Concepts of finance pdf

Maximizing Profitability When a firm decides on obtaining a higher rate of return on its investment, it is said to be maximizing profitability. Maximizing Profit Subject to Cash Constraint In the quest for profit maximization, undue emphasis is sometimes placed on cash balance.

Maintaining too large a cash balance reduces the chance of a favorable rate of return, while running out of cash when needed is disastrous. The ideal set-up is to maximize profits, while at the same time maintaining a cash balance that can take care of cash requirements anytime.

This condition is especially critical in the operation of banks. Maximizing Net Present Worth Under the net present worth concept, the objective of the firm is to maximize the current value of the company to its owners. The net present worth of the firm is equal to the value now of the firm plus values arising in the future. The present worth of values arising in the future are computed and added to the present worth of the other values of the firm.

Present values may be better understood by way of knowing the concept of the time value of money. Time Value of Money This concept indicates that money increases in value with the passing of time. A peso today could be deposited in a bank and made to earn interest. This capacity to earn makes the peso today worth more than the peso that would be received in the future. Thus, to be able to find the present worth of a peso that would be received in the future, the corresponding interest or discount should be deducted from the future peso.

Calculation of Present Worth The present worth of a value to be received in the future is illustrated as follows: Question: What is the value today of Php, Seeking an Optimum Position Along a Risk-Return Frontier A firm can set a goal of achieving the best possible combination of risk and return. A little more risk may be accepted, for instance, for an expected additional rate of return.

Return on Investment or Net Worth The net income generated by the use of investments or the net worth of a firm is referred to as return on investment. When it is expressed in percentage, it is called rate of return. Risk Uncertainty as to loss is called risk. When used in finance, the term applies to the potential incurrence of loss of money or its equivalent. Calculation of Expected Value Using Risk and Return Factors The optimum position of risk and return may be determined by calculating the expected value of alternative decisions.

The expected value of a return on investment is equal to the return multiplied by the percentage of probability that it will happen called the risk factor. Inasmuch as the finance manager is responsible for managing the financial activities of the firm, he is naturally one of the most concerned about getting relevant information through the use of financial statements. It means you can get assets through liabilities or equity.

Assets may consist of specific property or claims against others, in contrast to obligations due others. Because the factory would produce computers that would be sold in the market for cash. What are Liabilities? Thus, you have liability until cash an asset was used to payoff the money owed. In a business enterprise, the equity is the ownership interest. December 31, You would count every truck and add up every bank account to come up with a value of your assets.

Your cumulative GPA is affected by each semester and shows the net affect of all your efforts. Your semester GWA is earned over a specific period of time and refreshes each semester. Companies like GE will have huge amounts of Retained Earnings, while newer companies will often have a negative balance in Retained Earnings. However, what if I bought the shirt on credit. Materials and Purchases Budget This portion of the company budget refers to the estimate of the materials required by the firm, specified in quantities, costs, timing of purchase, the required delivery dates, and other requirements.

Owners 2. Management 3. Creditors 4. Government 5. Prospective Investors. The results of most business decisions are measured in financial terms; the financial manager plays a key operational role. People in all areas of responsibility, accounting, information systems, management, marketing, operations, and so forth, all these require a essential awareness of finance so they will understand how to quantify the consequences of their actions.

Zutter L. Investment decisions determine what types of assets the firm holds. The first goal relates to the firm's profitability. The goals concerning sales, market share, and cost control all relate, at least potentially, to different ways of earning or increasing profits.

The goals in the second group, involving bankruptcy avoidance, stability, and safety, relate in some way to controlling risk. Unfortunately, these two types of goals are somewhat contradictory Bradford D. Jordan R. No matter what type you started, you would have to answer the following three questions in some form or another Which long-term investments should you take on?

That is, what lines of business will you be in and what sorts of buildings, machinery, and equipment will you need? Will you bring in other owners or will you borrow the money? If a Financial manager's job is to maximize shareholder wealth, then he or she must recognize how that wealth is determined, fundamentally, shareholder wealth is the number of shares outstanding times the market price per share. The answer to this question may be diverse.

