MANAGERIAL FINANCE I
COURSE OBJECTIVE
 To
familiarize students with the basic concepts,
tools and techniques of financial management for
decision making.
to develop critical thinking
 to enable you to think in a broader perspective

COURSE OUTLINE
1.
2.
3.
4.
5.
6.
7.
Introduction
Financial Environment
Financial Statement, Taxes and Cash-flow
Time Value of Money
Working Capital Management
Cost of Capital
Capital Investments

COURSE
IN
DETAILS



Introduction
Meaning and nature of managerial/corporate finance.
Financial Management decisions: investment,
financing and working capital decisions, The goals of
Financial Management: profit maximization Vs
Wealth Maximisation, Agency relationship.
Financial Environment
Financial Markets: meaning and importance, types,
financial institutions
Financial Statement, Taxes and Cash Flow
The balance sheet; the income statement, taxes and
cash flow
Time Value of Money
Future Value, Present value, Future value of annuity,
Present value of annuity, annuity dues, uneven cashflow streams, perpetuities

COURSE
IN
DETAILS


Working Capital Management
Concept of Working Capital and Net Working
Capital
Alternative Current asset investment policies
Cash and liquidity management
Cash budget
Receivables management
Inventory management (ABC, EOQ)
Cost of Capital
Cost of components of capital
WACC
Capital Investments
Project classifications, Cash flow estimation,
identifying relevant cash flows, Capital budgeting
decision criteria. Ranking mutually exclusive projects.
TEXT BOOK AND REFERENCES
We will not be limited to a single text book.





Fundamentals of Corporate Finance by Ross, Westerfield and
Jordon.
Essentials of Managerial Finance by Weston, Besley and
Brigham
Fundamentals of Financial Management by Brigham and
Houston
Principles of Managerial Finance by Lawrence J. Gitman.
Principles of Corporate Finance by Richard A. Brealey: and
Stewart C. Myers
Other reference books and literatures will
always be the added advantage.
MANAGERIAL FINANCE
Learning Unit 1

Accountancy Vs Finance ???

Managerial/Corporate Finance ???
FINANCE

The art and science of managing money.
MEANING AND NATURE OF MANAGERIAL/CORPORATE
FINANCE
Corporate or managerial finance is the study of
ways to answer these three questions.
MEANING AND NATURE OF MANAGERIAL/CORPORATE
FINANCE
Corporate or managerial finance is the study of
ways to answer these three questions.
1.
What long-term investments should you take
on? - Buildings, machinery, and equipments… Capital budgeting
MEANING AND NATURE OF MANAGERIAL/CORPORATE
FINANCE
Corporate or managerial finance is the study of
ways to answer these three questions.
1.
2.
What long-term investments should you take
on? - Buildings, machinery, and equipments… Capital budgeting
Where will you get the long-term financing to
pay for your investment? Will you bring in other
owners or will you borrow the money?

Capital Structure – the mixture of debt and equity
MEANING AND NATURE OF MANAGERIAL/CORPORATE
FINANCE
Corporate or managerial finance is the study of
ways to answer these three questions.
1.
2.
What long-term investments should you take
on? - Buildings, machinery, and equipments… Capital budgeting
Where will you get the long-term financing to
pay for your investment? Will you bring in other
owners or will you borrow the money?

3.
Capital Structure – the mixture of debt and equity
How will you manage your everyday financial
activities such as collecting from customers and
paying suppliers?

Working capital management
TEN BASIC CONCEPTS THAT FORM THE FOUNDATION OF
FINANCIAL MANAGEMENT.
1.
2.
3.
4.
5.
The Risk-Return Tradeoff — we won’t take
additional risk unless we expect to be compensated
with additional return
The Time Value of Money — a rupee received today
is worth more than a rupee received in the future.
Cash—Not Profits – it is only cash flows that the firm
receives and is able to reinvest.
Incremental Cash Flows — In making business
decisions, we will concern ourselves with only what
happens as a result of that decision.
The Curse of Competitive Markets —why it is hard
to find exceptionally profitable projects. ... product
differentiation or by achieving a cost advantage.
TEN BASIC CONCEPTS THAT FORM THE FOUNDATION OF
FINANCIAL MANAGEMENT.
6.
7.
8.
9.
10.
Efficient Capital Markets —the markets are quick,
and the prices are right.
The Agency Problem — managers may make
decisions that are not in line with the goal of
maximization of shareholder wealth.
Tax –
Diversification Ethics - Ethical behavior is doing the right thing,
and ethical dilemmas are everywhere in finance.
Ethical behavior is important in financial
management, just as it is important in everything
we do. Unfortunately, precisely how we define
what is and what is not ethical behavior is
sometimes difficult.
FIRM AND FINANCIAL MANAGER
Those three decisions tend to be more complex in
large corporations than in small single-man
businesses.
 Sole proprietorships – sole proprietor - no
partners or stockholders; Unlimited liability;
 Partnerships – partners; unlimited liability
 Corporations – legally distinct from its owners;
publicly held shares; closely held or widely held
shares; legal entity; can sue can be sued; taxes;
lend and borrow; stockholders have limited
liability;
 Shareholders elect a Board of Directors;
separation of ownership and management

