Chapter 1 :-

Introduction Of
Financial Management
Prepared By :- Assistant Professor Manthan Rankaja
Meaning of Financial Management

• Financial management involves planning, organizing, directing, and

controlling the financial activities of an enterprise.
• It applies general management principles to financial resources to
achieve the organization's goals.
Objectives of Financial Management

1. Ensuring Regular and Adequate Supply of Funds

2. Maximizing Shareholder Returns
3. Optimal Utilization of Funds
4. Ensuring Safety of Investment
5. Planning a Sound Capital Structure
Ensuring Regular and Adequate Supply of
Funds

• Ensuring that the organization has enough funds to meet its operational
and investment needs is crucial for its smooth functioning.
• This involves forecasting future financial requirements, managing cash
flows, and maintaining liquidity.
Maximizing Shareholder Returns

• Achieving high returns for shareholders depends on the company's

earning capacity, market price of shares, and shareholder expectations.
• Financial management aims to maximize shareholder wealth by
optimizing investment decisions, dividend policies, and capital structure.
Optimal Utilization of Funds

• Using the procured funds in the most efficient way to minimize costs and
maximize returns is a key objective of financial management.
• This involves careful planning, budgeting, and monitoring of financial
resources to ensure their optimal utilization.
Ensuring Safety of Investment

• Investing in ventures that offer a safe and adequate return is essential for
protecting the organization's financial resources.
• Financial management involves assessing the risk and return profile of
investment opportunities to ensure the safety of investments.
Planning a Sound Capital Structure

• Maintaining a balanced composition of debt and equity is crucial for

ensuring financial stability.
• Financial management involves determining the optimal capital structure
that minimizes the cost of capital while maximizing shareholder value.
Profit Maximization

• Objective: Focuses on increasing the company's profits in the short term.

• Emphasis: Achieving immediate financial gains.
• Risk Consideration: Generally does not account for risks and
uncertainties.
• Time Frame: Short-term perspective, typically within a financial year.
• Advantages: Acts as a measure of operational efficiency and helps in
survival and growth in the competitive market.
• The costs that an organization incurs
even when there is little or no activity
are fixed costs, or overhead.
Finding Marginal Cost

• Variable costs are usually associated

with labor and raw materials and
change with the business’s rate of
operation or output.
Finding Marginal Cost

• Total cost is the sum of fixed and

variable costs.
Finding Marginal Cost

• Marginal cost is the extra cost

incurred to produce one more unit of
output.
Wealth Maximization

• Objective: Aims at increasing the market value of the company's shares, thereby
enhancing shareholder wealth.
• Emphasis: Achieving long-term financial goals and sustainable growth.
• Risk Consideration: Takes into account risks and uncertainties, as well as the
time value of money.
• Time Frame: Long-term perspective, focusing on the overall value of the
company.
• Advantages: Ensures long-term growth, market leadership, and stakeholder
satisfaction.
Comparison

• While profit maximization is about boosting short-term profits, wealth

maximization is concerned with increasing the overall value of the
company in the long run.
• Both strategies have their own merits and are chosen based on the
company's financial objectives and market conditions.
 Time Value of Money (TVM)

• The Time Value of Money (TVM) is a fundamental financial concept that

states that money available today is worth more than the same amount in
the future due to its potential earning capacity.
• This principle is the foundation for many financial decisions and
calculations.
• - Present Value (PV): The current value of a future sum of money or
stream of cash flows given a specified rate of return.
• - Future Value (FV): The value of a current asset at a future date
based on an assumed rate of growth.
• - Interest Rate: The percentage at which money grows over time.
• - Compounding: The process in which an asset's earnings, from
either capital gains or interest, are reinvested to generate
additional earnings.
Why there is time value of money?

• Opportunity Cost

• If you are given Rs1000 today you can invest it and earn a return (e.g. interest in bank),
resulting in a higher value in the future.
• However, if you only receive the Rs1,000 after 2 years’ time you cannot begin to accumulate
interest until then.
• This lost opportunity to earn interest/return is the opportunity cost (i.e. the benefit foregone
from delayed receipt of the cash).
2.Inflation/Purchasing Power

What you can buy today for Rs. 1,000 may not be the
same as what you can buy in 2 years’ time with the
same amount of cash.

•Generally inflation (i.e. increase in general price of

things) is positive such the purchasing power of your
money is continuously being eroded.
3.Consumption Preference

• Individuals typically prefer present consumption to future

consumption.
• In order to forego current consumption, people would have to be
offered more in the future to make it worthwhile delaying their
consumption.
4.Risk

• Receiving Rs. 1,000 today is certain, however receiving rs.1,000 in 2 years’

time comes with some risk (e.g. it won’t be paid or only part paid).
• Naturally the risk depends on who is making you the promise and your
assessment of their ability to repay.
• The greater risk surrounding the future payment the less valuable that
payment is in today’s terms. Thus a certain Rs. 1,000 today is worth more than
a risky Rs. 1,000 in 2 years’ time
Importance in Financial Decisions

• The Time Value of Money is crucial in making informed financial decisions

such as:

• - Investment Appraisal: Evaluating the profitability of investments.

