CH 9
CH 9
CH 9
FINANCIAL
MANAGEMENT
Introduction
1. Procurement of funds:
2. Usage of finance:
Objectives of financial
management
DIFFERENCE BETWEEN THE
TWO
MEANING
PERSPECTIVE
MEANS
SCOPE
APPROACH
Financial Decisions
I. INVESTMENT DECISION
RESOURCES SCARCE ALTERNATIVE
USE
WHERE TO INVEST HIGHEST RETURNS
INVESTMENT PROPOSALS
OTHER NAME
EXAMPLE
WHAT ALL IS AFFECTED
INGREDIENTS
FACTORS AFFECTING CAPITAL BUDGETING
DECISIONS:
NO COMMITMENT
BUT????? EXPECTATIONS
FACTORS AFFECTING FINANCING
DECISION
Cost
Risk
Flotation Cost
CASH FLOW POSITION
LEVEL OF Fixed Operating Costs
Control Considerations
State of Capital Markets
III. DIVIDEND DECISION
Dividend decision is whether to distribute earnings
to shareholder as dividends or to retain earnings to
finance long-term projects of the firm.
The dividend decisions are taken keeping in view
the overall objective of maximizing shareholder’s
wealth
FACTORS AFFECTING
DIVIDEND DECISIONS
Amount of Earnings/ STABILITY OF EARNINGS
Stability of Dividends
Growth Opportunities
Cash Flow Positions
Shareholders preference
Taxation Policy
Stock Market Reaction
Access to Capital Market
Legal constraints
Contractual Constraints
Identify the type of decisions
Ravi wants to open a restaurant and is looking for a proper place to open it.
He is also thinking of the amount of funds which will be required for some of
the set ups like food making and storing machineries.
Ravindra is running a toy manufacturing company. He thinks of expanding
his business. He meets his uncle and asks him for a sum of Rs. 2 crores. His
uncle asks for a high interest rate. He agrees to it and promises to pay the
money back within 2 years.
A leading marketing company has decided to raise money through the stock
market. It issued IPO in the market last year. The company knows there are
going to be sizeable floatation costs involved in it.
A company which has 10 branches in the city has decided to open its 11th
branch. The company has taken this branch on rent. In this way the company
has saved money which it would otherwise have invested in purchasing it.
A company has decided to plough back the money in the form of retained
earnings. This decision will save the company at least ‘50 crores. These funds
can be used for the long term growth of the business.
ANSWERS
Investment decision
Financing decision
Financing decision
Investment decision (short-term investment
decision/working capital)
Dividend decision
FINANCIAL PLANNING
ENSURE
S
FACILITAT HELPS
ES IN
IMPORTANC
E
HELPS FACILITA
TO TE
PROVID INCREASES
ES
CAPITAL STRUCTURE
SITUATION:::: 2
WHY???
RETURN ON INVESTMENT
= EBIT/TOTAL INVEST*100
= 800000/50,00000*100
= 16%
ANOTHER EXAMPLE:::
SOURCES SITUATION SITUATION 2
1
EQUITY SHARES @ 10 EACH 50,00,000 40,00,000
DEBT @10% -NIL- 10,00,000
TOTAL CAPITAL 50,00,000 50,00,000
EBIT 4,00,000 4,00,000
(-) INTEREST @ 10% - 100000
EBT 400000 300000
(-) TAX @ 30% 120000 90000
EAT 280000 210000
NO. OF EQUITY SHARES ISSUED 500000 400000
EPS 0.56 0.52
RATE OF INTEREST : 10%
RETURN ON INVESTMENT
= EBIT/TOTAL INVEST*100
=400000/5000000*100
=8%
ANOTHER EXAMPLE:::
SOURCES SITUATION SITUATION SITUATION
1 2 3
RETURN ON INVESTMENT
= EBIT/TOTAL INVEST*100
=400000/3000000*100
=14.33%
ANOTHER EXAMPLE:::
SOURCES SITUATION SITUATION SITUATION
1 2 3
RETURN ON INVESTMENT
= EBIT/TOTAL INVEST*100
=200000/3000000*100
= 6.67%
BUT………
FR
CHOOSE::::::::
R-R
COMBINATIO
N
FOR
??????
