1. FINANCIAL MANAGEMENT Objectives 1. Wealth maximization. 2. Profit maximization The main objective of Financial management is to increase the value of the company.That is maximizing shareholders wealth.Hence,wealth maximization is superior to profit maximization.

2. Contd… Financial Management  Studies the financial problems in individual firms.  Seek sources of financing.  Seek profitable investments.

3. Financial Management Contd… https://www.youtube.com/watch?v=pLuNpz vrDw8

4. PROJECT APPRAISAL PROJECT APPRAISAL 1.CAPITAL EXPENDITURE. Often involve bigger outlay of money & the benefits from capital expenditure are likely to accrue over a long period of time. Usually well over one year and often much longer. Therefore any proposed capital expenditure project should be properly appraised,and found to be worthwhile,before the decision is taken to go ahead with the expenditure.

5. Contd… Many different Investment projects exist including,  Replacement of assets.  New product or service developments.  Product or Service expansions.  Environmental and welfare proposals, etc..

6. Project Appraisal Techniques 1.The payback period. 2.Accounting rate of return.(ARR). 3.Net Present Value(NPV). 4.Internal Rate of Return.(IRR).

7. 1.The payback period.  This shows how long an investor has to wait to repay his investment.  Payback is the time required for the cash inflows from capital investment project to equal the cash outflows.  This is the time which elapses until the invested capital is recovered.  Assumed that the cash flows occur evenly during the year.

8. Computation of Payback Period. 1.For Constant Annual Cash Flows. Payback Period = Initial Investment Annual Cash Inflows

9. Practice Question -01 An expenditure of Rs.2 million is expected to generate net cash inflows of Rs.500,000 each year for the next seven years. Compute the payback period.

10. Answer – Payback Period = Initial Investment Annual Cash Inflow = 2,000,000 500,000 = 4 Years.

11. 2. For Uneven Annual Cash Flows. The payback has to be calculated by working out the cumulative cash flow over the life of a project. 2. For Uneven Annual Cash Flows. The payback has to be calculated by working out the cumulative cash flow over the life of a project.

12. Practice Question -02 A company intends to invest in a project with a total sum of Rs.100 million.The expected net cash flows from the project would be as follows. YearNet cash flows (millions) 01Rs.30 02Rs.45 03Rs.20 04Rs.15 05Rs.10 Compute payback period of the project.

13. Answer – Year NCF Cum NCF 0 (100) (100) 1 30 (70) 2 45 (25) 3 20 (5) 4 15 10 5 10 20 Pay back Period =3Yrs +(5/15*12) =3yrs +4 months.

14. 3.Mutually Exclusive Projects. Faced with a choice between mutually exclusive projects,choose the project with the quickest payback (provided it meets the company’s target payback period).

15. Practice Question -03 A Ltd. Is a company which evaluates two mutually exclusive projects and only one of them can be undertaken.The details of investment and cash flows from such projects are given below. Project AProject B (Rs) (Rs) Capital Assets (9,000) (10,000) Profit Year 1 3,000 8,000 Year 2 4,000 4,000 Year 3 6,000 500 Year 4 7,000 500 Year 5 8,000 500 Select the project based on payback period.

16. Answer – Payback Period Project A =2 yrs + (2/6*12) = 2Yrs & 4 Months. Project B =1 Yrs + (2/4*12) =1 Yrs & 6 Months

17. 2.Accounting Rate of Return (ARR)(ROCE/ROI) A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. ARR = Average Profit * 100 Average Investments Notes 1.The average profit is after depreciation. 2.The average value of the investment represents the average capital employed over the life of the project. Average Investment = Initial Investment + Residual Value 2 Decision Criteria(Single Project) – Project ARR > Target ARR

18. Mutually Exclusive Projects Practice Question -04 Project A Initial Investment Rs.450,000 Scrap value at the end of year 5 Rs. 20,000 Year 1 2 3 4 5 Annual CF’s (Rs.000) 200 150 100 100 100 Project B Initial Investment Rs.100,000 Scrap value at the end of year 5 Rs. 10,000 Year 1 2 3 4 5 Annual CF’s (Rs.000) 50 40 30 20 20 Mutually Exclusive Projects Practice Question -04 Project A Initial Investment Rs.450,000 Scrap value at the end of year 5 Rs. 20,000 Year 1 2 3 4 5 Annual CF’s (Rs.000) 200 150 100 100 100 Project B Initial Investment Rs.100,000 Scrap value at the end of year 5 Rs. 10,000 Year 1 2 3 4 5 Annual CF’s (Rs.000) 50 40 30 20 20

19. Calculate the ARR(ROI) for each project,and indicate which project should be chosen. Answer- Project A =(650000-(450000-20000))/5 * 100 (450,000+20000)/2 = 18.72% Project B =(160,000-(100,000-10,000))/5 *100 (100,000+10,000)/2 = 25.4% Based on ARR technique the project “B” would be recommended since it will resulting higher ARR.

20. ROI (ARR/ROCE) https://www.youtube.com/watch?v=7fB- 3Xh2IXg https://www.youtube.com/watch?v=7fB- 3Xh2IXg

21. The Time Value of Money Money received today is worth more than the same sum received in the future,because it has a time value. Today Rs.100.00 How much worth it in year 1? Eg:If offered the choice between Rs.100 now or the expectation of Rs.100 in a year’s time,then most people will prefer the Rs.100 now.However,what if the choice is between Rs.100 now and Rs.105 in one year or Rs.110 or ….? Suppose you are indifferent between Rs.100 now or the expectation of Rs.112 in one year –this would indicate that your time value of money can be expressed as an interest rate of 12% per annum.