Some might argue that managers should focus completely on satisfying clients. Others recommend that managers must first inspire and motivate employees; in that case, employee turnover might be the key success metric to watch.

Once again, in large firms this task is delegated to the company Controller, who also reports to the CFO. The goal of the Management It had come to be known that firm's management goal may compete with those with the share holders that is enhancing wealth of share holders, in specifically, firm's management may be more interested maximizing their own wealth than their investors.

Houston E. The goal of financial management in a for profit business is to make decisions that increase the value of the stock or, more generally, increase the market value of the equity Goal of the corporation Firms are in business to make their owners, or shareholders, wealthier. With this goal in mind, financial managers must make financial decisions regarding long-term investments, financing, and management of short-term cash needs. According to Dr.

Suresh Mittal Wealth maximization is the main objective of financial management and growth is essential for increasing the wealth of equity shareholders. The growth can be achieved through expanding its existing markets or entering in new markets.

Instead, the managers will have an incentive to enrich themselves with perks and other financial benefits. Arthur J. Nevertheless the functions of financial can be summarized as assessing firm's financial requirement, proper utilization of firm's resources weather, physical, financial, technological and human, increasing profitability ,Forecasting financial requirements: Financial manager of any organization has the responsibility of panning, estimating and forecasting firm's financial needs, as how much money would be required to finance specific project, or to acquire assets that is heavy in nature, he is also responsible for estimating the value of working capital in specific time frame and most importantly increasing share holders' wealth Q2.

Assume that you are finance manager in a company and take charge of all financial aspects of the company. Explain the financial activities of the company that you are expected to perform and how are you going to achieve the objective of those activities.

Financing decisions determine how the firm raises money to pay for the assets in which it invests Zutter, Outlay decisions usually refer to the items that appear on the left-hand side of the balance sheet, and financing decisions relate to the items on the right-hand side. Keep in mind, though, that financial managers make these decisions based on their impact on the value of the firm, not on the accounting principles used to Construct a balance sheet.

Sheridan Titman, Conclusion Managing firms over all financial activities is not an easy task, as a firm's financial officer I'm supposed to do a number of activities, including forecasting firm's financial requirement, investment decisions, deciding purchasing equipments, proper utilization of organization's resources, analyzing financial reports, enhancing firm's value. How ever financial activities of the firm may include buying and selling of goods or assets, organizing and maintain accounts, issuing stocks, bonds, arranging loans.

Is it possible for the risk premium to be negative before an investment is undertaken? Can the risk premium be negative after an investment is undertaken? Introduction In this information age we live in a world that is very dynamic, due to the normal circumstances and even advanced technology, these changes bring about risk into our lives, our businesses and our environment; the risk may be internal or external, before we further explain let's see the concept of risk, types of risk and definition of risk.

What is risk? There are different types of risks but the financial manager is more concerned about the financial risk which is created by a high debt-equity ratio than about any other risk. If earnings are high, the financial risk may not have much of an impact. In other words if the economic risks of the business activities are reduced to minimum, a firm may not be exposed to financial risks. This type of risk is of particular concern to investors who hold bonds in their portfolios.

Market Risk - This is the most familiar of all risks. Also referred to as volatility market risk is the the day-to-day fluctuations in a stock's price. Market risk applies mainly to stocks and options. As a whole, stocks tend to perform well during a bull market and poorly during a bear market - volatility is not so much a cause but an effect of certain market forces.

Additional return we must expect to receive for assuming risk. As the level of risk increases, we will demand additional expected returns. A risk premium is the return in surplus of the risk-free rate of return that an outlay is expected to yield.

An asset's risk premium is a form of compensation for investors who tolerate the extra risk compared to that of a risk-free asset in a given investment. Actually risk premium is the sum of return one wants to realize before taking a chance with an unsecured investment versus a guaranteed investment. This is a very significant factor investors think when picking up how best to allocate their limited resources.

