FINANCIAL MANAGEMENT

Title: Financial Management

Objective
In todays dynamic world engineers along with taking technical decisions also have to
take financial decisions. So they need to understand, analyze and interpret financial
data and financial issues. This course will help them in understanding the concepts
and principles of accounting and finance with the support of software packages so
that they can make quick informed financial decisions.
Learning Outcomes
At the end of the course the students will be able to understand:
- basic accounting principles.
- how to measure the performance of a business.
- how to make and evaluate the impact of business decisions at all levels.
Methodology
The course will be taught with the aid of lectures, case studies, and use of computer
spreadsheet programs. The students will self-learn the usage of accounting
packages available in the industry.

Text Book
Financial Management by M.Y. Khan, and P.K. Jain, Tata McGraw Hill.
Financial Management by Prasanna Chandra, Tata McGraw Hill.

Books for Reference
Principles of corporate finance by Brealey, Richard A. and Myers, Stewart C. Tata
McGraw-Hill Publishing Delhi.
Fundamentals of financial management by Brigham, Eugene F,Houston, Joel
F. Thomson Asia Pte Ltd.
Financial management by I.M. Pandey, Vikas Publishing House Pvt Ltd.
Course Contents
Topic-
Introduction to Accounting and financial management
Basic Financial Concepts
Long Term Sources of Finance
Capital Budgeting: Principle Techniques
Concept and measurement of cost of capital
Cash Flows for Capital Budgeting
Financial statements & analysis
Leverages and Capital structure decision
Working capital management
Evaluation (Lecture Course)
Exam % of Marks Duration
of
Examinat
ion
Coverage / Scope
(i) TEST-1
(T-1)
20 1 Hour

Syllabus covered upto test 1
(ii) TEST -
2 (T-2)
20 1 Hour Syllabus covered after Test-1
upto T-2.
(iii)TEST-3
(T-3)
35 2 Hours Whole syllabus
(iv)
Teachers
Assessment
25
Attendance: 10
Class Discipline:5
Project /Quizzes:
10
Entire
Semester
As decided and announced by
the teacher concerned in the
class at the beginning of the
course
Time Value of
Money
The Interest Rate
Obviously, Rs10,000 today.
You already recognize that there is TIME
VALUE TO MONEY!!
Which would you prefer Rs10,000 today
or Rs10,000 in 5 years?
Why TIME?
TIME allows you the opportunity to postpone
consumption and earn INTEREST
A rupee today represents a greater real purchasing power
than a rupee a year hence
Receiving a rupee a year hence is uncertain so risk is
involved

Why is TIME such an important element in your
decision?
Time Value Adjustment
Two most common methods of adjusting cash
flows for time value of money:
Compoundingthe process of
calculating future values of cash flows
and
Discountingthe process of calculating
present values of cash flows.

Types of Interest
Compound Interest
Interest paid (earned) on any previous interest
earned, as well as on the principal borrowed
(lent).
Simple Interest
Interest paid (earned) on only the original
amount, or principal borrowed (lent).
Simple Interest Formula
Formula SI = P
0
(i)(n)
SI: Simple Interest
P
0
: Deposit today (t=0)
i: Interest Rate per Period
n: Number of Time Periods
Simple Interest Example
SI = P
0
(i)(n)
= Rs1,000(.07)(2)
= Rs140
Assume that you deposit Rs1,000 in an
account earning 7% simple interest for 2
years. What is the accumulated interest at the
end of the 2nd year?
Simple Interest (FV)
FV = P
0
+ SI
= Rs1,000 + Rs140
= Rs 1,140
Future Value is the value at some future time of a
present amount of money, or a series of
payments, evaluated at a given interest rate.
What is the Future Value (FV) of the deposit?
Simple Interest (PV)
The Present Value is simply the Rs 1,000 you
originally deposited. That is the value today!
Present Value is the current value of a future
amount of money, or a series of payments,
evaluated at a given interest rate.
What is the Present Value (PV) of the previous
problem?
Future Value
Single Deposit (Graphic)
Assume that you deposit Rs 1,000 at a
compound interest rate of 7% for 2 years.
0 1 2
Rs 1,000
FV
2
7%
FV
1
= P
0
(1+i)
1
= Rs 1,000 (1.07)
= Rs 1,070
FV
2
= FV
1
(1+i)
1