FINANCIAL MANAGER
Corporation employs managers to represent the
owners’ interests and make decisions on their
behalf.
 Financial manager will be in charge of answering
those three questions.
 That’s why managerial finance is said to be
"concerned with the duties of the financial
manager in the business firm".
 Financial management function is usually
associated with a top officer of the firm, such as a
vice president of finance or some other chief
financial officer CFO.

BOD
CEO
COO
CFO
TREASURER
CONTROLLER
CASH MANAGER
TAX MANAGER
CREDIT MANAGER
COST ACCOUNTING
MANAGER
CAPITAL EXPENDITURE
FINANCIAL ACCOUNTING
MANAGER
FINANCIAL PLANNING
DATA PROCESSING MANAGER
FINANCIAL MANAGEMENT DECISIONS
1.
Investment decisions: long-term
investments.
Capital budgeting decisions.

Financial manager tries to identify investment
opportunities that are worth more to the firm
than they cost to acquire.

Varies with the nature of business.

How much cash they expect to receive, when
they expect to receive it and how likely they are
to receive it? Evaluating the size, timing, and
risk of future cash flows is the essence of the
capital budgeting.
FINANCIAL MANAGEMENT DECISIONS
2.




Financing Decisions: how to obtain the long
term finance?
Ways in which the firm obtain and manages the
long-term financing which it needs to support its
long term investments.
Determination of capital structure – the mixture
of long-term debt and equity the firm uses to
finance its operations.
How much should the firm borrow? Or what
should be the mixture of debt and equity? What
are the least expensive sources of funds for the
firm?
This decision affects, What percentage of firm’s
cash flow goes to creditors and what percentage
goes to shareholders?
FINANCIAL MANAGEMENT DECISIONS
3.




Working capital decisions
Concerned with short term assets and liabilities –
cash, inventory, receivables, payables…
ensures that the firm has sufficient resources to
continue its operations and avoid costly
interruptions.
Level of cash, inventory, … ; Credit policy …; Short
term financing … (ST borrowings)
How much cash and inventory should we keep on
hand? Should we sell on credit? If so, what terms will
we offer, and to whom will we extend them? How will
we obtain any needed short-term financing? Will we
purchase on credit or will we borrow in the short
term and pay cash? If we borrow in the short term,
how and where should we do it?
GOALS
Survive
 Avoid financial distress and bankruptcy
 Beat the competition
 Maximize the sales or market share
 Minimize costs
 Maximize profits
 Maintain steady earnings growth




The goals involving sales, market share, and cost control all
relate, to different ways of earning or increasing profits.
The goals like bankruptcy avoidance, stability and safety,
relate in some way to controlling risk.
But these two types of goals are somewhat contradictory.
The pursuit of profit normally involves some element of
risk, so it isn’t really possible to maximize both safety and
profit.
GOAL OF FINANCIAL MANAGEMENT

For the profit-oriented businesses, the goals of
financial management are to make money or add
value for the owners. Profit maximization would
probably be the most commonly cited goal, but
even this is not a very precise objective.
(controversies: Long run or short run, average or
total, accounting net income or earning per share,
….)
GOAL