In many cases, this premium is hypothetical. Very few may really have a set risk premium in their minds, or at least refer to it in those terms. In other words, risk premium can also be described as the return one expects to make on the market security, against what kind of return they can make on a more risk-free investment.

In the case of a risk-free investment, this typically means an interest rate paid on something like US Treasury bonds or some other sort of guaranteed investment. Of course, even these investments are not guaranteed completely. If there was a catastrophic failure of the financial institution or central government in the case of treasury bonds, all would be lost. Of course, any cash assets would quickly become worthless under those conditions. For stocks, the return on investment is calculated by looking at two factors, one the dividend payout, which can come as often as every quarter, along with the capital gains.

The capital gains are only realized when a stock is sold. The historical market risk premium compares the historical return of the stock market compared to U. Where stocks are considered, this is sometimes referred to as equity or stock risk premium. Negative Risk Premium A positive beta indicates that the asset fluctuates in accordance with the market, whereas a negative beta means that the asset's price moves in the opposite direction as the market.

Of equal importance is what is known as the risk premium. A risk premium is a calculation of how likely the business that has been invested in will go bankrupt while the investment is maturing, where the entire value of the security could be lost Conclusion There are different types of risks but the financial manager is more concerned about the financial risk which is created by a high debt-equity ratio than about any other risk.

In other words if the economic risks of the business activities are reduced to minimum A risk premium is the amount of return one needs to realize before taking a chance with an unsecured investment versus a guaranteed investment. This is a very important factor investors consider when choosing how best to allocate their limited resources. Of course, in many cases, this premium is theoretical. Very few may actually have a set risk premium in their minds, or at least refer to it in those terms Q 4.

A number of publicly traded firms pay no dividends yet investors are willing to buy shares in these firms. How is this possible? Does this violate our basic principle of stock valuation? Introduction More often than not, the main purpose of making business is to generate a profit and to pursue that objectives, most business are always trying to reduce operating cost, satisfy their customers and operate to resist the competition to survive, There are many forms of business organization as sole proprietorship, partnership, corporation, limited liability company and unlimited liability company Publicly traded are firms that are not private, so investors buy shares these firms in order to generate reasonable return.

Common stockholders are the true owners of the firm. Bondholders and preferred stock holders can be viewed as creditors, but there are times that a number of publicly traded firms pay no dividends yet investors are willing to buy shares in these firms. How is this possible, the answer is quite clear, the management of these firms may see another opportunity and they instantly have the desire to re-invest the profits that were suppose to divide the share holders and obviously these share holders may possible to have the return that is much more than they expected and this doesn't violate the basic principle of stock evaluation Stock Evaluation Company valuation literature offers to a lots of ways to determine the value of company.

Most of them can be applied for stock valuation. This means that stock valuation can be considered as the business valuation. The key idea of this valuation method is to change projected future cash flows into the present value of the stock. This benefit is treated like projected future cash flow and is converted to present value of the share Valez — Pareja et al.

Another commonly discussed and broadly used valuation approach is a relative valuation. The chief principle of this technique is to discover the same or very similar assets whose prices are known for the analyst International Valuation Standards In order to use this method, the market must be active in shares trades with a reasonable amount of comparable assets and it must contain sufficient information about transactions conducted with these assets Peterson The little review of the evaluation methods and their core principles shows that the stock valuation quality is extremely dependent on capital market development level.

If we were to think about possible financial goals, we might come up with some thoughts like the following as Survive. Avoid financial distress and bankruptcy. Beat the competition. Maximize sales or market share. Minimize costs. Maximize profits and Maintain steady earnings growth. Financial managers have to be worried not only with how much money they expect to obtain, but also with when they expect to receive it and how likely they are to receive it.

Financial activities of the firm may include buying and selling of goods or assets, organizing and maintain accounts, issuing stocks, bonds, arranging loans.