Financial Management Lesson Notes

FINANCIAL MANAGEMENT Ekrem Tufan [email_address] Anadolu University Open Education Faculty Canakkale Office

What will we learn? An overview of managerial finance - What is the finance? -Managerial finance in the 1990s -The financial manager’s responsibility - The goals of the corporation

What will we learn? The financial environment: Markets, institutions -The financial markets -Financial institutions -The stock market

What will we learn? 3. F inancial Ratios as a tool of financial analysis Profitability Ratios —ability of the firm to earn an adequate return and control costs. Asset Utilization Ratios —How efficiently the firm’s assets are being utilized. Liquidity Ratios —focus on short term risk management. Debt Utilization Ratios —focus on the capital structure and long-term risk management

What will we learn? Risk and rates of return -Defining and measuring risk -Expected rate of return

What will we learn? 4. Strategic long-term investment decisions -Generating ideas for capital projects -Project classifications -Similarities between capital budgeting evaluation techniques

What will we learn? 5. Capital budgeting evaluation techniques -Payback period method -Net present value method -Internal rate of return method

What will we learn? 6. Practice of NPV and IRR methods -Example of NP V -Example of IRR -Example of sensitivity analysis Continuation of examples… So on, so far…

What kind of resources can we use when we doing research? All finance books All articles about finance www.ssrn.com www.makalem.com www.ceterisparibus.com Essentials of Managerial Finance, J. Fred Weston and Eugene Brigham, Harcourt Brace&Company International Edition, 1992. Finansal Yönetim, Semih Büker and et all, 2005. ( The main book of our lesson! )

What is the finance? Money Stock exchange Banks What else? How about the companies ? Balance sheet

What is the finance? To achieve the goals of company; Finding funds from the most suitable sources Using them effectively and Control the results…

An Overview o f Managerial Finance A Short History of Managerial Finance 1930s: Liabilities and equity , Great Depression 1940 and 1950s: Assets, quantitative methods, discounted cash flow methods World War II 1960 and 1970s: Optimization of assets and liabilities and equity, statistical methods , oil crises 1980s: Globalization, interest rate and exchange risk , macintosh 1990s to today: More risk, more computer, new financial instruments and methods , Wall Street

An Overview o f Managerial Finance Board of Directors President Vice President:Sales Vice President:Manufacturing Vice President:Finance Treasurer Controller Credit Manager Inventory Manager Director of Capital Budgeting Cost Accounting Financial Accounting Tax department

An Overview o f Managerial Finance The Financial Manager’s Responsibility Forecasting and planning Major investment and control Coordination and control Dealing with the financial markets

An Overview o f Managerial Finance The goals of the corporation Managerial incentives to maximize shareholder wealth Social responsibility Stock price maximization and social welfare

Managerial incentives to maximize shareholder wealth Stockholders Make the highest money from the company Do not want to share theirs company with others. Managers Having autonomy Protect themselves from a hostile takeover or a proxy fight Hostile takeover . doc Try to maximize stock prices in reasonable level

Social responsibility Ethical responsibility to provide a safe working environment To avoid polluting water and air Produce safe products But social responsibility has a cost If the other firms in its industry do not follow suit, their prices and costs will be lower Most investors do not like to buy socially oriented companies shares.

Stock price maximization and social welfare What requires stock price maximization ? Efficient, low-cost plants that produce high-quality goods and services at the lowest possible cost Development of products that consumers want and need, so the profit motive leads to new technology , to new products, and to new jobs

The Financial Environment: Markets, Institutions The Financial Markets Physical asset markets Spot markets and futures markets Money markets Mortgage markets World, national, regional and local markets Primary markets-secondary markets

Physical asset markets ( Real asset markets ) Wheat, autos, real estate, computers, stocks, bonds, notes, mortgages etc.

Spot markets , futures markets, money markets, capital markets In spot and futures markets you can buy and sell assets on the spot delivery or for delivery at some future date, such as six months, or a year in the future. Money markets are the markets for debt securities with maturities of less than one year where capital markets for the long term.

World, national, regional and local markets , primary-secondary markets Primary markets, are the markets in which corporations raise new capital. Secondary markets, are markets in which existing, already outstanding securities are traded among investors.

