CORPORATE FINANCE

Dr C.Sivashanmugam.
Dept. of Management Studies (PG)
Sivashanmugam@pes.edu
Unit-2-Corporate Finance
PES – II Sem-MBA
Financial management

Definition :
Managerial decision on acquisition of funds and effective utilisation in
business is financial management.
What would be the objective of a business?
How would you define profit?
 Profit:

Excess of Revenue over expenses.

Profit= Total Revenue- Total Cost

How do you Maximize the Profit ?
Objectives of business firms

Profit Maximization
Vs
Wealth Maximisation
Characteristics of firm with Profit maximisation

Sole proprietor/ownership may with few hands

Owners managing the business
Profit oriented
Keep jumping to the More Profitable projects
Less concern about the society
Less concern about employees
Less concern about other stakeholders.
 Is it wrong in objective of Profit maximizing

Limitations of Profit maximisation:

• It is vague concept( nothing is specific),

• It Ignores the time value of money,
• It ignores risk.
Shareholder Vs Stake holder

Who are all the stakeholders ?

Shareholders
Creditors
Suppliers
Consumers
Govt / Govt agencies
Society
Shareholder Wealth maximisation

• Maximizing the shareholder’s value is wealth maximisation.

• It means maximizing the net present value of the shares of the
company .
• It means earning profits by reaching the mission and vision of the
company.
Role of finance manager

• Raising of funds
• Funds Allocation
• Profit Planning
• Understanding capital markets
• Merger& acquisition Decision
Scope of Financial Management

Investment Decisions
Financing Decision
Liquidity Decision
Dividend Decision
Scope of Financial Management

Investment Decisions ( Capital Budgeting Decisions)

Financing Decision(Capital structure Decisions)
Liquidity Decision (Working Capital Decisions)
Dividend Decision( ( Dividend Policy, Dividend Pay-out Decision)
• Investment Decisions (Capital Budgeting Decisions)
• Risk & Return
Return- Hurdle Rate.
• Liquidity Decision (Working Capital Decisions)
Allocation of funds for short –term sources
• Financing Decision(Capital structure Decisions)
Mix of long-term sources of funds
What would be the combination of debt and Equity?
Criteria- EPS.
• Dividend Decision ( Dividend Policy, Dividend Pay-out Decision)
Whether to pay or not ?
How much to pay ?
Time Value of Money
Time Value of Money

• Money received today is different in its worth from the money

receivable in some other time in future.
• Otherwise money received today is much worthier than money
received tomorrow.

• The concept of TVM is applicable in equal strength to individuals as

well as the firms .
Define : Time Value of Money ( TVM)

TVM is the rate of return which an investor can earn by

reinvesting its present money. This is otherwise called as
required rate of return to make equal the worth of money of
two different time periods.

Eg
Fixed deposit , Investing Rs1,00,00,000 today = 1,05,00,000 a year
latter .
Why there is a time preference for money?

Future uncertainties
Preference for present consumption
Reinvestment opportunities.
Inflationary economy
Why there is a time preference for money?

Future uncertainties
(Future is uncertain we will not prefer to invest in risky
investments)

Preference for present consumption

Investment and spending is decision of present or
future
Why there is a time preference for money?

Reinvestment opportunities.
Whenever there is the best reinvestment opportunity is there ,
people prefer to invest.

Inflationary economy
In inflationary economy prefer to invest or buy products because
of expected price hikes in near future .
Time Value of Money(TVM)

There would be two types of problems:

• I .Compounding Technique:-
Calculate Future Value(FV)of cash flows
• II.Discounting Technique:
Calculate Present Value (PV)of cash flows
 I .Compounding Technique:
• The compounding technique is used to find out the FV of a present
money. it is the same concept as of compound interest.
II . Discounting Technique:

• The discounting technique is used to find out the present value of a

future receipt / payment .
Doubling Period

Doubling Period

1.Rule 72
=72 / i = Number of Years
i-interest Rate

2.Rule 69
=[0.35 + (69/i)] = Number of Years
Doubling Period
Doubling Period – Rule 72 and 69: Illustrations:

