MANGERIAL FINANCE

Lecture 1
 BUSINESS FIRM

A firm procures assets to create

value to the firm.

Production Sales Generation Add Value to

of Cash the Firm
 Balance Sheet Model of Firm

Current Net Current

Assets Working Liabilities
Capital
Long Term Debt

Fixed Assets Equity

Three Legal Forms of Firms

(a) Sole Proprietorship
(b) Partnership
(c) Corporation
 FINANCE
Finance can be defined as the art and
science of managing money.

In a broader sense, finance is the management

of cash flows in an organization.
 

Every business decision is ultimately a

finance decision.
 FINANCE FUNCTIONS
Finance function is concerned with the
financial aspects of management
decisions that ultimately contribute to
the attainment of corporate goals.
 Cash – the Lifeblood of Business
The generation and management of cash is
central to the whole of finance.

Customers Suppliers

Government Cash Lenders

Shareholders Employees
 FINANCE
Major areas of finance:
(a) Financial markets and institutions
(b) Investments
- Determining the values, risks and returns
- Optimal mix of securities
(c) Financial services
- FIs provide services for investment, financial
stability, sustainability, budgeting etc.
(d) Managerial finance
 MANAGERIAL FINANCE

Managerial finance is concerned with the

duties of a finance manager in the
business firm.
 Three Major Issues for
Finance Manager
1. In what long-term assets the firm
should invest?
2. How can the firm raise cash for
required capital expenditure?
3. How should the short-term operating
cash flows be managed?
 How do Finance Managers
Create Value?
1. Buy assets that generate more cash than
they cost.
2. Sell bonds, stocks and other financial
instruments that raise more cash than they
cost.
Should consider
 Identification of cash flows.
 Timing of cash flows.
 Risk of cash flows.
Finance Manager’s Responsibilities

Create Value for the firm

1. Forecasting and Planning
2. Investment Decisions
3. Financing Decisions
4. Liquidity Management
5. Dividend Decision
6. Coordination and Control
7. Risk Management
 Profit Maximization vs.
Wealth Maximization
Market economies achieve their goals when
businesses maximize their economic profits.
 

Economic Profit=
Revenue–Costs–Other Opportunity Costs
 

We expect firms to expand the production of

goods and services that provide positive
economic profits.
 Profit Maximization vs.
Wealth Maximization
But some opine that profit maximization is vague.
– Short-run profitability or long-run profitability?
– Ignores the risk.

– Overlooks quality aspects of future activities (like

sales growth, quality improvement, new market)

– Sometimes it is unethical (e.g., exploiting labor or

customers, charging higher prices).
 Wealth Maximization
Aims at maximizing the net worth of the
firm. It means the maximization of market
value of owners’ investment.
–  maximizes the shareholders’ interest.
–  socially responsible, helps society use
scare resources efficiently.
–  ethical, does not hurt others’ interest.
Wealth maximization is translated into
maximization of stock price.
 TIME VALUE OF MONEY
A Taka received tomorrow is not the
same as a Taka today.

0 1 2 3 4 5

Opportunity cost is the sacrifice of return

that could be attained from the best possible
alternative.
 Discount Rate

The discount rate includes:

(a)  Pure time value of money
(b)   Premium for inflation
(c)   Premium for risk
 
 Discount Rate
Pure Time Value of Money

- Compensation for the sacrifice of current

consumption.
- price charged for the exchange between
current goods and future goods.
 Discount Rate
Premium for Inflation
Compensation for the purchasing
power loss.

Premium for Risk

Compensation for the risk (chance
that the return may vary).
 Discount Rate
Use of Discount Rate:
Future Value = Present Value (1+k)t
k=Discount Rate, t=time
Say, Present value = Taka 100
Discount Rate = 10 %
Time = 2 years 
Future value = 100 (1+0.10)2 = 121
 Discount Rate
Say, Future Value = Taka 400 after 5 years.
Discount Rate = 10 %

FV
Present Value 
1  k t

400
Present Value   248.37
1  0.105
 Annuity

An annuity is a series of payments made at

fixed intervals for a specified number of
periods.
 Future Value of an Annuity
0 1 2 3 4

0 100 100 100 100.0

0
110.00
121.00
133.10
Future 464.10
Value
 Future Value of an Annuity
FVAn  PMT (1  i )1  PMT (1  i ) 2  .......  PMT (1  i ) n
n 1
 PMT  (1  i ) t
t 0

 (1  i ) n  1
 PMT  
 i 
PMT = Annual Payment
i = Discount Rate
 Future Value of an Annuity
Example:
You deposit Taka 100 per year for four years at
an annual interest rate of 10%. How much will
you receive after 4 years?
 (1  i ) n  1
FVAn  PMT  
 i 
 (1  0.10)  1
4
 100 
 0.10 
 464.10
 Present Value of an Annuity
0 1 2 3 4

0 100 100 100 100

90.91
82.64
75.13
68.30
316.99 Present Value
 Present Value of an Annuity

PVAn  PMT   PMT   ...  PMT  

1
(1 i )1
1
(1 i ) 2
1
(1 i ) n

n 1 
 PMT   (1i )1 
t 1 
1  (11i ) n 
 PMT  
 i 
 Present Value of an Annuity
Example: Annuity of Taka 100 per year for
four years; Discount Rate is 10%.

1  (11i ) n 
PVAn  PMT  
 i 
1  (1 01.10) 4 
 100 
 0.10 
 316.99
Future Value of Annuity (Due)
Payments are made at the beginning of
the period.
0 1 2 3 4

100 100 100 100

110.00
121.00
133.10
146.41
Future Value 510.51
 Future Value of Annuity (Due)

 (1  i ) n  1
FVAn  PMT   (1  i )
 i 
 (1  0.10) 4  1
 100  (1  0.10)
 0.10 
 510.51
Present Value of an Annuity (Due)
0 1 2 3 4

100 100 100 100

90.91
82.64
75.13
348.69
Present Value of an Annuity (Due)
Example: Annuity of Taka 100 per year (at the
beginning of each year) for four years;
Discount Rate is 10%.
1  (11i ) n 
PVAn  PMT   (1  i )
 i 
1  (1 01.10) 4 
 100  (1  0.10)
 0.10 
 348.69