Fundamentals of Financial Management

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Cover Preface to the Third Edition Preface Contents About the Author Part I: Fundamental Concepts of Financial Management Chapter 1: Nature and Goal of Financial Decisions 1.1 Nature of Financial Decisions 1.1.1 Long-term Investment Decision 1.1.2 Working Capital Decision 1.1.3 Financing Decision 1.1.4 Dividend Decision 1.2 Factors Influencing Financial Decisions 1.2.1 Microeconomic Factors 1.2.2 Macroeconomic Factors 1.3 Objective of Corporate Financial Decisions 1.3.1 Profit Maximisation 1.3.2 Objective of Wealth Maximisation 1.3.3 Appraisal of the Objective of Maximisation of Corporate Wealth 1.3.4 The Agency Problem Summary Points to Remember Descriptive Questions Objective–type Questions Study Topic: Managing Agency Problem References Select Further Readings Chapter 2: Time Value of Money 2.1 The Concept 2.2 Computation of Future Value 2.2.1 Future Value of a Single Amount 2.2.2 Future Value of a Series of Payments 2.2.3 Future Value in Case of Annuities 2.2.4 Frequency of Compounding 2.3 Computation of Present Value of Cash Flows 2.3.1 Present Value of a Single Amount 2.3.2 Present Value of a Series of Future Values 2.3.3 Present Value in Case of Annuity 2.3.4 Special Cases of Annuity 2.3.5 Present Value of a Cash Flow with Growth Element Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Readings Chapter 3: Concept of Risk and Return 3.1 Basic Concepts of Returns 3.1.2 Average Return: Simple and Weighted Average 3.1.3 Arithmetic and Geometric Mean 3.1.4 The Concept of Probability 3.1.5 Expected Return from a Single Investment 3.1.6 Expected Returns from International Investment 3.1.7 Portfolio Return 3.2 Concept and Measurement of Risk 3.2.1 Sources of Risk 3.2.2 Risk in Case of a Single Investment 3.3 Portfolio Risk 3.4 The Capital-Asset-Pricing Model (CAPM) 3.4.1 Systematic Risk versus Unsystematic Risk 3.4.2 Measurement of Systematic Risk and Determinants of Beta 3.4.3 Beta and the Required Rate of Investment 3.4.4 Security Market Line 3.4.5 Appraisal of CAPM Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems References Select Further Readings Chapter 4: Valuation of the Firm 4.1 Various Concepts of Value 4.1.1 Intrinsic Value 4.1.2 Market Value 4.1.3 Book Value 4.1.4 Liquidation Value 4.1.5 Going-concern Value 4.1.6 Replacement Value 4.2 Valuation of Bonds or Debentures 4.2.1 Valuation of Bonds with Fixed Maturity 4.2.2 Perpetual Bonds 4.3 Factors Influencing Bond Valuation 4.3.1 Discount Rate versus Coupon Rate 4.3.2 Maturity and Value of Bonds 4.3.3 Yield to Maturity 4.3.4 Duration and the Bond Price 4.3.5 Riskiness and the Value of Bond 4.4 Valuation of Preference Shares 4.5 Valuation of Ordinary Shares 4.5.1 Single-period Analysis 4.5.2 Multi-period Analysis 4.5.3 P/E Ratio Approach to Equity Valuation Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Reference Select Further Reading Appendix A Appendix B Part II: Long-term Investment Decision Chapter 5: Principles of Capital Budgeting 5.1 Nature of Capital Budgeting 5.1.1 Meaning and Significance 5.1.2 Types of Proposals 5.1.3 Steps in Capital Budgeting Process 5.2 The Concept of Cash Flows 5.2.1 Nature and Timing of Cash Flows 5.2.2 Factors Considered for Cash Flow Computation 5.2.3 Process of Computation 5.3 Project Evaluation Criteria 5.3.1 NPV Rule 5.3.2 Profitability Index 5.3.3 Profitability Ratio Versus NPV 5.3.4 IRR Rule 5.3.5 NPV versus IRR 5.3.6 Modified IRR (MIRR) 5.3.7 Pay-back Period 5.3.8 Accounting Rate of Return Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Reference Select Further Readings Chapter 6: Capital Budgeting in Practice 6.1 Capital Rationing 6.1.1 