• - Loan Amortization: Calculating loan payments and interest.
• - Retirement Planning: Estimating future savings and income needs.
• - Capital Budgeting: Assessing long-term projects and expenditures.
Present Value Formula

• The Present Value (PV) formula is used to determine the current worth of a future sum of money or stream of cash flows
given a specified rate of return:

• PV = FV / (1 + r)^n

• Where:
• - PV = Present Value
• - FV = Future Value
• - r = Interest Rate (decimal)
• - n = Number of Periods
Example of Present Value

• Suppose you are to receive $1,000 in 3 years, and the annual interest rate is 5%. What is the present
value?

• Using the PV formula:

• PV = $1,000 / (1 + 0.05)^3
• PV ≈ $863.84

• So, the present value of $1,000 to be received in 3 years at an annual interest rate of 5% is approximately
$863.84.
Future Value Formula

• The Future Value (FV) formula is used to calculate the value of a current asset at a future date based on an assumed
rate of growth:

• FV = PV * (1 + r)^n

• Where:
• - FV = Future Value
• - PV = Present Value
• - r = Interest Rate (decimal)
• - n = Number of Periods
Example Calculation

• Suppose you have $1,000 today and you invest it at an annual interest rate of 5% for 3 years. What will be the future
value?

• Using the FV formula:

• FV = $1,000 * (1 + 0.05)^3
• FV ≈ $1,157.63

• So, the future value of $1,000 invested for 3 years at an annual interest rate of 5% is approximately $1,157.63.
Sum 1 - Question

• Suppose you are to receive $2,000 in 5 years, and the annual interest rate
is 6%. What is the present value?
Sum 1 - Answer
• Using the Present Value (PV) formula:

• PV = FV / (1 + r)^n

• Where:
• - FV = $2,000
• - r = 0.06
• -n=5

• PV = $2,000 / (1 + 0.06)^5
• PV ≈ $1,494.52

• So, the present value of $2,000 to be received in 5 years at an annual interest rate of 6% is
approximately $1,494.52.
Sum 2 - Question

• Suppose you have $3,000 today and you invest it at an annual interest rate
of 4% for 4 years. What will be the future value?
Sum 2 - Answer
• Using the Future Value (FV) formula:

• FV = PV * (1 + r)^n

• Where:
• - PV = $3,000
• - r = 0.04
• -n=4

• FV = $3,000 * (1 + 0.04)^4
• FV ≈ $3,499.46

• So, the future value of $3,000 invested for 4 years at an annual interest rate of 4% is approximately
$3,499.46.
Sum 3 - Question

• Suppose you are to receive $5,000 in 10 years, and the annual interest rate
is 7%. What is the present value?
Sum 3 - Answer
• Using the Present Value (PV) formula:

• PV = FV / (1 + r)^n

• Where:
• - FV = $5,000
• - r = 0.07
• - n = 10

• PV = $5,000 / (1 + 0.07)^10
• PV ≈ $2,541.48

• So, the present value of $5,000 to be received in 10 years at an annual interest rate of 7% is
approximately $2,541.48.
Sum 4 - Question

• Suppose you have $4,000 today and you invest it at an annual interest rate
of 5% for 6 years. What will be the future value?
Sum 4 - Answer
• Using the Future Value (FV) formula:

• FV= PV * (1 + r)^n
•
• Where:
• - PV=$4,000
• - r=0.05
• - n=6
•
• FV=$4,000 * (1+0.05)^6
• FV ≈$5,368.57
•
• So,the future value of $4,000 invested for six years at an annual interest rate of five percent is
approximately $5,368.57.
Case 1: Future Value of a lump sum annual
compounding
𝐹 =𝑃 1+𝑖 𝑛
• Find the future value of Rs. 2000 in 5 years at 5% per annum.
• 𝐹 = 2000 1 + 0.05 5 = 2000 1.05 5 = 2000 1.2763 = 2552.6

• Time line
P = 2000 F = ? (2552.60)

0 1 2 3 4 5

Years 
Case 2: Future Value of a lump sum
continuous compounding

• Continuous compounding formula

• 𝐹 = 𝑃. 𝑒 𝑟𝑡
• Where e = 2.71828
• Find future value of Rs 5000 continuously compounded at 5% for 5
years.
• 𝐹 = 5000 . 𝑒0.05x5 = 5000 . 𝑒0.25 = 5000 . 1.2840 = 6420
Case 3: Present Value of a lump sum annual
discounting
𝐹
𝑃=
1+𝑖 𝑛
• What amount should be deposited in bank today if at the end of 5
years you want Rs. 10,000. The bank pays interest @ 4% annually.
𝐹 10000 10000
•𝑃= = = = 8219.63 or 8220
1+𝑖 𝑛 1.04 5 1.2166
P = ? (8220) F = 10000

0 1 2 3 4 5

Years 
Case 4: Present Value of a lump sum
continuous discounting
𝐹
𝑃 = 𝑟𝑡 = 𝐹 . 𝑒−𝑟𝑡
𝑒
What amount should be deposited in bank today if at the end of 5
years you want Rs. 10,000. Take 4 % cc rate.