= P
0
(1+i)(1+i) = Rs1,000(1.07)(1.07) = P
0
(1+i)
2
= Rs1,000(1.07)
2

= Rs1,144.90
You earned an EXTRA Rs 4.90 in Year 2 with
compound over simple interest.
Future Value
Single Deposit (Formula)
General Future Value Formula
FV
1
= P
0
(1+i)
1

FV
2
= P
0
(1+i)
2


General Future Value Formula:
FV
n
= P
0
(1+i)
n

or FV
n
= P
0
(FVIF
i,n
)
Problem
Reena wants to know how large her deposit of Rs 10,000
today will become at a compound annual interest rate of
10% for 5 years.
0 1 2 3 4 5
Rs10,000
FV
5
10%
Solution
Calculation based on general formula:
FV
n
= P
0
(1+i)
n

FV
5
= Rs10,000 (1+ 0.10)
5

= Rs 16,105.10
Double Your Money!!!
We will use the Rule-of-72.
Quick! How long does it take to double Rs
5,000 at a compound rate of 12% per year
(approx.)?
Doubling Period = 72 / Interest Rate
6 years
For accuracy use the Rule-of-69.
Doubling Period
=0.35 +(69 / Interest Rate)
6.1 years
Present Value
Single Deposit (Graphic)
Assume that you need Rs 1,000 in 2 years. Lets
examine the process to determine how much you
need to deposit today at a discount rate of 7%
compounded annually.
0 1 2
Rs 1,000
7%
PV
1
PV
0
Present Value
Single Deposit (Formula)
PV
0
= FV
2
/ (1+i)
2
= Rs 1,000 / (1.07)
2
= FV
2
/
(1+i)
2
= Rs 873.44
0 1 2
Rs 1,000
7%
PV
0
General Present Value
Formula
PV
0
= FV
1
/ (1+i)
1

PV
0
= FV
2
/ (1+i)
2


General Present Value Formula:
PV
0
= FV
n
/ (1+i)
n

or PV
0
= FV
n
(PVIF
i,n
)
etc.
Problem
Reena wants to know how large of a deposit to
make so that the money will grow to Rs 10,000 in
5 years at a discount rate of 10%.
0 1 2 3 4 5
Rs 10,000
PV
0
10%
Problem Solution
Calculation based on general formula:
PV
0
= FV
n
/ (1+i)
n

PV
0
= Rs 10,000 / (1+ 0.10)
5

= Rs 6,209.21

Types of Annuities
Ordinary Annuity: Payments or receipts occur
at the end of each period.
Annuity Due: Payments or receipts occur at the
beginning of each period.
An Annuity represents a series of equal
payments (or receipts) occurring over a
specified number of equidistant periods.
Examples of Annuities
Student Loan Payments
Car Loan Payments
Insurance Premiums
Retirement Savings
Parts of an Annuity
0 1 2 3
Rs 100 Rs 100 Rs 100
(Ordinary Annuity)
End of
Period 1

End of
Period 2
Today
Equal Cash Flows
Each 1 Period Apart

End of
Period 3
Parts of an Annuity
0 1 2 3
Rs 100 Rs 100 Rs 100
(Annuity Due)
Beginning of
Period 1

Beginning of
Period 2
Today
Equal Cash Flows
Each 1 Period Apart

Beginning of
Period 3
Ordinary Annuity -- FVA
FVA
n
= A(1+i)
n-1
+ A(1+i)
n-2
+
... + A(1+i)
1
+ A(1+i)
0
A A A
0 1 2 n n+1
FVA
n
A = Periodic
Cash Flow
Cash flows occur at the end of the period
i%
. . .
Example of an
Ordinary Annuity -- FVA
Rs1,000 Rs1,000 Rs1,000
0 1 2 3 4
7%
Cash flows occur at the end of the period
Example of an
Ordinary Annuity -- FVA
FVA
3
= 1,000(1.07)
2
+
1,000(1.07)
1
+ 1,000(1.07)
0