Illustration-1: Mr .A deposits Rs.5,000 today at 6% rate of interest, in

how many years will this amount double basis Rule 72 and Rule 69?
1. Rule of 72
72 / 6 = 12 Years

2. Rule of 69
[0.35 + (69/6)] = 0.35 + 11.50 = 11.85 Years

Illustration-2: Mr.C deposits Rs. 9,500 today at 9% rate of interest, in how many
years will this amount double basis Rule 72 and Rule 69?
1. Rule of 72
72 / 9 = 8 years

2. Rule of 69
[0.35 + (69/9)] = 0.35+7.67=8.01 years
• Illustration-3: C deposits Rs. 11,500 today at 9.5% rate of interest, in how many
years will this amount double basis Rule 72 and Rule 69?

• Rule 72= 72/9.5= 7.5 years

• Rule 69= (0.35+(69/9.5)=7.61 years

• Illustration-4: B deposits Rs.7,500 today at 7.5% rate of interest, in how many

years will this amount double basis Rule 72 and Rule 69?
• Rule 72=72/7.5=9.6 years
• Rule 69=9.55 years
Future Value of Annuity

Annuity - Meaning: An annuity is a stream of equal annual cash flows.

Annuities involve calculations based upon the regular periodic contribution or
receipt of a fixed sum of money.

There are two types of annuities:

Types- Two
Annuity:

The future value of an ordinary annuity refers to the future returns of periodic

equal cash flows that occur at the end of each period.  This future return
comes from the sum of compound interest of each cash flow of invested
funds at the end of the lifetime of such annuity.

(E.g. of this would be companies paying dividends to shareholders)

Annuity due:

The second type of annuity is known as an annuity due. This is the type
of payment which requires the payment to be made at the beginning
of the payment period. The payment typically covers the balance owed
for the remaining period following the payment. 
(E.g. Recurring Deposit in bank)
 Future Value of Annuity -

Future Value of Annuity

FV of an ordinary annuity formula: In the below formula, we need to have the future value of an ordinary
annuity table to find the FV interest factors of ordinary annuity.

FVA= PMT × FVIFA i, n

Where:
PMT = Periodic cash flow of annuity
FVIFA = FV interest factors of an ordinary annuity
i = Annual interest
n = Number of years

FVA = PMT × [((1+i)n -1) /i]

Where:
[((1+i)n -1) /i] = FVIFA (FV interest factors of an ordinary annuity).
 Future Value of Annuity - Oridnary

Future Value of Annuity – Ordinary:

Annuity is a term used to describe a series of periodic flows of equal amounts. These Formula for calculating
flows can be inflows or outflows. Future Value of Annuity
when table information
Mathematically, it is represented as: (log table) is provided

(1 + i) n – 1 Sn = CVIFA x A
FVA n = A ----------------- * (1 + i)
i Where:

Where, Sn = Compound sum of an

A = Amount of Annuity
Annuity
i = rate of interest
A = Value of Annuity
n = time period
CVIFA = Compounded
FVAn = compounded at the end of n years
Interest factor Annuity

(1 + i) n – 1
---------------- * (1 + i) is the Future Value of Interest Factor for Annuity (FVIFA)
i
Future Value of Annuity

Future Value of Annuity –Illustration-1:

Mr.Prasad is considering investing in an annuity of 5 years for INR 1,000 each. This annuity has an annual compound
interest of 8% and he wants to know how much he would get at the end of year 5.

Calculate the FV of ordinary annuity for the above

We can calculate the FV of ordinary annuity in three different ways

First method is by looking at the future value of an ordinary annuity table and then substitute the FV interest factors of
an ordinary annuity into the formula.

FVA= PMT × FVIFA i, n

Where:
PMT = INR 1,000

FVIFA 8%, 5 Yrs  = 5.867 (As per the future value of an ordinary annuity table)
PMT= Rs1000/-

Thus, FVA = INR 1,000 × 5.867 = Rs 5,867

Financial Management – Future Value of Annuity - Ordinary

Future Value of Annuity – Ordinary – Illustration-1…Cont:

Second method uses the financial calculator.

