Financial Management GEN 10 Recap (Module 1) PDF

FINANCIAL MANAGEMENT GEN: 10 RECAP (Module 1)  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: MEANING  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: MEANING FINANCIAL or BUSINESS DECISIONS are a. PROCUREMENT of FU...

FINANCIAL MANAGEMENT GEN: 10 RECAP (Module 1)  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: MEANING  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: MEANING FINANCIAL or BUSINESS DECISIONS are a. PROCUREMENT of FUNDS also known as FINANCING Decision b. UTILIZATION of FUNDS also known as INVESTING Decision FINANCING DECISION = Where to GET the money from i.e., SOURCES INVESTING DECISION = Where to INVEST the money i.e., APPLICATION PROCURMENT or FINANCING DECISIONS involve COST UTILIZATION or INVESTING DECISIONS involve RETURNS  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: MEANING FINANCING Decision 1. LONG TERM Financing Decision 2. SHORT TERM Financing Decision INVESTING Decision 1. LONG-TERM Investing Decision LONG TERM LONG TERM FINANCES INVESTMENTS 2. SHORT-TERM Investing Decision SHORT TERM SHORT TERM FINANCES INVESTMENTS  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: MEANING FINANCING Decision 1. LONG TERM Financing Decision = CAPITAL 2. SHORT TERM Financing Decision = CURRENT LIABILITIES INVESTING Decision 1. LONG-TERM Investing Decision = FIXED ASSETS 2. SHORT-TERM Investing Decision = CURRENT ASSETS CAPITAL FIXED ASSETS CURRENT CURRENT LIABILITIES ASSETS BALANCE SHEET  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: FUNCTIONS  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: OBJECTIVES  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT: SCOPE  © 2022 Vinod Kr Sharma FINANCE MANAGEMENT FINANCIAL DECISIONS: FINANCING DECISION involves COSTS (Dividend & Interest) INVESTING DECISION involves RETURNS (Return on Investments) RETURN ON INVESTMENT should be MORE than COST of FINANCING CAPITAL RETURN ON INVESTMENT = PROFIT PROFIT distributed among SHAREHOLDERS = DIVIDEND Distribution of DIVIDEND creates demand for SHARES Demand for SHARES increases the MARKET VALUE of the SHARES Increase in MARKET VALUE of SHARES creates WEALTH for the SHAREHOLDERS WEALTH for SHAREHOLDERS = Increase in MAREKT CAPITALIZATION of the Company.  © 2022 Vinod Kr Sharma FINANCIAL DECISIONS & TIME VALUE OF MONEY: FINANCIAL DECISIONS: In finance, the timing of all cash flows (INFLOW and OUTFLOW) must correspond to the same point in time. FINANCIAL DECISIONS & TIME VALUE OF MONEY: TIME VALUE OF MONEY Money in the PRESENT is more than the same sum of money to be received in the FUTURE. Money in the PRESENT can be invested to earn a RETURN, whereas Money in the future carries the DEFAULT RISK. INFLATION erodes PURCHASING POWER and TIME VALUE OF MONEY  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: TIME VALUE OF MONEY: ‘MONEY HAS TIME VALUE” The value of money changes over a period of time. A rupee today has MORE value than a rupee after a year. Implication of TIME VALUE OF MONEY 1. Person will have to pay in future MORE for a rupee received today 2. Person may accept LESS today than to receive in future. These statements relate to two different concepts: 1. COMPOUND VALUE (Increase in Value) 2. DISCOUNTING VALUE (Decrease in Value)  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: TIME VALUE OF MONEY: Time Value for money is expressed by an INTEREST RATE. METHODS OF ADJUSTING CASH FLOWS FOR TIME VALUE OF MONEY: COMPOUNDING is the process of calculating FUTURE VALUE of an Investment. It INCREASES the value of Investment. DISCOUNTING is the process of calculating PRESENT VALUE of an Investment. It DECREASES the value of Investment  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: i or r = Rate of Return or Interest Rate n or t = Time period or Duration A = Annuity PV = Present Value FV = Future Value FVIF = Future Value Interest Factor PVIF = Present Value Interest Factor PVA = Present Value of Annuity FVA = Future Value of Annuity FVIFA = Future Value Interest Factor of Annuity PVIFA = Present Value Interest Factor of Annuity TIME VALUE OF MONEY: TIME VALUE OF MONEY = NET PRESENT VALUE Timing of cash OUTFLOWS and INFLOWS has Economic consequences, i.e. Time Value of Money. Financial VALUES and DECISIONS are evaluated using 1. FUTURE VALUE (FV) or 2. PRESENT VALUE (PV) PV and FV are reciprocals of one another Present Value (PV) is always LESS than the Future Value (FV) TIME VALUE OF MONEY: TIME VALUE OF MONEY 1. FUTURE VALUE (FV) 2. PRESENT VALUE (PV)  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: TIME VALUE OF MONEY FUTURE VALUE (FV) measures cash flows at the END of a project’s life. PRESENT VALUE (PV) measure cash flows at the BEGINING of a project’s life FUTURE VALUE (FV) is cash received at a FUTURE DATE, and PRESENT VALUE (PV) is cash as of TODAY.