22. Contd… Discounted cash flow (DCF) techniques take account of this time value of money when appraising investments. Reasons for time value of money  Consumption Preferences.  Impact of Inflation(Price Level).  Risk

23. Compound Interest A sum invested to day will earn interest.Compounding calculates the future value(terminal value) of a given sum invested today for a number of years. To compound a sum,the figure is increased by the amount of interest it would earn over the period.

24. Contd… V = X(1+r) n Where V = Future Value X = Initial Investment(Present Value) r = Interest rate n = Number of time periods. Practice Question -05 Rs.100,000 is invested in an account for five years.The interest rate is 10% per annum.Compute the future value of the investment after five years.

25. Answer V = X(1+r)n Future Value = 100,000(1.10) 5 = Rs.161,051 Future value represent that Rs.100,000/- to day is equivalent to Rs.161,051/- at the end of year 05,at the interest rate of 10% per annum. There fore due to the rate of interest the time value of money is different from year 01 & year 05.

26. Discounting Present Value = Future Value * Discount Rate Discount Rate = 1 (1+r) n Eg –How much should be invested now in order to have Rs.250million in eight years time?The account pays 12% interest per annum.

27. Contd.. Discount Rate = 1 (1+r) n = 1 (1.12) 8 = 0.4038 PV = Rs.250Mn *0.4038 = Rs.100Mn It means that Rs.250Mn in 08 years time is equivalent to Rs.100 Mn to day at the interest rate of 12% per annum.

28. Cost of Capital of the Company (WACC) This is computed based on the actual cost of the finance of a project.This shows the average cost of different financing methods. Eg : Asiri is a company which is engaged in hospital projects.The total investment of the company is Rs.1,000 Mn.The sources of finance are as follows.

29. WACC Source of Finance Rs(Mn) Rate of Return Shares & Equity 500 Dividend@20% Debentures 300 Interest @ 18% Long term Loan 200 Interest @ 16%

30. Calculation of WACC Source Rs(Mn) Annual Cost Equity 500 500 * 20%=100 Debentures 300 300 * 18%= 54 Loan 200 200 * 16% = 32 1000 186 WACC = 186 *100 1000 = 18.6%

31. WACC The cost of capital represent the actual cost from the alternative source of finance.Accordingly where the project generate higher return than the company cost of capital,the project is viable.

32. Net Present Value (NPV) The net benefit or loss in present value terms from an investment opportunity. NPV =PV of Inflows – PV of Outflows NPV = PV of net cash flows. Decision Criteria (Single Project) NPV is positive = Project Accept NPV is negative = Project Not Accept NPV is Zero= Just Accept (Project Break Even)

33. NPV Contd… https://www.youtube.com/watch?v=HFFkF MfotT0 https://www.youtube.com/watch?v=zGRVV SC4UUQ

34. NPV Mutually Exclusive Projects. Practice Question - 06 Healthcare Ltd is considering two mutually-exclusive projects with the following details. Project A Initial Investment Rs.450,000 Scrap value at the end of year 5 Rs. 20,000 Year 1 2 3 4 5 Annual CF’s (Rs.000) 200 150 100 100 100 Project B Initial Investment Rs.100,000 Scrap value at the end of year 5 Rs. 10,000 Year 1 2 3 4 5 Annual CF’s (Rs.000) 50 40 30 20 20

35. NPV Assume that the initial investment is at the start of the project and the annual cash flows are at the end of each year. Required : Calculate the Net Present Value for projects A and B if the relevant cost of capital is 10%.

36. NPV Computation of NPV (Rs.000) Project A Year Invest Inflows NCF DF 10% PV 0 (450) - (450) 1.00 (450.00) 1 - 2002000.9091 181.82 2 - 1501500.8264 123.97 3 - 100100 0.7513 75.13 4 - 1001000.6830 68.30 5 20 1001200.6209 74.51 NPV74.00

37. NPV NPV Project B Year Invest Inflows NCF DF 10% PV 0 (100) - (100) 1.00 (100.00) 1 - 50 500.9091 45.45 2 - 40 400.8264 33.05 3 - 30 30 0.7513 22.53 4 - 20200.6830 13.66 5 10 20300.6209 18.62 NPV33.31

38. NPV contd.. Recommendation The both projects are profitable as both will give you positive NPV. However since the projects are mutually exclusive, project A is recommended since the project A will generate higher NPV.

39. NPV Contd.. Timing of cash flows Y0 =Now Y1 =End of year 1 Y2 =End of year 2 If the cash flow occurred in start of the year, then it should be considered as it generated in the previous year end. Y1 = Beginning of Year 2

40. Annuity An annuity is a constant cash flow from year to year. PV of Annuity = Annuity * Annuity Factor 1 Annuity Factor = (1+r) n - 1 r r = Discount rate n = No of years

41. Contd.. Eg :What is the present value of Rs.500,000 in contribution earned each year from years 1-5,when the required return on investment is 15%. PV of Annuity = 500,000 *3.3522 =1,676,100

42. Internal Rate of Return (IRR) This is the rate of return at which the project has a NPV of Zero. Decision Criteria IRR > COC = Accept the project IRR < COC = Not accept.

43. IRR IRR = L + N L * (H –L) N L - N H L = Lower rate of interest H = Higher rate of interest N L = NPV at lower rate of interest. N H = NPV at higher rate of interest

44. IRR Contd.. Practice Question -07 Calculate the internal rate of return of the project with following NPV at different discounting factor. At 10% the NPV was Rs.33,310/- At 20% the NPV is Rs.8,510/- At 30% the NPV is –Rs.9,150/-

45. Answer IRR = L + N L * (H –L) N L - N H = 20% + 8510 * 10% (8510+9150) =24.8% IRR is at 24.8%,in other words where the cash flow is discounted at 24.8%, NPV should be exactly 0.

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