FVA = PMT × [((1+i)n -1) /i]

Where:
PMT = INR 1,000
i = 8%
n = 5 years
Therefore, FVA = 1,000 × [((1+0.08)5 -1) /0.08] = INR 5,867
Future Value of Annuity Due
Future Value of Annuity Due – Illustration-1:
Mr. Prasad sees an ad for a 3 bedroom house available, listed at INR 1,800 per month. He wants to rent the property
for three years, but the rent is INR 9,600 per year more than he is paying for his rent now in his apartment. 

Before he signs a lease, Prasad wants to know how much money he would have in three years if he were to stay in his
current home and invest the additional INR 9,600 per year in an account with a 5% annual interest rate. 

Break it down to identify the meaning and value of the different variables in this problem. 

Number of Payments (n): 3 years

Cash value of payments per period (A): INR 9,600
Interest rate (i): 5% or 0.05 Formula:
[(1 + i) n – 1]
Calculation based on Log Table: FVAn = A -------------------- * (1 + i)
Sn = CVIFA x A i
Solution:
CVIFA = ((1+.05)3+ (1+.05)2+ (1+.05)1) [ (1+0.05)3−1​]
[1.1576 + 1.1025 +1.05 ] = 3.3101 FV=INR 9,600 × ---------------- × ( 1+0.05 ) = INR 31,777
A = INR. 9,600 0.05
Sn = 3.3101 x Rs 9,600 = RS.31,777
Future Value of Annuity Due
Sum:What is the Future value of Annuity of an amount of Rs.2,000
invested at the beginning of every year at 3.42% interest for 5 years.
Future Value of Annuity Due [(1 + i) n – 1]
FVAn = A -------------------- * (1 + i)
Future Value of Annuity Due – Illustration-2:
i
What is the Future value of Annuity of an amount of Rs.2,000
invested at the beginning of every year at 3.42% interest for 5 years 2,000 * [(1+0.0342) 5 -1] * (1+0.0342)
= ----------------------------------------------------
0.0342

2,000 * [(1.0342) 5 -1] * (1.0342)

= -----------------------------------------------
0.0342

2,000 * [(1.183103) – 1] * (1.0342)

= ----------------------------------------------
0.0342
Calculation based on Log Table:
Sn = CVIFA x A 2,000 * [0.1831] * (1.0342)
= --------------------------------------
CVIFA = [ 1.261 + 1.168 + 1.103 + 1.050 + 1.000 ] = 5.537 0.0342
A = Rs.2,000
Sn = 5.537 x Rs.2,000 = Rs.11,074 378.7309
= -------------------- = Rs.11,074
0.0342
Future Value of Annuity Due
Future Value of Annuity Due – Illustration-3: Solution:
What is the Future value of Annuity of an amount of Rs.500 invested
500 * [(1+0.09)3 -1] * (1+0.09)
at the beginning of every year at 9%% interest for 3 years
= ----------------------------------------------------
0.09
Formula
500 * [(1.09)3 -1] * (1.09)
[(1 + i) – 1]
n
= --------------------------------------------
FVAn = A ---------------------- * (1 + i)
0.09
i
500 * [(1.2950) – 1] * (1.09)
= -------------------------------------------
Calculation based on Log Table: 0.09

Sn = CVIFA x A 500 * [0.2950] * (1.09)

= --------------------------------
0.09
CVIFA = [ 1.09 + 1.188 + 1.295 ] = 3.573
A = Rs. 500
160.775
Sn = 3.573x Rs.500 = Rs. 1,786
= -------------------- = Rs. 1,786
0.09
 Effective Interest Rate ( EIR)

EIR= 1+i/m -1

I- NOMINAL INTEREST RATE

M- FREQUENCY OF COMPOUNDING
Effective Interest Rate ( EIR)

Sum: A company offers 12 percent rate of interest on deposits . What

is the effective rate of interest if the compounding is done.
i) Half yearly
ii) Quarterly
iii) Monthly
Effective Interest Rate ( EIR)

i) Half Yearly:

m
EIR= 1+i/m -1

EIR= (1+0.12/2)2-1

= 0.1236 (or) =12.36%

Effective Interest Rate ( EIR)

ii) Quarterly :

