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Prior to With the


advent of advent of
›  › 

Exchange your Everything could be Money gave you


Could not The currency served
Consume all the goods for other denominated in the freedom
put away goods as the medium
goods you have goods and then units of to
for later use of exchange
consume them the currency 


    
G Money has two roles to play
As a Measure
G Estimating cash flow
G Valuing the assets and liabilities
G Financial & Cost Accounting
As a Resources
G Planning of Spending
G Planning of Investment
G Allocation of Money (capital) as resources
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Study of Time Value of Money Helps in Consistent Measurement«


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Input Process Output

G Labor G Product
G Capital G Services
G Raw
Material

G What is price of Capital?


G Interest Rate
G Dividend Yield
G Expected Capital Appreciation
G Bond/Debenture Yield
G Who Provides Capital?
G Individual
G Financial Institutions

Financial Market Provides Capital for a Price and Firms Create


Assets with the Help of Capital to Generate Wealth«
  
 
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A Firm Need to Use its Scare Resources (Capital) Optimally to


Achieve the Goal«
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Services

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Financial
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Finance Manager Plays an Important Role to Make Sure the Firm Meets the
Goal it has Aimed for«

 

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Finance Strategy is Driven by Objective of the Firm, Business


Opportunity, Cost of Capital for the Firm«
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Treasurer Controller
ÿ Manages the cash ÿ Prepare the accounts
ÿ Planning and capital ÿ Manage the expenditure
budgeting ÿ Internal audit
ÿ Raising the money ÿ Reporting and preparing
ÿ Managing the external balance sheet and P&L
relationship
ÿ Managing the credit
and fraud issues

Financial Management Objective is to Maximize Value of the Firm by


Balancing Between Risk and Reward..
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The effective rate Y can be calculated by using the formula when the
Nominal rate is and  # of interest conversion periods per
measurement period.

Conversely the nominal rate can be calculated if we know Y and 


And N=1

Two Nominal Rates Compounded at Different Intervals are Equivalent if they


Yield the Same Effective Rate «

 
 
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G If # of compounding very large and approaches infinite; as m


the terminal value will be

Effective Rate is Nothing But Compounding Rate When Interest Rate Conversion
Period is Different From Measurement Period«
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G ( 1 + r/m)Nm is the amount to which an investment of Rs 1 will grow at
the end of N periods.
G It is called FVIF Future Value Interest Factor.
It is a function of r and N.
It is given in the form of tables for integer values of r and N
If the FVIF is known, the future value of any principal can be found by
multiplying the principal by the factor.
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PV = FV / [( 1 + r/m)Nm]
Where r is interest rate and m is the # of times interest is accessed per
measurement period.
G 1 / [( 1 + r/m)Nm] is the amount that need to be invested to get Rs 1 at
the end of N periods.
G It is called PVIF Present Value Interest Factor.
It is a function of r and N.
It is given in the form of tables for integer values of r and N
If the PVIF is known, the present value of any amount can be found by
multiplying the future value by the factor.
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G ICICI Bank is offering 9% per annum with semi-annual


compounding.
G What should be the equivalent rate offered by HDFC
Bank if it intends to compound quarterly.
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Thus F.V. = 10,000 x 1.6105 = Rs 16,105

G Pritam has deposited Rs 10,000 for 4 years at 10% per annum


compounded semi-annually.
G What is the Future Value?
10% for 4 years is equivalent to 5% for 8 half-years

Thus F.V. = 10,000 x 1.4775 = Rs 14,775


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G The first step is to calculate the future value after 5


years:

G The next step is to treat this as the principal and


compute its terminal value after another 5 years
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Illustration 10: Evaluating an Investment

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G The rate of return that would equal LHS with RHS is


14.87%
G In this case the actual rate of return is 14.87% and the
required rate for the investor is 10%
G Therefore the investment is attractive.
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G The solution to this equation is called the


Internal Rate of Return (IRR)
G It can be obtained using the IRR function in
EXCEL.
In this case, the solution is 14.5189%
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G The interval between successive payments/receipt is called the


payment/receipt period
G We will assume that the payment/receipt period is the same as the
interest conversion period for valuation purpose
The assumption implies that is, if the annuity paid/received
annually/semi-annually, we will assume annual/semi-annual
compounding
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Where
A = Regular Annuity
r = interest rate
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Present Value Interest Factor of Annuity Future Value Interest Factor of Annuity
(PVIFA) (FVIFA)

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G The present value of an annuity due is greater than that


of an ordinary annuity that makes N payments
Why?
G Each cash flow has to be discounted for one period less.
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G The future value of an annuity due is greater than that of


an ordinary annuity that makes N payments
Why?
G Each cash flow will get one period more to yield return.

G An annuity that pays forever is called a perpetuity.
G The future value of a perpetuity has a finite present
value.
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The Present Value of Annuity would Decrease if the Interest Rate


Goes Up and Increases with the # of Years of Payment
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The Future Value of Annuity would Increase if the Interest Rate


Goes Up and Increases with the # of Years of Payment
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The Value of the Perpetuity would Decrease if the Required Rate of


Return Increases and Value would Increase if the Payment Increases
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G At time 0, the outstanding principal is 10,000


G After one period an installment of Rs 2,637.97 is made.
The interest due for the first period is 10% of 10,000 or Rs 1,000
So the excess payment of Rs 1,637.97 is a partial repayment of principal.
After the payment the outstanding principal is Rs 8,362.03
After another period a second installment is paid.
The interest for this period is 10% of 8,362.03 which is Rs 836.20.
The balance of Rs 1,801.77 constitutes a partial repayment of principal.
G The value of the outstanding balance at the end should be zero.
G After each payment the outstanding principal keeps declining.
G Since the installment is constant
The interest component steadily declines
While the principal component steadily increases
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This is of course the nominal annual rate.
The effective annual rate is 10.8554%
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G Therefore value of any equity share is the present value expected


stream dividends expected to be paid over infinite period
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0 -1000 -1000
1 550 350
2 655 465
3 405 750
4 355 600
G The project A has an IRR of 38% and Project B has an IRR of 35%. if use IRR
as the tool project A is better
G Let use NPV as a tool to evaluate the projects
If our required rate is 15%, the NPV method would identify the project B to be
better
If our required rate is 25%, the NPV method would identify the project A to be
better
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Project Flow the Project
0 (155,000) (155,000)
1 55,000 (100,000)
2 75,000 (25,000)
3 25,000 0
4 25,000 25,000

G The project recovers the initial investment amount by 3rd year


G Therefore for this project the payback period is 3 years.
G The payback period rule would be
If required payback is higher than the actual payback period then accept
the project else reject it
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- Variable Costs (80% of Revenue) 1,400,000

= Contribution 350,000
- Fixed Cost (excluding Non-Cash Charges) 150,000
- Non-Cash Charges (like Depreciation) 100,000

= EBIT 100,000
- Interest 0
= Taxable Income 100,000
- Taxes @34% 34,000

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Net Sales OR Revenue 1,750,000

- Variable Costs and Fixed Costs 1,550,000


£ 
  
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£  

 


= Operating CF 166,000

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NI (Net Income) 66,000
+ Non-Cash Charges 100,000
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= Operating CF 166,000
$ 
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Revenue ($70,000 x 25) 1,750,000


- Variable Costs (80% of Revenue) 1,400,000
= Contribution 350,000
- Fixed Cost (excluding Non-Cash Charges) 150,000
= Taxable Income without Non-Cash Charges & Interest 200,000
- Taxes @34% 68,000
= EAT 132,000
+ !+ !  #
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= OCF (Un-levered) 166,000


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