Capital
 Financial Management

 Investment “ Financial Manager emphasis

Decisions on left side of Balance Sheet; OR
how much assts are available,
 Capital what is current position of cash
Budgeting & other assets, what long term
investment should be?”
 Financial Management

Financing
Decisions
OR
Capital
Structure
 Financial Management

Assets Mgt:
Decisions
OR
Working
Capital
 FINANCIAL MANAGEMENT
 Financial management is that managerial activity which
is concerned with the planning and controlling of the
firm's financial resources.

 Making financing and investment decisions to achieve

organizational goals.
WHY BUSINESS NEED FINANCE

 WORKING CAPITAL

Salaries
Payment to supplier
Utilities
Short term Promotional activity
Miscellaneous expenses

Unexpected events
 WHY BUSINESS NEED FINANCE
 FIXED CAPITAL

Start up

Replacement current assets

Long term advertisement

Long term investment

Expansion and production

Social projects

Acquisition & mergers

THE BALANCE-SHEET MODEL OF THE FIRM
Total Value of Assets: Total Firm Value to Investors
Investment Financing

Current Liabilities
Current Assets

Long-Term Debt

Fixed Assets
1 Tangible Shareholders’
2 Intangible Equity
 THE BALANCE-SHEET MODEL OF THE FIRM

The Capital Budgeting Decision

(Investment Decision)

Current Liabilities

Current Assets Long-Term Debt

Fixed Assets
Shareholders’
1 Tangible Equity
What long-term
2 Intangible investments should the
firm engage in?
 THE BALANCE-SHEET MODEL OF THE FIRM

The Capital Structure Decision

(Financing Decision)

Current Liabilities
Current Assets

How can the firm raise

the money for the Long-Term Debt
required investments?

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity
THE BALANCE-SHEET MODEL OF THE
FIRM
The Net Working Capital Investment Decision
(Financial Decision)
Current Liabilities

Net
Current Assets Working
Capital Long-Term Debt

Fixed Assets How much

1 Tangible
short-term cash
flow does a Shareholders’
2 Intangible Equity
company need
to pay its bills?
FINANCIAL MARKETS

Investors
Stocks and
Bonds
Firms securities
Money Ali Faisal
money

Primary Market
Secondary Market
CORPORATE GOVERNANCE
SEPARATION OF OWNERSHIP AND CONTROL

Board of Directors

Debtholders

Shareholders
Management

Debt
Assets
Equity
OBJECTIVE OF FIRM

To maximize the Shareholders’ Wealth

• Firm Value
• Share Price

Why?
• It is easily observable
• constantly updated
• It is a real measure of stockholder wealth, since stockholders
can sell their stock and receive the price now.
FACTORS AFFECTING THE VALUE OF
THE FIRM/ SHARE PRICE

SIZE OF CASH FLOW

TIMING OF CASH FLOW

ELEMENT OF RISK
ROLE OF FINANCIAL MANAGER
 Maximize stock value by:

Forecasting and planning

Investment and financing decisions

Coordination and control

Transactions in the financial markets

Managing risk
CONCEPTS IN FINANCIAL MANAGEMENT
A rupee today worth more than rupee tomorrow

• Time value of money

Don’t Compare Apples with Oranges

• Net present value

A safe rupee worth more than a risky one.

• Risk and return

Don’t put all eggs in one basket

• Portfolio management & diversification

Insure eggs, some might broken

• Hedge & Risk management

FUNCTIONS OF FM

Planning

Decision making

• Financing
• Investment
• Dividend policy

Controlling
 FINANCIAL MANAGEMENT Fruit
DECISIONS
Net Goods &
Working
Capital
Earnings Services Management
Operating
Activities

Reinvested Investment
Investing Capital
in Producing
Activities Budgeting
Assets

Debt Branches
Payment Trunk &
Debt
Financing Financing
Activities
Distribution Dividends Equity Capital
Decisions Financing Structure
Roots
FINANCIAL MANAGEMENT DECISIONS

Capital Structure

Capital Budgeting

Working Capital Management

Distribution Decisions
THE
THE TIME
TIME VALUE
VALUE OF
OF MONEY
MONEY

It is a common Saying, “A Bird in the hand is worth two in

the bush”

It means time value of of the bird that is better to have a

single bird in a hand now rather than bush in the Future..

