MGSM835:FinancialManagement–CourseSummary

- Objectiveso Valuation+pricingofassetso Evaluationofinvestmentproposals/CapitalBudgetingo Corporatefinancialpolicy

- CompanyObjective

àMaximiseshareholderwealthbymaking§ Investmentdecisions§ Financingdecisions§ PayoutdecisionsàKnowCASH,TIME,RISKàBeconsistent

- Rateofreturnonsecurities: 𝑟 =

𝑁𝑒𝑡 𝑔𝑎𝑖𝑛 𝑓𝑟𝑜𝑚 𝑎𝑠𝑠𝑒𝑡𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙

𝑟!!!"# =𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 − 𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 + 𝐷𝑖𝑣

𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒

- AssetValuation

o Interestcompoundedannually

𝐹𝑉 = 𝑃𝑉 × (1+ 𝑟)!

o Interestcompoundedweeklyormonthlyordaily(Calculateannualeffectiverate)

𝐸𝑓𝑓 = 1+ !"#. !"#$

!". !" !"#$"%&'(' !"#$%&' !

!− 1

o Interestcompoundedcontinuously

𝐹𝑉 = 𝑃𝑉 × 𝑒! !"#$

!"#$!!"# !"#$%− 1(solvewithln)

o Annuities

𝐹𝑉 = 𝐴 !!! !!!

!𝐹𝑉 = 𝐴 × 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 𝐹𝑎𝑐𝑡𝑜𝑟

𝑃𝑉 = 𝐴 !!(!!!)!!

!𝑃𝑉 = 𝐴 × 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 𝐹𝑎𝑐𝑡𝑜𝑟

o Perpetuities(growing)

!!!!

or!!!!!!

=!!(!!!)!!!!

(DividendGrowthModel)

o AnnuityDue(Annuitystartsbeforetheendofyear1)

𝑃𝑉 = 𝐴 + 𝐴 !! !!! !(!!!)

!

o DeferredAnnuity(Annuitystartslater)

𝑃𝑉 = ! × !! !!! !!

!

(!!!)!!!

- CapitalBudgeting

à Process of decidingon theoptimumuseof the scarce resourcesof acorporation1. Forecastcosts/benefits2. Applyinvestmentevaluationtechnique3. Makedecision

InvestmentEvaluationTechniques

o Paybackà Time taken to recover initial cash outlay associated with aproject.Acceptprojectwithshortestpaybackperiod.𝑃𝑎𝑦𝑏𝑎𝑐𝑘 = 𝑌𝑟 𝑏𝑒𝑓𝑜𝑟𝑒 𝑓𝑢𝑙𝑙 𝑟𝑒𝑐𝑜𝑣𝑒𝑟𝑦 + !"#$%&'$#$( !"#$ !" !"#$" !" !"

!"#! !"#$ !"#$%& !"

+ Simpletoestimateanddecide- Notsurewhattheappropriatepaybackperiodshouldbe- IgnoresCFbeyondpaybackperiod- Ignorestimevalueformoneyandrisk

o AverageAccountingRateofReturn(AAR)

à%returnoninvestedphysicalcapital𝐴𝐴𝑅 = !"#!"#$ !"#$%&

!"#$%&# !"#$%&$' !"#$%"&

+ Usesreportedaccountingnumbers- Ignorestimevalueformoneyandrisk- Usesaccountingnumbers- Doesnotincreaseshareholderwealth

o NetPresentValue(NPV)àNetpresentvalueofallfutureCFs;increaseinwealthofownerfromtakingonproject𝑁𝑃𝑉 = 𝑆𝑡𝑎𝑟𝑡 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐶𝑜𝑠𝑡 + 𝑀𝑖𝑑𝑑𝑙𝑒 𝑅𝑒𝑔𝑢𝑙𝑎𝑟 𝐶𝐹 𝐴𝑛𝑛𝑢𝑖𝑡𝑦) + 𝐸𝑛𝑑 (𝐷𝑖𝑠𝑝𝑜𝑠𝑎𝑙)

NPV>0àaccept NPV<0àreject NPV=0àindifferent

+ Cleardecisionrulethatmaximizesshareholderwealth+ Incorporatestimevalueformoneyandrisk+ ConsidersallCFsthataregeneratedbyaproject+ Correctlyranksprojectsonwealthmaximisingcriteria- DifficultyinforecastingfutureCFs- Thereareproblemsinestimatingtheappropriatediscountrate- Difficult fornon-finance trainedmanagers to fullyunderstand

whatitmeans

o InternalRateofReturn(IRR)à Rate of returnwhichmakesNPV of project 0, implicit rate ofreturn generated by a project taking into account time value formoney,acceptprojectifIRR>Requiredrateofreturn(IRRwillgenerallyresultinsameinvestmentdecisionasNPV)IRRà 0=START|MIDDLE|END =NPVxAnnuityFactor àBottomUpApproach

+ Providesacleardecisionrulethattargetsahurdlerate+ Easilycomparabletorateofreturnonotherinvestments+ IncorporatestimevalueofmoneyandriskandallCFs+ Easiertounderstand+ Summarisesprojectinformationintoonenumber- Doesn’t always choose project that maximizes shareholder

wealth- Calculationismathematicallyproblematicwithoutcomputer- Decision rule requiresknowledgewhether it is a financingor

investingdecision- If there are positive and negative CFs à may be multiple

solutions- Doesn’t take intoaccount the scaleof theproject, only shows

rateàMIRRconsidersboththecostoftheinvestmentandtheinterestreceivedonreinvestmentàIRRhasitslimitations,useMIRRtoquestionIRR!