4
EIR= 1+i/4 -1

EIR= (1+.12/4)4-1

= 0.1255 (or) =12.55%

Effective Interest Rate ( EIR)

iii) Monthly:

m
EIR= 1+i/m -1

EIR= (1+.12/12)12-1

= 0.1268 (or) =12.68%

II . Discounting Technique

Present Value= FVn

(1+i)

Calculate present value of Rs1,000 to be received after one year at

10% time preference rate as below:

PV= 1000/(1+.10)1 = 1000/(1.10)= Rs 909

II . Discounting Technique/Present Value

Calculate present value of Rs5,000 to be received after 5 year at 10% time

preference rate as below:

PV= 5000/(1+.10)5 =5000/(1.61)=Rs3,106

Present Value of Series of Payments

Sum: Calculate present value of the following cash flows assuming a

discount rate of 10% .
Year Cash Flow
1 5,000
2 10,000
3 10,000
4 3,000
5 2,000
Solution :
Year Cash flow Present Value factor Present Value of
@10% Cash flow ( Rs)

1 5,000 (1/1.10) 1 =
0.909 4545
2 10,000 (1/1.10) 2 =
0.826 8260
3 10,000 (1/1.10) 3 =
0. 751 7510

4 3,000 (1/1.10) 4 =
0.683 2049
5 2,000 (1/1.10) 5 =
0. 621 1242
Total Present Value 23,606
of Cash Flow
 Present Value of Annuity

Sum: Mr. X has to receive Rs2,000 per Year for 5 years . Calculate the
present value of the annuity assuming that he can earn interest on his
investment at 10% p.a.
Method 1:
Using Annuity Discount Factor Table
PV= FV(ADFi,n)

PV= 2000(3.791)=Rs7,582
Method 2:

Using Manual method

PV= FV 1/(1.10)1+1/(1.10)2+1/(1.10)3 +1/(1.10)4 + 1/(1.10)5

PV= 2000 (0.909+0.826+0.7513+0.6830+0.6209)

PV= 2000(3.791)= Rs7,582

• Sum Mr. X has to receive Rs4,000 per Year for 5 years . Calculate the
present value of the annuity assuming that he can earn interest on
his investment at 12% p.a.

• PV = 4000(3.602)=14,408
(Or )
• PV=4,000(3.6047)=14,418
Present Value of Annuity Due:

Method 1:

PV= FV(ADFi,n) ( 1+i)

Method 2:

PV= FV 1/(1.10)1+1/(1.10)2+1/(1.10)3 +1(1/(1.10)4 + 1(1/1.10)5 (1.i)

Present Value of Annuity Due:

Sum: Mr. X has to receive Rs2,000 in every beginning of the year for 5
years . Calculate the present value of the annuity assuming that he can
earn interest on his investment at 10% p.a

Method 1:
Using Annuity Discount Factor Table
PV= FV(ADFi,n) ( 1+i)

PV= 2000(3.791)(1+.10)= Rs8,340

Method 2: Manual Method :

PV= FV 1/(1.10)1+1/(1.10)2+1/(1.10)3 +1/(1.10)4 + 1/1.10)5 (1.10)

PV= 2000(3.791)(1.10)= Rs8,340

Sum: Mr. X has to receive Rs4,000 in every beginning of the year for 5
years . Calculate the present value of the annuity assuming that he can
earn interest on his investment at 12% p.a

• PV = 4,000(3.602)(1.12)=16,137
Time Value of Money
Loan Amortization

Loan Amortization Schedule – Illustration-1

Scenario: When Installment amount and rate of Interest is given.

Mr. X has taken a loan of Rs. 500,000 at 8% pa to be repaid in 5 years. The annual installment to paid
is Rs. 125,228.20. Using the above information calculate the share of interest amount and principal
amount from the installment amount paid every year till the end of 5 years.