Similarly! “ A Dollar/ Rs. Today is worth more than the

$ / Rs. Tomorrow, this concept is referred to as the
TIME VALUE OF MONEY!!
THE
THE TIME
TIME VALUE
VALUE OF
OF MONEY
MONEY

Which would you rather have -- $100,000 today or

$100,000 in 5 years?

Obviously, $100,000 today.

Money received sooner rather than later allows one to

use the funds for investment or consumption purposes.
TODAY
TODAY OR
OR TOMORROW?
TOMORROW?

Mr. A wants to receive $100,000 now & Ms. B wants to receive

$100,000 after 5 years?

Who is Smart Decision Maker?

Definitely Mr. A…………Why?

Because he will have $ 248,892 after 5 years, (20% per annum) while
Ms. B will have same $ 100,000.
TIME
TIME LINES?
LINES?

It is a line which shows the equal intervals (Periods) of Time, interest

rate $ cash flows for certain periods of time.,

OR

in other words….

Graphical representation of TVM; Showing Equal intervals of time,

interest rate, cash inflows &as well as cash out flow of an
investment..
CASH
CASH INFLOW
INFLOW $$ CASH
CASH OUTFLOW?
OUTFLOW?

Cash Inflow (s) is clear from term…

In+ flows….

Means flow inside, cash flows from outside to inside of the

organization through various possible sources.

Cash inflow is also known as cash Receipt or Sources of cash..

CASH
CASH INFLOW
INFLOW $$ CASH
CASH OUTFLOW?
OUTFLOW?

Cash outflow (s) is opposite to…

Cash In flows….

It Means flow outside, cash flows from Inside to outside of the

organization through various possible USES.

Cash outflow is also known as cash Payment or USES of cash..

 FUTURE
FUTURE VALUE
VALUE (COMPOUNDING)
(COMPOUNDING)

Future value means NOT now but after some time period (s) the value
of money…it defined as.” Such a Value of money which is computed on
Compounding basis for particular period of time”
 FUTURE
FUTURE VALUE
VALUE (COMPOUNDING)
(COMPOUNDING)

Three Factors Of Future Value:

 Principal: Amount of money either borrowed or

received.
 Interest: extra amount you pay or receive on usage
of money.
 Time periods: it is a length of time or number of
periods during which interest is paid or received.
 FUTURE
FUTURE VALUE
VALUE (COMPOUNDING)
(COMPOUNDING)
Formula for computing FV……..
 FV = PV (1+ i)n

OR
 FV = PV (FVIF i*n)

Suppose, a firm deposits $ 2,000 @ 6% compounded annually for

one year, what will be its worth after a year?

FV = Principal + (Principal x Interest)

= 2,000 + (2,000 x .06)
= 2,000 + 120
FV = $ 2,120
FUTURE
FUTURE VALUE
VALUE (TIMELINES)
(TIMELINES)
If you invested $2,000 today in an account that pays 6%
interest, with interest compounded annually, how much will be
in the account at the end of two years if there are no
withdrawals?

0 1 2
6%
$2,000
FV
 FUTURE
FUTURE VALUE
VALUE (FORMULA)
(FORMULA)

FV1 = PV (1+i)n = $2,000 (1.06)2 =

$2,247.20

FV = future value, a value at some future point in time

PV = present value, a value today which is usually designated as time 0
i = rate of interest per compounding period
n = number of compounding periods

Calculator Keystrokes: 1.06 (2nd yx) 2 x 2000 = $2,247.20

 FUTURE
FUTURE VALUE
VALUE EXAMPLE
EXAMPLE
Anees wants to know how large his $5,000 deposit will become at an
annual compound interest rate of 8% at the end of 5 years.

0 1 2 3 4 5
8%
$5,000
FV5
 FUTURE
FUTURE VALUE
VALUE SOLUTION
SOLUTION

 Calculation based on general formula:

FVn = PV (1+i)n FV5 =
$5,000 (1+ 0.08)5 = $7,346.64

 Calculator keystrokes: 1.08 2nd yx x 5000 =

PRESENT
PRESENT VALUE
VALUE (DISCOUNTING)
(DISCOUNTING)

PV is opposite of FV …

Justification….

Present Value is the current value of the future amount of

money computed on discount rate or required rate of return.
 PRESENT VALUE (DISCOUNTING)
 Since FV = PV(1 + i)n.