The Financial Environment: Markets, Institutions Financial Institutions in Turkey Commercial banks Pension funds Mutual funds Life insurance companies Stock exchange (ISE) Gold exchange (IGE) Futures markets (Izmir Futures Market)

The Financial Environment: Markets, Institutions Stock Exchanges ISE IGE Turkish Derivatives Exchange Over the counter market

The Financial Environment: Markets, Institutions Istanbul Stock Exchange 1985 December Inauguration of the Istanbul Stock Exchange under the Chairmanship of Mr. Muharrem KARSLI 1986 January Commencement of stock trading at the Cagaloglu building on January 3, 1986 1991 June Initiation of the Bonds and Bills Market and commencement of Outright Purchases and Sales Transactions 1997 August launch of the Repo/ Reverse Repo Market 2005 January ISE Derivatives Market is closed permanently as of January 28, 2005

The Financial Environment: Markets, Institutions Istanbul Gold Exchange 26 July 1995 Inauguration of the IGE 15 August 1997 establishment of the Futures and Options Market

The Financial Environment: Markets, Institutions Turkish Derivatives Exchange (TURKDEX) 04 July 2002, establishment of the Turkish Derivatives Exchange 04 February 2005, transactions started officially

Risk And Rates Of Return Defining and measuring risk Expected Rate of Return Measuring Risk: The Standard Deviation Measuring Risk: Coefficient of Variation

Risk And Rates Of Return What is the risk in finance? Risk is the financial uncertainty that the actual return on an investment will be different from the expected return. The exposure to loss of investment as a result of changes in business conditions, domestic or foreign economies, investment markets, interest rates, relative currency rates, or inflation.

Expected Rate of Return Calculation of Expected Rates of Return: Payoff Matrix Expected Rate of Return.xls

Expected Rate of Return The weights are the probabilities, and the weighted average is the expected rate of return, Expected rate of return=

Measuring Risk: Standard Deviation XU1002002-12. xls

Coefficient of Variation as a Risk Measure Coefficient of variation (CV), standard deviation divided by the expected return

Strategic Long-Term Investment Decisions Generating ideas for capital projects Who creates the capital budgeting projects? Do we need to be an entrepreneur? Two questions for testing being entrepreneur ( CV and address book )

Strategic Long-Term Investment Decisions Project classifications Replacement: Maintenance of business Replacement: Cost reduction Expansion of existing products or markets Expansion into new products or markets Safety and/or environmental projects Other

Project classifications Replacement: Maintenance of business One category consists of expenditures to replace worn-out or damaged equipment used in the production of profitable products. Should we continue to produce these products or services? Should we continue to use our existing production processes?

Project classifications Replacement: Cost reduction This category includes expenditures to replace serviceable but obsolete equipment. The purpose here is to lower the costs of labor, materials, or other inputs such as electricity.

Project classifications Expansion of existing products or markets Expenditures to increase output of existing products, or to expand outlets or distribution facilities in markets now being served are included here.

Project classifications Expansion into new products or markets These are expenditures necessary to produce a new product or to expand into a geographic area not currently being served.

Project classifications Safety and/or environmental projects Expenditures necessary to comply with government orders, labor agreements, or insurance policy terms fall into this category.

Project classifications Other project investments This catch all includes office buildings, parking lots, executive aircraft, and so on.

Strategic Long-Term Investment Decisions Similarities between capital budgeting evaluation techniques Project cost Expected cash flows estimation Estimation of project riskiness Cost of capital decision Measurement of present value of cash inflows Present value of the expected cash inflows and required outlay

Capital Budgeting Evaluation Techniques Payback Period Net Present Value (NPV) Internal Rate of Return (IRR) Sensitivity Analysis

Capital Budgeting Evaluation Techniques Payback period Project S : Net Cash Flow Cumulative NCF

Payback period Project (S) Uncovered cost at start of year Payback=Year before full recovery + Cash flow during year 100 Payback Period (S)= 2 + = 2,333 Years 300

Capital Budgeting Evaluation Techniques Payback period Project L : Net Cash Flow Cumulative NCF

Payback period Project (L) 200 Payback Period ( L )= 3 + = 3 ,333 Years 6 00

Capital Budgeting Evaluation Techniques Net Present Value (NPV)

Capital Budgeting Evaluation Techniques Internal rate of return (IRR) The IRR is defined as that discount rate which equates the present value of a project’s expected cash inflows to the present value of its expected costs.

Capital Budgeting Evaluation Techniques Internal rate of return (IRR)

Net Present Value (NPV) To implement this method, it should be proceeded as follows: Find the present value of investment and its future cash flows with discounting at the project’s cost of capital Sum discounted investment and cash flows If the NPV is positive then we accept the project. If we have to choose a project among the alternate projects, we should take into consider the highest NPV

Example of NPV and IRR Small Scale Flower Cultivation Project This project h as written by Weitz Center experts for an area in India. The project covers an area about one acre. The aim is producing and selling flowers. Project’s cost will be covered by a bank loan. All cost and sale data have been collected and realised that target sales could be achieved. Cost benefit analysis Flower . xls

Financial Management Lesson Notes

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Financial Management Lesson Notes