Step - 1: Calculate the Interest amount by applying the interest rate on the outstanding loan amount
at the start of each period

Step - 2: Deduct the calculated interest amount from the annual installment amount to arrive at the
Principal amount of every period
Financial Management
Loan Amortization

Loan Amortization Schedule – Illustration-2

Scenario: When Installment amount is not provided.

Mr. X has taken a loan of Rs. 10,00,000 at 9% pa to be repaid in 10 years. Calculate

the annual installment amount showing interest and principle element of the
installment amount. Using the information calculate the share of interest amount
and principal amount from the installment amount paid every year till the end of
10 years.

Variables:
P = Rs. 10,00,000
r = 9%
n = 10 years
Financial Management
Loan Amortization

Loan Amortization Schedule – Illustration-2

Scenario: When Installment amount is not provided.

Step-1: Find the EMI amount (Repayment amount)

[ 0.09 (1.09)10 ]
A = 10,00,000 ------------------------- = Rs.155,819.97
[ (1.09)10 −1) ]

Step-2: Find the Interest amount for 1st month

Principle amount x Interest rate per month

Rs.10,00,000 x 0.09 = Rs. 90,000

Step-3: Find the Principle amount for 1st month

EMI – Interest for the month

Rs.155,819.97 – Rs, 90,000 = Rs.65,819.97

Financial Management
Loan Amortization

Loan Amortization Schedule – Illustration-3

Scenario: When EMI Installment, Interest and Principle amount and Effective Interest Rate has to be
determined.

Mr. X has taken a loan of Rs. 15,00,000 at 9.5% pa to be repaid in 5 years. Calculate the annual
installment amount showing interest and principle element of the installment amount. Using
the information calculate the share of interest amount and principal amount from the
installment amount paid every year till the end of 5 years. Also calculate the Effective Interest
Rate.

Variables:
P = Rs. 15,00,000
r = 9.5% (Nominal Interest)
n = 5 years
Financial Management
Loan Amortization

Loan Amortization Schedule – Illustration-3

Scenario: When Effective Interest Rate has to be

determined.

Step-1: Find the EMI amount (Repayment amount)

[ 0.095 (1.095)5 ]
A = 15,00,000 ------------------------- = Rs.390,654.66
[ (1.095)5 −1) ]

Step-2: Find the Interest amount for 1st month

Principle amount x Interest rate per month

Rs.15,00,000 x 0.095 = Rs. 142,500

Step-3: Find the Principle amount for 1st month

EMI – Interest for the month

Rs.390,654.66 – Rs.142,500 = Rs.248,154.66

Financial Management
Loan Amortization

Loan Amortization Schedule – Illustration-4

Scenario: When EMI Installment, Interest and Principle amount and Effective Interest Rate has to be
determined.

Mr. X has taken a loan of Rs. 12,00,000 at 7.5% pa to be repaid in 6 years. Calculate the annual
installment amount showing interest and principle element of the installment amount. Using
the information calculate the share of interest amount and principal amount from the
installment amount paid every year till the end of 10 years. Also calculate the Effective
Interest Rate.

Variables:
P = Rs. 12,00,000
r = 7.5% (Nominal Interest)
n = 6 years
Financial Management
Loan Amortization

Loan Amortization Schedule – Illustration-4

Scenario: When Effective Interest Rate has to be

determined.

Step-1: Find the EMI amount (Repayment amount)

[ 0.075 (1.075)6 ]
A = 12,00,000 ------------------------- = Rs.255,653.87
[ (1.075)6 −1) ]

Step-2: Find the Interest amount for 1st month Formula: EIR / APR i.e. r = { 1 + (i/m) } m - 1

Principle amount x Interest rate per month r = [ 1 + (0.075 / 6]6 - 1

Rs.12,00,000 x 0.075 = Rs. 90,000 r = [ 1 + 0.0125 ]6 - 1

Step-3: Find the Principle amount for 1st month r = [ 1.077383181 ] – 1

EMI – Interest for the month r = 0.07738318

Rs.255,653.87 – Rs.90,000 = Rs.165,653.87 r = 7.738%