PV = FV / (1+i)n.
OR
 PV = FV (PVIF i*n)
 Discounting is the process of translating a future value or
a set of future cash flows into a present value.
PRESENT
PRESENT VALUE
VALUE (TIMELINES)
(TIMELINES)
Assume that you need to have exactly $4,000 saved 10 years from
now. How much must you deposit today in an account that pays
6% interest, compounded annually, so that you reach your goal of
$4,000?........................ ($232.36)

0 5 10
6%
$4,000
PV0
PRESENT
PRESENT VALUE
VALUE EXAMPLE
EXAMPLE
Teena needs to know how large of a deposit to make today so that
the money will grow to $2,500 in 5 years. Assume today’s deposit
will grow at a compound rate of 4% annually.

0 1 2 3 4 5
4%
$2,500
PV0
PRESENT
PRESENT VALUE
VALUE SOLUTION
SOLUTION

 Calculation based on general formula: PV0

= FVn / (1+i)n PV0 = $2,500/(1.04)5
= $2,054.81

 Calculator keystrokes: 1.04 2nd yx 5 = 2nd 1/x X

2500 =
EXAMPLE
EXAMPLE OF
OF AN
AN ORDINARY
ORDINARY ANNUITY
ANNUITY --
-- FVA
FVA
End of Year
0 1 2 3 4
7%
$1,000 $1,000 $1,000
$1,070
$1,145
FVA3 = $1,000(1.07)2 + $1,000(1.07)1 +
$1,000(1.07)0 = $3,215
If one saves $1,000 a year at the end of every year for three years in an
$3,215 = FVA3
account earning 7% interest, compounded annually, how much will
one have at the end of the third year?
EXAMPLE
EXAMPLE OF
OF AN
AN ORDINARY
ORDINARY
ANNUITY
ANNUITY --
-- PVA
PVA
End of Year
0 1 2 3 4
7%

$1,000 $1,000 $1,000

$934.58
$873.44
$816.30
PVA3 = $1,000/(1.07)1 + $1,000/(1.07)2 +
$2,624.32 = PVA3
$1,000/(1.07)3 = $2,624.32
If one agrees to repay a loan by paying $1,000 a year at the end of
every year for three years and the discount
rate is 7%, how much could one borrow today?
 MULTIPLE
MULTIPLE CASH CASH FLOWS FLOWS
EXAMPLE
EXAMPLE
Suppose an investment promises a cash flow of $500 in one year, $600 at
the end of two years and $10,700 at the end of the third year. If the
discount rate is 5%, what is the value of this investment today?

0 1 2 3
5%
$500 $600 $10,700
PV0
 MULTIPLE
MULTIPLE CASH
CASH FLOW
FLOW SOLUTION
SOLUTION

0 1 2 3
5%
$500 $600 $10,700
$476.19
$544.22
$9,243.06

$10,263.47 = PV0 of the Multiple

Cash Flows
Double Your Money!!!

Quick! How long does it take to double

$5,000 at a compound rate of 12% per year
(approx.)?

We will use the “Rule-of-72”.

The “Rule-of-72”

Quick! How long does it take to double $5,000

at a compound rate of 12% per year
(approx.)?

Approx. Years to Double = 72 / i%

72 / 12% = 6 Years
[Actual Time is 6.12 Years]
FINDING “N” OR “I” WHEN ONE KNOWS PV
AND FV

 If one invests $2,000 today and has accumulated $2,676.45

after exactly five years, what rate of annual compound interest
was earned?

Solution on Board
FREQUENCY
FREQUENCY OF
OF
COMPOUNDING
COMPOUNDING
General Formula:
FVn = PV0(1 + [i/m])mn

n: Number of Years
m: Compounding Periods per Year
i: Annual Interest Rate
FVn,m: FV at the end of Year n
PV0: PV of the Cash Flow today
FREQUENCY OF COMPOUNDING
EXAMPLE
 Suppose you deposit $1,000 in an account that pays 12%
interest, compounded quarterly. How much will be in the
account after eight years if there are no withdrawals?

PV = $1,000
i = 12%/4 = 3% per quarter
n = 8 x 4 = 32 quarters
SPECIAL
SPECIAL THANKS….
THANKS….

TO?

“BBA VI -STUDENTS”