Conditions of Capital Rationing 6.1.2 Capital Rationing and the Choice for a Proposal 6.2 Capital Budgeting Under Inflationary Conditions 6.3 Decision Concerning Mutually Exclusive Proposalswith Unequal Lives 6.3.1 Annualised NPV Method 6.3.2 Replacement Chain Method 6.4 The Conditions of Risk 6.4.1 Inclusion of Risk Factor in Cash Flow 6.4.2 Risk Analysis Based on Portfolio Approach 6.4.3 Sensitivity Analysis 6.4.4 Scenario Analysis 6.4.5 Monte Carlo Simulation 6.5 Managerial Options and the Cash Flow 6.5.1 The Decision-tree Approach 6.6 International Capital Budgeting 6.6.1 Parent’s Perspective and the Cash flow 6.6.2 Parent–Subsidiary Perspective Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems References Select Further Readings Chapter 7: Cost of Capital 7.1 Significance of Cost of Capital 7.2 Computation of the Cost of Capital 7.2.1 Cost of Debt 7.2.2 Cost of Preference Share Capital 7.2.3 Cost of Equity Shares 7.2.4 Cost of Retained Earnings 7.3 Weighted Average Cost of Capital 7.3.1 The Measurement 7.3.2 The Influencing Factors 7.4 Marginal Cost of Capital Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Reference Select Further Readings Part III: Working Capital Management Chapter 8: Working Capital Policy 8.1 Concept of Working Capital 8.1.1 Gross and Net Working Capital 8.1.2 Permanent and Variable Working Capital 8.2 Size of Current Assets 8.2.1 Assessment of the Size: The Concept of Operating Cycle 8.2.2 Ratio between Current Assets and Fixed Assets: Liquidity versus Profitability 8.2.3 Other Factors Influencing the Size of Current Assets 8.3 Financing of Current Assets Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Reference Select Further Readings Chapter 9: Management of Cashand Near-Cash Assets 9.1 Cash Planning 9.1.1 Motives behind Holding Cash 9.1.2 Ascertaining Cash Requirements 9.2 Managing Cash Inflows and Outflows 9.2.1 The Concept of Float 9.2.2 Instruments of Cash Collection 9.2.3 Ways to Accelerate Cash Collections 9.2.4 Controlling Disbursements 9.3 Investment of Surplus Cash in Near-Cash Assets 9.3.1 Determination of Ratio between Cash and Near-Cash Assets 9.3.2 Optimal Cash Balance under Conditions of Certainty: Baumol Model 9.3.3 Optimal Cash Balance under Uncertainty: The Miller-Orr Model 9.3.4 Selection of Near-Cash Assets 9.4 Cash Management in International Firms 9.4.1 Intra-firm Transfer of Funds in Presence of Exchange Control 9.4.2 Investment of Surplus Cash Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems References Select Further Readings Chapter 10: Management of Accounts Receivable 10.1 Benefits and Costs of Accounts Receivable 10.1.1 Benefits 10.1.2 Costs 10.2 Credit Policy 10.2.1 Optimising the Term of Credit 10.2.2 Changes in Credit Standard 10.2.3 Discount Policy 10.3 Selection of Customers 10.3.1 Collecting Necessary Information 10.3.2 Analysis of the Information 10.3.3 Fixation of the Credit Limit 10.4 Monitoring and Control of Credit 10.4.1 Monitoring at the Customer’s Level 10.4.2 Monitoring at the Aggregate Level 10.4.3 Factoring 10.4.4 Forfaiting Summary Points to Remember Descriptive Questions Objective-type Questions Numerical Problems Solved Numerical Problems References Select Further Readings Chapter 11: Inventory Management 11.1 Benefits and Cost of Maintaining Inventory 11.1.1 Benefits 11.1.2 Costs 11.2 Goal of Inventory Management 11.2.1 Classification of Inventories 11.2.2 Economic Order Quantity (EOQ) 11.2.3 Determination of Re-order Point 11.2.4 Safety Level of Stock 11.3 Just-in-time Inventory System Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Reference Select Further Readings Chapter 12: Sources of Short-term Finance 12.1 Trade Credit 12.1.1 Nature of Trade Credit 