= 1,145 + 1,070 + 1,000
= Rs 3,215
Rs1,000 Rs1,000 Rs1,000
0 1 2 3 4
Rs3,215 =
FVA
3
7%
Rs1,070
Rs1,145
Cash flows occur at the end of the period
General Formula for Calculating
Future Value of an Ordinary
Annuity
A i A i A FVAn
n n
... ) 1 ( ) 1 (
2 1
+ + + + =

(

+
=
i
i
A
n
1 ) 1 (
Annuity Due -- FVAD
FVAD
n
= R(1+i)
n
+ R(1+i)
n-1
+
... + R(1+i)
2
+ R(1+i)
1

= FVA
n
(1+i)
R R R R R
0 1 2 3 n-1 n
FVAD
n
i%
. . .
Cash flows occur at the beginning of the period
Example of an
Annuity Due -- FVAD
FVAD
3
= 1,000(1.07)
3
+
1,000(1.07)
2
+ 1,000(1.07)
1

= 1,225 + 1,145 + 1,070
= Rs 3,440
1,000 1,000 1,000 1,070
0 1 2 3 4
Rs 3,440 =
FVAD
3

7%
Rs1,225
Rs1,145
Cash flows occur at the beginning of the period
Ordinary Annuity -- PVA
PVA
n
= R/(1+i)
1
+ R/(1+i)
2
+ ... + R/(1+i)
n
R R R
0 1 2 n n+1
PVA
n
R = Periodic
Cash Flow
i%
. . .
Cash flows occur at the end of the period
Example of an
Ordinary Annuity -- PVA
Rs1,000 Rs1,000 Rs1,000
0 1 2 3 4
7%
Cash flows occur at the end of the period
Example of an
Ordinary Annuity -- PVA
PVA
3
= 1,000/(1.07)
1
+
1,000/(1.07)
2
+
1,000/(1.07)
3

= 934.58 + 873.44 + 816.30
= 2,624.32
Rs1,000 Rs1,000 Rs1,000
0 1 2 3 4
Rs 2,624.32 = PVA
3
7%
934.58
873.44
816.30
Cash flows occur at the end of the period
n
n
i
A
i
A
i
A
PVA
) 1 (
...
) 1 ( ) 1 (
2
+
+ +
+
+
+
=
(

+
+
=
n
n
i i
i
A
) 1 (
1 ) 1 (
General Formula for Calculating
Present Value of an Ordinary
Annuity
Annuity Due -- PVAD
PVAD
n
= R/(1+i)
0
+ R/(1+i)
1
+ ... + R/(1+i)
n-1
= PVA
n
(1+i)
R R R R
0 1 2 n-1 n
PVAD
n
R: Periodic
Cash Flow
i%
. . .
Cash flows occur at the beginning of the period
Example of an
Annuity Due -- PVAD
PVAD
n
= 1,000/(1.07)
0
+ 1,000/(1.07)
1
+
1,000/(1.07)
2
= Rs 2,808.02
1,000.00 1,000 1,000
0 1 2 3 4
2,808.02 = PVAD
n
7%
934.58
873.44
Cash flows occur at the beginning of the period
Mixed Flows Example
Reena will receive the set of cash flows below.
What is the Present Value at a discount rate of
10%?
0 1 2 3 4 5
600 600 400 400 100
PV
0
10%
Solution
0 1 2 3 4 5
600 600 400 400 100
10%
545.45
495.87
300.53
273.21
62.09
Rs 1677.15 = PV
0
of the Mixed Flow
Shorter Discounting Periods
General Formula:
FV
n
= PV
0
(1 + [i/m])
mn
Or
= PV
0
* PVIF
i/m,m*n
n: Number of Years
m: Compounding Periods per Year
i: Annual Interest Rate
FV
n,m
: FV at the end of Year n
PV
0
: PV of the Cash Flow today
Example
Reena has Rs1,000 to invest for 1 year at an
annual interest rate of 12%.