FACTORS AFFECTING CHOICE OF CAPITAL
STRUCTURE
DEBT EQUITY
2. ICR
ICR= EBIT/ INTEREST
Ex: Loan : Rs. 500000 @10% and EBIT is Rs.
1,00,000
So, ICR =
100000/50000= 2 DEBT EQ
UIT
2 TIMES Y
3. DSCR: DEBT SERVICE COVERAGE RATIO
COD
HIGH LOW
ISSUE
EQUIT
OF
Y
DEBT
6. TAX RATE
TAX RATE
HIGH LOW
ISSUE
DEBT EQUIT
Y
7. COST OF EQUITY
EQUITY SHARE CAPITAL IS ----- RISK
CAPITAL
SHAREHOLDERS EXPECT ---- RR MATCH
DEBT SHARE HOLDERS RISK INCREASES
EXPECT RETURNS
SHARE PRICES EVEN IF EPS IS
AGAINST THE OBJECTIVE
8. FLOATATION COST
CONTROL
DEBT EUITY
DOES’N
T DILUT
EFFEC ES
T
12. REGULATORY
FRAMEWORK
GUIDELINES
NOT TO BE FOLLOWED
JUSTIFICATION REQUIRED
14. STOCK MARKET CONDITIONS
BULLISH
BEARISH
FACTORS AFFECTING FIXED
CAPITAL REQUIREMENT
Nature of Business:
Scale of Operation:
Technique of Production:
Technology Up-gradation:
Growth Prospects:
Diversification:
Level of Collaboration/Joint Ventures:
FACTORS AFFECTING
WORKING CAPITAL
REQUIREMENT
1. NATURE OF BUSINESS
NATURE OF
BUSINESS
TRADING MANUFACTURING
LESS MORE
2. SCALE OF OPERATIONS
SCALE OF
OPERATIONS
SMALL LARGE
LESS MORE
3. BUSINESS CYCLE
BOOM DEPRESSION
DEMAND-
SALE –
PRODUCTION –
REQUIRES -
4. SEASONAL FACTORS
CYCLE
LONGER SHORTER
MORE LESS
6. CREDIT ALLOWED
CREDIT ALLOWED
YES NO
MORE LESS
7. CREDIT AVAILED
CREDIT AVAILED
YES NO
LESS MORE
8. OPERATING EFFICIENCY
OPERATING
EFFICIENCY
HIGH LOW
LESS MORE
9. AVAILABILITY OF RAW MATERIAL
(REMEMBER LEAD TIME)
AVAILABILITY OF RM
EASY DIFFICULT
LESS MORE
10. GROWTH PROSPECTS
GROWTH PROSPECTS
YES NO
MORE LESS
11. LEVEL OF COMPETITION
LEVEL OF
COMPETITION
HIGH LOW
MORE LESS
12. INFLATION
INFLATION
HIGH LOW
MORE LESS
Wooden Peripheral Pvt. Ltd. is counted among the top furniture
companies in Delhi. It is known for offering innovative designs and
high quality furniture at affordable prices. The company deals in a wide
product range of home and office furniture through its eight showrooms
in Delhi. The company is now planning to open five new showrooms
each in Mumbai and Bangalore. In Bangalore it intends to take the
space for the showrooms on lease whereas for opening showrooms in
Mumbai, it has collaborated with a popular home brand, ‘Creations.’
1. Identify the factors mentioned in the paragraph which are likely to
affect the fixed capital requirements of the business for opening new
showrooms both in Bangalore and Mumbai separately.
2. “With an increase in the investment in fixed assets, there is a
commensurate increase in the working capital requirement.” Explain
the statement with reference to the case above.
‘Sarah Ltd.’ is a company manufacturing cotton yarn. It has been
consistently earning good profits for many years. This year too, it has
been able to generate enough profits. There’re is availability of enough
cash in the company and good prospects for growth in future. It is a
well managed organization and believes in quality, equal employment
opportunities and good remuneration practices. It has many
shareholders who prefer to receive a regular income from their
investments. It has taken a loan of Rs. 40 lakhs from IDBI and is bound
by certain restrictions on the payment of dividend according to the
terms of loan agreement. The above discussion about the company
leads to various factors which decide how much of the profits should be
retained and how much has to be distributed by the company.
Quoting the lines from the above discussion identify four such factors.