12.1.2 Benefits and Costs of Trade Credit 12.1.3 Stretching of Accounts Payable 12.2 Bank Finance 12.2.1 Nature of Bank Finance 12.2.2 Effective Interest Rate 12.2.3 Bank Financing Norms in India 12.3 Other Sources of Short-term Funds 12.3.1 Commercial Papers 12.3.2 Public Deposits 12.3.3 Intercorporate Deposits Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Readings Part IV: Long-term Financing and Dividend Decisions Chapter 13: Capitalisation 13.1 Significance and Bases of Capitalisation 13.1.1 Meaning of Capitalisation 13.1.2 Bases of Capitalisation 13.2 Over–capitalisation 13.2.1 Meaning of Over-capitalisation 13.2.2 Causes of Over-capitalisation 13.2.3 Effects of Over-capitalisation 13.3 Under-capitalisation 13.3.1 Meaning and Causes of Under-capitalisation 13.3.2 Impact of Under-capitalisation 13.4 Way to Optimum Capitalisation 13.4.1 Re-organisation of Capital 13.4.2 Maintenance of Desired Earnings Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Reading Chapter 14: Capital Structure 14.1 The Basic Issue 14.2 The Irrelevance Approach 14.2.1 The Arbitrage Process 14.2.2 Leverage and the Cost of Capital 14.2.3 Value of the Firm 14.3 Relevance of Capital Structure 14.3.1 Financial Leverage and EPS 14.3.2 Financial Leverage and Cost of Capital 14.3.3 Value of Leveraged and Unleveraged Firm in Presence of Taxes 14.3.4 Views of Modigliani and Miller in Presence of Taxes 14.4 Determination of Optimal Capital Structure 14.4.1 The Lowest WACC 14.4.2 Corporate Income Tax and Personal Income Tax 14.4.3 Bankruptcy and Agency Costs 14.4.4 The Pecking Order Hypothesis: A Critique ofan Optimal Leverage 14.4.5 Process of Attaining Optimal Capital Structure 14.5 Features of a Sound Capital Structure Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems References Select Further Readings Chapter 15: Corporate Securities 15.1 Equity Shares 15.1.1 Features of the Equity Shares 15.1.2 How do Companies Issue New Shares? 15.1.3 Pre-emptive Rights of Equity Shareholders 15.2 Preference Shares 15.2.1 Features of Preference Shares 15.3 Debentures 15.3.1 Significance of Debentures 15.3.2 Features of Debentures 15.3.3 Economic Size of the Issue of Debentures 15.3.4 Retirement of Debt 15.4 Warrants 15.4.1 Features of Warrants 15.4.2 Valuation of a Warrant 15.4.3 Usefulness of Warrants 15.5 International Securities 15.5.1 International Equities 15.5.2 International Bonds Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Readings Chapter 16: Term Loans and Leases 16.1 Term Loans 16.1.1 Basic Characteristics 16.1.2 Amortisation Schedule 16.1.3 Advantages of Term Loans 16.2 Nature and forms of Lease 16.2.1 Operating Lease 16.2.2 Financial Lease 16.2.3 Straight and Modified Lease 16.3 Lease Versus Purchase Decision 16.3.1 Net Present Value Approach 16.3.2 Net Advantage of Leasing (NAL) Approach 16.3.3 Internal Rate of Return (IRR) Method 16.3.4 The Lessor’s Viewpoint 16.4 Advantages and Disadvantages of Leasing 16.4.1 Advantages 16.4.2 Disadvantages Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Readings Chapter 17: Dividend Theories and Policy 17.1 Theories of Dividend 17.1.1 Dividend Irrelevance—Miller-Modigliani (M-M) Approach 17.1.2 Miller-Modigliani Hypothesis in Imperfect Market 17.1.3 Residual Theory of Dividends 17.1.4 “Smoothened” Residual Theory of Dividend 17.1.5 Walter’s Model of Dividend Policy 17.1.6 Dividend Relevance—Gordon’s Dividend Capitalisation Model 17.1.7 Dividend Preference Theory—Ezra Solomon’s Approach 17.2 Factors Influencing the Dividend Policy 17.2.1 Expectations of the Shareholders 17.2.2 Financial Requirements of the Firm 17.2.3 Legal and Financial Constraints 17.2.4 General Economic Conditions 17.3 Stability of Dividend