1. Financial management is the operational activity of a
business that is responsible for obtaining and effectively
utilising the funds necessary for efficient operations
Joseph and Massie
Financial management is that managerial activity which is concerned
with the planning and controlling of the firm’s financial resources

2. SCOPE AND FUNCTIONS OF FINANCIAL MANAGEMENT
First approach
(Traditional approach)
Second Approach Third approach
(Modern approach)
1. Investment decision
2. Financing decision
3. Dividend decision
Capital budgeting
working capital decision

3. OBJECTIVES OR GOALS OF FINANCIAL MANAGEMENT
I . Profit maximisation
Reasons
a. Profit is the test of economic efficiency
b. It is difficult to survive with out profit
c. It leads to efficient allocation of resources
d. Profit ensure maximum social welfare(i,e maximum
dividend to shareholders, timely payment to creditors,
more and more wages to employees, more
employment opportunities etc)

4. DISADVANTAGES OF PROFIT MAXIMISATION
I . PROFIT MAXIMISATION
1. Ambiguity
It is vague and ambiguous concept
2. Timing of benefit
It ignores the time pattern of benefit
Alternative (A) Alternative (B)
Period I 5000 -
Period II 10000 10000
Period III 5000 10000
Total 20000 20000

5. 3. Quality of benefits
Alternative A AlternativeB
Recession
Period(I)
900 -
Normal
Period (II)
1000 1000
Boom
Period (III)
1100 2000
Total 3000 3000

6. II . WEALTH MAXIMISATION

7. TIME VALUE OF MONEY
A B10000 loan
One Year
Market value of interest 10%
Reasons
1. More purchasing power
2. An investor can profitably invest which make him to give a higher value

8. TIME VALUE OF MONEY
Compounding value concept
(Future value of present money)
Discounting or
Present value concept
(Present value of future money)

9. RISK AND RETURN
The chance of future loss that can be foreseenRisk :
The unforeseen chance of future loss or damage
Eg : Earth quake, Coup
Uncertainty :
It represents the benefits derived by a business
from its operations
Return:

10. METHODS OF RISK MANAGEMENT
Avoidance
of risk
Prevention
of risk
Transfer
of risk
Retention
of risk
Insurance

11. CAPITAL BUDGETING
 Investment in fixed assets
 Benefits derived in future which spreads over no: of
years
NEED FOR CAPITAL BUDGETING
 Large investments
 Irreversible nature
 Difficulties of investment decision
 Long term effect on profitability

12. EVALUATION OF INVESTMENT PROPOSALS
Traditional methods Discounted cash flow method
1. Payback period method
2. Average rate of return method
1. Net present value (NPV method)
2. Internal rate of return method (IRR)
3. Profitability index (PI method)

13. I. TRADITIONAL METHOD
1. Pay back period method or pay out or pay off
period method
 Representing the no of years required to
recover the original investment
 Under this method projects are ranked on the
basis of length of payback period
Payback period = Initial investment
annual cash inflow
Note: Annual cash inflow is the annual earnings (Profit before depreciation and after
tax)
Payback period = Initial investment
cumulated annual cash inflow
Un even cash inflow

14.  Investment proposals are judged on the
basis of their relative profitability
 Projects with higher rate of return is accepted
ARR = Average income after tax and depreciation x100
Average investment
Average investment = Original investment
2
Average investment = original Cost - Scrap value
2
+ additional W.C
+Scrap value
2. Average rate of return method or Rate of return
method or Accounting rate of return method

15. II. DISCOUNTED CASH FLOW METHODS
OR TIME ADJUSTED TECHNIQUE
1 Net present value method
 Best method for evaluating the capital investment
proposals
 It gives consideration to the time value of money
Formula=Discounted cash inflow-Discounted
cash outflow
Note1 : If only in the beginning initial investment is made,
then the discounted cash outflow will be the same i.e.,
initial investment
Note2 : Cash inflow means profit before depreciation and after
tax
If NPV is zero or positive the project can be
accepted

16. 2. Profitability index method
This method is also called benefit cost ratio
PI = Present value of cash inflow
Present value of cash outflow
PI is equal to or more than one the proposal can be accepted

17. 3. Internal rate of return (IRR)
IRR is that rate at which the sum of discounted
cash inflow equals the sum of discounted
cash outflows
L = Lower discount rate
P1 = Present Value at lower rate
P2 = Present Value at higher rate
Q = Actual investment
D = Difference in rate
P1 – Q
IRR = L+
P1-P2
xD

18. COST OF CAPITAL
 Rate of return expected by the suppliers of
capital
Importance of cost of capital
Capital budgeting decision
(Business must earn at least
a rate which is equal to its
cost of capital in order to
make at least a break even)
Capital structure decision
(Raise capital from different
sources which optimizes the
risk and cost factors)

19. COMPUTATION OF COST OF CAPITAL
I. COST OF DEBT (PERPETUAL OR
IRREDEEMABLE)
a. Debt issued at par = Kd =(1-T)R
Kd =Cost of debt, T=Marginal Tax rate
R= Debenture interest rate OR R= Annual Interest :- Net Proceeds of Loan or debentures
b. Debt issued at premium or discount
Formula = Kd = (1-T)R
Here R = I Where I = Annual interest payment
NP
NP = Net proceeds of loan or debentures

20. II. COST OF REDEEMABLE DEBT
a. Issued at par redeemable at par
Kd= I+(Rv-Sv)/nm
(Rv +Sv)/2
I = annual interest
Rv = Payable value at the time of maturity
Sv=Sales price or (face value of debt - Expenses)
Nm = Term of debt or no: of years

21. b. Debt issued at premium redeemable at par
Kd = I + F - P
Nm Nm
(Rv + Sv)/2
P = premium on debenture
F=Flotation cost

22. c. Issued at discount redeemable at par
D = Discount on debenture
F=Flotation cost
Kd = I + F + D
Nm Nm
(Rv + Sv)/2

23. III. COST OF PREFERENCE SHARES
a. Cost of preference shares : Irredeemable
Kp= d
P0 (1-F)
Where
Kp = Cost of preference shares
d = Constant annual dividend payment
Po= Expected sales price of preference shares
F= Flotation cost

24. Kp= d+(Rv-Sv)/nm
(Rv+Sv)/2
b. Cost of preference share : Redeemable

25. IV. COST OF EQUITY CAPITAL
a. Dividend approach
P0 = face value or market price per share
G=growth rate
Ke= D1
P0
+g
b. Earnings approach
Ke = Cost of equity
E0 = Current earnings per share or Total earnings
Share outstanding
P0 = Current net proceeds per share or (net proceeds per share - flotation cost)
Ke= E0
P0

26. V. COST OF RETAINED EARNINGS
Kr = Ke(1-T) ( 1-B)
T= Tax
B=Brokerage
Ke = Shareholders required rate of return
Or
Ke = D1
+g
P0

27. WEIGHTED AVERAGE COST OF CAPITALOR OVERALL COST
OF CAPITAL
It involves the following steps
1. Calculation of the cost of each specific source of funds.
2. Assigning weights to specific cost
This involves determination of the proportion of each source of
funds in the total capital structure of the company.
3. Adding of the weighted cost of all sources of funds to get an
overall weighted average cost of capital.