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: ANNUITY: Series of equal payments made or received at equal intervals over time. Example: Monthly payment of Fixed loan Instalments. PERPETUITY: Perpetuity is an annuity in which the periodic payments or receipts begin on a fixed date and continue indefinitely or perpetually. R = the payment or receipt each period i = the interest rate per payment or receipt period  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: FUTURE VALUE (FV) = COMPOUNDING FV = Money to be received in FUTURE n Future Value (FV) = PV x (1 + r) Where: CAN YOU SPOT PV = Present Value of the Investment THE PROBLEM? i or r = Rate of Return t or n = Number of Periods  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: FVIF = Future Value Interest Factor = FVIF indicates how much the initial investment or amount will MULTIPLY or ACCUMULATE to reach its FUTURE VALUE. Example: If 100 is invested today, its value after one year would be 100 x 1.10 = 110. It means that the amount invested will grow by a factor of 1.10 over the course of one year. FVIF (1,10%) = 1.100  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY:  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: FINANCIAL TABLES: Financial tables include FUTURE and PRESENT VALUE interest factors that simplify time value calculation.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY:  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: PRESENT VALUE (PV) = DISCOUNTING PV = Current worth of a future sum of money discounted at a specific interest rate. CAN YOU SPOT Where: THE PROBLEM? FV = Future Value of the Investment i or r = Rate of Return n or t = Number of Periods  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY:  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY:  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: FINANCIAL TABLES: Financial tables include FUTURE and PRESENT VALUE interest factors that simplify time value calculation.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY:  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: Present Value of 80,000 to be received after 5 years when required rate of return is 10% PRESENT VALUE = 80000/ (1+0.10)5 = 80000 x (1.10)(1.10)(1.10)(1.10)(1.10) = 49,674 OR = 80000 (.621) = 49,674  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: TIME VALUE OF MONEY Money received in the present is more valuable than the equivalent amount of money received in the future. This necessitates Future cash flows to be DISCOUNTED to the current date in “PRESENT TERMS.” Lower Discount Rate → Higher Valuation Higher Discount Rate → Lower Valuation  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: TIME VALUE OF MONEY Future Value (FV): Projected or Expected Cash flow Discount Rate (r) or Expected rate of return (i) is a function of the RISKINESS of the expected cash flow Higher Discount Rate → Greater Risk Lower Discount Rate → Lower Risk  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: INTEREST RATES (r) or Expected rate of return (i) INTERPRETATION Interest rates interpreted in three ways: 1. Required Rate of Return 2. Discount Rate and 3. Opportunity Cost  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: INTEREST RATES (r): Interpretation Lets assume 9,500 today & 10,000 in one year are equivalent in value. So 500 is the required compensation for receiving 10,000 in one year instead of 9500 now. REQUIRED RATE OF RETURN is 500/9,500 = 0.0526 or 5.26%. REQUIRED RATE OF RETURN can be used to discount the future payment of 10,000 for calculating the PRESENT VALUE of 9,500. So 5.26% can be a DISCOUNT RATE. OPPORTUNITY COST is the value forgone by choosing a particular course of action. If 9,500 is spend today then the opportunity of earning 5.26% is foregone.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: COMPOUNDING and DISCOUNTING For calculating FUTURE VALUE of Investment use COMPOUNDING. For calculating PRESENT VALUE of Investment use DISCOUNTINGING.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: ANNUTIES: These are stream of equal periodic cash flows, over a specified time period. FVA = Future Value of Annuity PVA = Present Value of Annuity FVIFA = Future Value Interest Factor of Annuity PVIFA = Present Value Interest Factor of Annuity  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: ANNUTIES: These are stream of equal periodic cash flows, over a specified time period. FVA = Future Value of Annuity FVA(n) = PMT x FVIFA(i,n) where PMT =Periodic Payments PVA = Present Value of Annuity PVA(n) = PMT x PVIFA(i,n) where PMT =Periodic Payments  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: FVIFA = Future Value Interest Factor of Annuity = FVIFA is a factor used to calculate the FUTURE VALUE OF A SERIES OF EQUAL PAYMENTS. It represents the MULTIPLIER by which each annuity payment should be multiplied to find the FUTURE VALUE of the ANNUTIES FVA = PMT x PMT =Periodic Payments FVA = PMT x (FVIFA) A FVIFA value GREATER THAN 1 indicates that the future value of the annuity is larger than the sum of the individual payments. This is because each payment earns interest contributing to the overall growth.