𝑃 = 𝐹 . 𝑒−𝑟𝑡 = 10000 . 𝑒 −0.04x5

= 10000 . 𝑒−0.2 = 10000 x 0.8187 = 8187
Annuity & its types

• What is an annuity?
• Annuity is equal amounts paid or received at equal interval of time.
• Annuity can be classified as:
1. Ordinary Annuity – where equal amounts is paid or received at the end of
equal periods
• E.g. equal rent is paid every month at the end of the month
2. Annuity Due – where equal amount is paid or received at the beginning
of equal periods.
• E.g. Equal semester fees paid at the beginning of each semester
Annuity & its types – Time lines
2000 2000 2000 2000 2000

0 1 2 3 4 5

Years 

Ordinary Annuity

2000 2000 2000 2000 2000

0 1 2 3 4 5

Years 
Annuity Due
Case 5: Future Value of an Annuity
1+𝑖 𝑛 −1
𝐹𝑉 𝑜𝑓 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 = 𝐴
𝑖
• What will be the maturity value of a recurring deposit of Rs. 5000
paid at end of each year for 10 years if the interest rate is 4% per
annum?
1+𝑖 𝑛 −1 1+0.04 10−1
• 𝐹𝑉 𝑜𝑓 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 = 𝐴 = 5000
𝑖 0.04
1.4802−1
• = 5000 = 5000 12.005 = 60025
0.04
5000 5000 5000 5000 5000 5000 5000 5000 5000 5000
Case 6: Present Value of an annuity
1− 1+𝑖 −𝑛
𝑃𝑉 𝑜𝑓 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 = 𝐴
𝑖
• What is the present value of a equal stream of Cash Flows of Rs 2000
paid at end of each year for 10 years @ 4% per annum?
1− 1+𝑖 −𝑛 1− 1.04 −10
• 𝑃𝑉 𝑜𝑓 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 = 𝐴 = 2000
𝑖 0.04
1−0.67556
• = 2000 = 2000 8.111 = 16,222
0.04
Perpetuity

• If an amount is received or paid at equal interval of time endlessly

then it is known as perpetuity
Case 7: Present Value of a perpetuity
• 𝑃𝑉 𝑜𝑓 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 = 𝐴𝑖
• What is the PV of a perpetuity earing 5% per annum interest of Rs.
5000?
• 𝑃𝑉 𝑜𝑓 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 = 5000 = 100000
0.05
Case 8: Present Value of a growing
perpetuity
• If a perpetuity grows every year at g% rate and initial amount is
A1 then
𝐴1
• 𝑃𝑉 𝑜𝑓 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 =
𝑖−𝑔
• Find the PV of a cash flow of Rs. 1000 that continues indefinitely, The
cash flow is expected to grow at a rate of 5% per year and the
discount rate is 10% per annum.
1000
• 𝑃𝑉 𝑜𝑓 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 = = 1000 = 20000
0.10−0.05 0.05
Case 9: Present Value of unequal cash flows
• In annuity there are equal cash flow paid or received at equal interval
of time.
• But if the cash flows are not equal but different then PV is
𝐶𝐹𝑛 𝐶𝐹1 𝐶𝐹2 𝐶𝐹𝑛
• 𝑃𝑉 = σ = + + …+
1+𝑖 𝑛 1+𝑖 1 1+𝑖 2 1+𝑖 𝑛
Case 9: Present Value of unequal cash flows
• Suppose a company’s revenue at end of the year are 100000, 120000,
145000, 130000 & 150000 for first to five year respectively. The rate
of discounting is 8% per annum. Find the PV of all cash flows.
𝐶𝐹𝑛 𝐶𝐹1 𝐶𝐹2 𝐶𝐹𝑛
• 𝑃𝑉 = σ = + + …+
1+𝑖 𝑛 1+𝑖 1 1+𝑖 2 1+𝑖 𝑛
• 𝑃𝑉 = 100000
+ 120000
+ 145000
+ 130000
+ 150000
1.08 1 1.08 2 1.08 3 1.08 4 1.08 5
• 𝑃𝑉 = 92592.59 + 102880.66 + 115105.67 + 95553.88 +
102087.48 = 508220.28
• Q. You want to take a world tour which costs Rs.
10,00,000 – the cost is expected to remain unchanged
in nominal terms. You are willing to save annually Rs.
80,000 to fulfill your desire.
• How long will you have to wait if your savings earn a
return of 14 percent per annum?
• The Future value of an annuity of Rs. 80,000 that earns 14 percent is Equated to Rs. 10,00,000.

• 80000*FVIFA n=?,14% = 10,00,000

• 80,000 (1.14n – 1 / 0.14) = 10,00,000

• 1.14n – 1 = 10,00,000 / 80000 * 0.14 = 1.75

• 1.14n = 1.75 + 1 = 2.75

• n log 1.14 = log 2.75

• n * 0.0569 = 0.4393

• n = 0.4393/0.0569

• = 7.72 Years

• You will have to wait for 7.72 years.

if you deposit Rs. 5000 at end of every year for 5 year in a bank and the
bank is paying 10% interest, what is future Value Of annuity?