Annual FV = 1,000(1+ [.12/1])
(1)(1)

= 1,120
Semi FV = 1,000(1+ [.12/2])
(2)(1)

= 1,123.6

Effective vs. Nominal Rate of Interest
Rs. 1000 Rs.1123.6
So,
Rs. 1000 grows @ 12.36% annually
Effective Rate of Interest

r = 1 + i/m
m
- 1

Problem
Basket Wonders (BW) has a Rs1,000 CD at the
bank. The interest rate is 6% compounded
quarterly for 1 year. What is the Effective
Annual Interest Rate (EAR)?

EAR = ( 1 + 6% / 4 )
4
- 1
= 1.0614 - 1 = .0614 or
6.14%!

Perpetuity
A perpetuity is an annuity with an infinite
number of cash flows.
The present value of cash flows occurring in
the distant future is very close to zero.
At 10% interest, the PV of Rs 100 cash
flow occurring 50 years from today is Rs
0.85!
Present Value of a Perpetuity
n
n
i
A
i
A
i
A
PVA
) 1 (
...
) 1 ( ) 1 (
2
+
+ +
+
+
+
=
When n=
PV
perpetuity
= [A/(1+i)]
[1-1/(1+i)]
= A(1/i) = A/i
Present Value of a Perpetuity
What is the present value of a perpetuity of
Rs270 per year if the interest rate is 12% per
year?
PV
A
i
perpetuity
=
=
=
Rs270
0.12
Rs 2250
Steps to Amortizing a Loan
1. Calculate the payment per period.
2. Determine the interest in Period t.
Loan balance at (t-1) x (i%)
3. Compute principal payment in Period t.
(Payment - interest from Step 2)
4. Determine ending balance in Period t.
(Balance - principal payment from Step 3)
5. Start again at Step 2 and repeat.
Amortizing a Loan Example
Reena is borrowing Rs10,000 at a compound annual
interest rate of 12%. Amortize the loan if annual
payments are made for 5 years.
Step 1: Payment
PV
0
= A(PVIFA
i%,n
)
Rs10,000 = A(PVIFA
12%,5
)
Rs10,000 = A(3.605)
A = Rs10,000 / 3.605 = Rs2,774
Amortizing a Loan Example
End of
Year
Payment Interest Principal Ending
Balance
0
1
2
3
4
5



Amortizing a Loan Example
End of
Year
Payment Interest Principal Ending
Balance
0 --- --- --- Rs10,000
1 Rs2,774 Rs1,200 Rs1,574 8,426
2
3
4
5



[Last Payment Slightly Higher Due to Rounding]
Amortizing a Loan Example
End of
Year
Payment Interest Principal Ending
Balance
0 --- --- --- Rs10,000
1 Rs2,774 Rs1,200 Rs1,574 8,426
2 2,774 1,011 1,763 6,663
3 2,774 800 1,974 4,689
4 2,774 563 2,211 2,478
5 2,775 297 2,478 0
Rs13,871 Rs3,871 Rs10,000


[Last Payment Slightly Higher Due to Rounding]
Usefulness of Amortization
2. Calculate Debt Outstanding -- The
quantity of outstanding debt
may be used in financing the day-to-
day activities of the firm.
1. Determine Interest Expense --
Interest expenses may reduce
taxable income of the firm.
EXERCISE
Ashish recently obtained a Rs.50,000 loan. The
loan carries an 8% annual interest. Amortize
the loan if annual payments are made for 5
years.
SOLUTION
50000 5 0.08
12523
TIME PAYMENT INTERESTPRINCIPAL AMOUNT
OUTSTANDING
0 50000
1 12523 4000 8523 41477
2 12523 3318 9205 32272
3 12523 2582 9941 22331
4 12523 1786 10737 11594
5 12522 928 11594 0
EXERCISE
Compute the present value of the following
future cash inflows, assuming a required
rate of 10%: Rs. 100 a year for years 1
through 3, and Rs. 200 a year from years 6
through 15.

ANS: 1011.75
Solution
100 100 100 200 200 200
0 1 2 3 6 7 15
248.70
i%
. . .
Cash flows occur at the end of the period
. . .
1228.9
763.05
1011.75
Till 5
th
year