The goal of financial management is to maximize
the current value per share (maximization of
shareholder wealth) of the existing stock. They
should act in the shareholders’ best interests.
PROFIT MAXIMIZATION VS WEALTH
MAXIMIZATION
Profit maximization ... microeconomics … Maximizing EPS
(example)
 While the goal of profit maximization stresses the efficient
use of capital resources, it assumes away many of the
complexities of the real world
Timing - timing differences of returns. ...the timeframe over which
profits are to be measured (with in a year or some longer period?)...
current profits by cutting down costs like routine maintenance and
R&D expenditures
2. Cash flows - profits do not necessarily result in cash flows available
to stockholders
3. Risk - alternatives are compared by examining their expected values
or weighted average profit. Whether one project is riskier than
another! does not enter into these calculations.
1.
Thus a more realistic goal is needed, which we consider to be
Maximization of Shareholder Wealth
EXAMPLE
Expected EPS
Investment
Year 1
Year 2
Year 3
Total (1-3)
X
Rs 1.4
Rs 1
Rs 0.4
Rs 2.8
Y
0.60
1
1.4
3
In terms of the profit maximisation goal, Y would be preferred over X,
because it results in higher total EPS over the 3-year period.
<<
PROFIT MAXIMIZATION VS WEALTH
MAXIMIZATION
Maximization of shareholder wealth
 There is no ambiguity in this criterion, and there is no
short-run versus long run issue. We explicitly mean
that our goal is to maximize the current stock value.
 Stockholders are the residual owners. If the
stockholders are winning in the sense that the leftover,
residual portion is growing, it must be true that
everyone else is winning also.
 The challenge is, how to identify those investments
and financing arrangements that favorably impact the
value of the stock, and this is what the corporate
finance deals with. Corporate finance is the study of
the relationship between business decisions and the
value of the stock in the business.
PROFIT MAXIMIZATION VS WEALTH
MAXIMIZATION
However, financial manager should not take illegal or
unethical actions in the hope of increasing the value of
the equity in the firm.
 Financial manager best serves the owners of the
business by identifying goods and services that add
value to the firm because they are desired and valued
in the free market place.
 In order to employ this goal, we need not consider
every price change to be the worth of our decisions.
Other factors, such as changes in the economy, also
affect stock prices. What we do focus on, is the effect
that our decision should have on the stock price if
everything were held constant.

AGENCY PROBLEM
The possibility of conflict of interest
between the stockholders and management
of a firm.
 The relationship between stockholders and
management is called an agency relationship.
Such a relationship exists whenever someone
(the principal) hires another (the agent) to
represent his/her interests.
 Stockholders/ owners – principal
 Managers – agents
 Will management necessarily act in the best
interests of the stockholders? Might not
management pursue its own goals at the
stockholders’ expense?

AGENCY COST
The term agency costs refers to the costs of the conflict
of interest between stockholders and management.
 These costs can be indirect or direct.
 An indirect agency cost is a lost opportunity. Suppose,
the firm is considering a new investment. The new
investment is expected to favorably impact the share
value, but it is also a relatively risky venture. The
owners of the firm will wish to take the investment
(because the stock will rise), but management may not
because there is the possibility that things will turn
out badly and management jobs will be lost. If
management does not take the investment, then the
stockholders may lose a valuable opportunity. This is
one example of indirect agency cost.

Direct agency costs come in two forms.
 The first type is a corporate expenditure that
benefits management but costs the stockholders.
Perhaps the purchase of a luxurious and
unneeded corporate jet would fall under this
heading.
 The second type of direct agency cost is an
expense that arises from the need to monitor
management actions. Paying outside auditors to
assess the accuracy of financial statement
information could be one example.








Do managers act in the stockholders’ interest?
Two factors:
How closely the management goals aligned with
stockholder goals? (managerial Compensation)
Can management be replaced if they do not pursue
stockholder goals? (control of the firm)
Compensation (economic incentive to increase share value)
Top managerial compensation is tied to financial
performance and often to share value.
Managers are frequently given the option to buy stock at a
bargain price. The more the stock is worth, the more
valuable is this option.





Job prospects: better performers within the firm will tend to get
promoted. More generally, those managers who are successful in
pursuing stockholder goals will be in greater demand in the labor
market and thus command higher salaries.
Control of the firm
Control of the firm ultimately rests with stockholders. They elect
the board of directors, who, in turn, hire and fire management.
(An important mechanism by which unhappy stockholders can act
to replace existing management is called a proxy fight.)
Another way that management can be replaced is by takeover.
Those firms that are poorly managed are more attractive as
acquisitions than well-managed firms because a greater profit
potential exists. Thus, avoiding a takeover by another firm gives
management another incentive to act in the stockholders’
interests.
Even so, often management goals are pursued at the
expense of the stockholders, at least temporarily.