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: Example: FVIFA at 5% for 4 years is 4.31 it means that an annuity of 100 per year will grow to 431 in 4 years at a 5% interest rate i.e. Rs. 100 x (4.310) = 431  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY:  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: PVIFA = Present Value Interest Factor of Annuity = PVIFA is a factor used to calculate the present value of a series of equal payments made or received at regular intervals DISCOUNTED at certain rate of interest. It represents the discounting factor by which each annuity payment (received or made) should be multiplied to find the present value of the future payment of series.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: Example: Annuity pays 500 per year with annual interest rate of 8% for 3 years. Find PRESENT VALUE of the ANNUITY PVA = PMT x (PVIFA i,n) PVIFA = 1 - (1+.08)-3/.08 PVIFA = 1 – (1/1.259712)/.08 PVIFA = 1 – (.7938)/.08 PVIFA =.2062/.08 Present Value of Annuity PVIFA = 2.577 PVA = PMT x (PVIFA) = 500 x (2.577) = 1288.55  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: Mr. A wishes to know how much money he will have at the end of 5 years if he chooses to deposit 1,000 annually, at the end of each of the next 5 years, into a savings account paying 8% annual interest.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: Mr. A wishes to know how much money he will have at the end of 5 years if he chooses to deposit 1,000 annually, at the end of each of the next 5 years, into a savings account paying 8% annual interest. PVA(n) = PMT x PVIFA(i,n) where PMT =Periodic Payments Present Value Interest Factor (PVIFA) of an ordinary annuity of Re 1 per period at 8% for 5 years = PVIFA (i,n) = 3.993 PVA = 1,000 x 3.993 = 3,993  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: A person wishes to have a FUTURE SUM of Rs. 5,00,000 for his son’s education after 10 years from now. What is the single payment that he should deposit now so that he will get the desired amount after 10 years? The bank gives 7% interest rate.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: A person wishes to have a FUTURE SUM of Rs. 5,00,000 for his son’s education after 10 years from now. What is the single payment that he should deposit now so that he will get the desired amount after 10 years? The bank gives 7% interest rate. PV = FV / (1+i)n = FV (PVIFi,n) = 5,00,000 / (1+ 0.07)10 PVIF =.508 PV = 5,00,000 x.508 = 2,54,174.67 The person has to invest 2,54,174.67 now to get a sum of 5,00,000 after 10 years.  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: A 30 years old man plans to invest an equal sum of 10,000 at the end of every year for the next 30 years. The bank gives 8% interest rate. Find the maturity value of his account when he is 60 years old. A= 10,000 n= 30 years i= 8%  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: A 30 years old man plans to invest an equal sum of 10,000 at the end of every year for the next 30 years. The bank gives 8% interest rate. Find the maturity value of his account when he is 60 years old. A= 10,000 n= 30 years i= 8% FVA = A x {[(1+i)n - 1]/i} = A (FVIFAi,n) FVA = A x {[(1+i)n - 1]/i} = 10,000 x {[(1+0.08)30 - 1]/ 0.08} = 10,000 x (FVIFA) = 10,000 x (113.28) = Rs. 11,32,800  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY:  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: A firm has to replace a machine after 10 years at an outlay of Rs. 4,00,000. It plans to deposit an equal amount at the end of every year for the next 10 years at an interest rate of 6%, compounded annually. Find the equivalent amount that must be deposited at the end of every year for the next 10 years. FVA = A x {[(1+r)t - 1]/r} = A x (FVIFA i, n)  © 2022 Vinod Kr Sharma TIME VALUE OF MONEY: A firm has to replace a machine after 10 years at an outlay of Rs. 4,00,000. It plans to deposit an equal amount at the end of every year for the next 10 years at an interest rate of 6%, compounded annually. Find the equivalent amount that must be deposited at the end of every year for the next 10 years. FVA = 4,00,000 t= 10 years r= 6% FVA = A x {[(1+r)t - 1]/r} = A x (FVIFA i, n) A = FVA / {[(1+r)t - 1]/r} = 4,00,000/ {[(1+ 0.06)10 - 1]/ 0.06} = 4,00,000 / FVIFA FVIFA = 13.181 = 4,00,000 / 13.181 A = Rs. 30,347.16 FINANCIAL MANAGEMENT CA Vinod Kr Sharma Professor of Practice (Finance & Entrepreneurship)