Payments 17.3.1 Meaning of Stable Dividend 17.3.2 Significance of Stable Dividend 17.4 Bonus Shares 17.4.1 Impact of the Bonus Issue 17.4.2 Merits and Demerits 17.4.3 Bonus Share Issue in India 17.5 Share Split and Reverse Split 17.5.1 Share Split 17.5.2 Reverse Split 17.6 Repurchase of Shares 17.6.1 Modes of Share Repurchase 17.6.2 Purpose of the Share Buy–back 17.6.3 Advantages and Disadvantages of Share Buy-back 17.6.4 Share Buy–back in India Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems References Select Further Readings Part V: Financial Analysis Planning and Forecasting Chapter 18: Financial Statements 18.1 Income Statement 18.1.1 Managerial Format 18.1.2 Marginal-Analysis Format 18.2 Balance Sheet 18.2.1 Assets 18.2.2 Liabilities 18.2.3 Limitations of the Balance Sheet 18.2.4 Complementarity between Income Statement and Balance Sheet 18.2.5 Comparative Financial Statements 18.3 Funds-Flow Statement 18.3.1 Sources of Funds 18.3.2 Uses of Funds 18.3.3 Preparation of a Funds-flow Statement 18.4 Cash-Flow Statement 18.4.1 Sources and Uses of Cash 18.4.2 Preparation of Cash-flow Statement Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Reading Chapter 19: Financial Ratio Analysis 19.1 Significance of Ratio Analysis 19.2 Types of Financial Ratios 19.2.1 Liquidity Ratios 19.2.2 Profitability Ratios 19.2.3 Ownership Ratios 19.3 Application of Ratios 19.3.1 Financial Statements 19.3.2 Computation of the Ratios 19.4 Uses of Ratio Analysis 19.5 Limitations of Financial Ratio Analysis Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Reference Select Further Readings Chapter 20: Break-even Analysis 20.1 Significance of Break-even Analysis 20.2 Determination of Break-even Point 20.2.1 Graphical Presentation 20.2.2 Computation of BEP Sales 20.3 Break-even Point and Profit Planning 20.3.1 Increase in Sales Volume 20.3.2 Increase in Sale Price 20.3.3 Varying Costs and Level of Profits 20.4 Sales-mix and Break-even Analysis 20.5 Uses of Break-even Analysis 20.6 Limitations of Break-even Analysis Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Readings Chapter 21: Leverage 21.1 Return-on-Investment Leverage 21.2 Marginal-Analysis Leverage 21.2.1 Operating Leverage 21.2.2 Fixed-charge Leverage 21.2.3 Combined Leverage 21.3 Financial Leverage 21.3.1 Financial Leverage with Preference Shares Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Readings Chapter 22: Financial Forecasting 22.1 Forecast of Single Financial Variable 22.1.1 The Financial Variables 22.1.2 Techniques of Forecast 22.2 Complete Forecast of Financial Position 22.2.1 Cash-flow Approach 22.2.2 Balance-sheet Approach Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Select Further Readings Part VI: Special Topics in Financial Management Chapter 23: Corporate Combinations 23.1 Forms of Corporate Combinations 23.1.1 Classification by Corporate Structure 23.1.2 Classification by Financial Relationship 23.1.3 Classification Based on Technique 23.2 Motivations Behind Combination 23.3 Gains and Costs of M&AS 23.4 Determination of Consideration Value 23.5 Modes of Merger Financing 23.5.1 Cash Payment 23.5.2 Exchange of Equity Shares 23.5.3 Preference Shares and Debentures 23.5.4 Deferred Payment Plan 23.6 Mergers and Take-over Regulations in India 23.7 Accounting Procedures for Combinations 23.7.1 Acquisition 23.7.2 Holding Companies 23.8 Pure Divestitures, Spin-offs and Equity Carve-outs 23.8.1 Pure Divestitures 23.8.2 Spin-offs 23.8.3 Equity Carve-outs Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems Reference Select Further Readings Chapter 24: Corporate Financial Distress 24.1 Concept of Financial Distress 24.1.1 Economic Failure 24.1.2 Financial Failure 24.2 Symptoms of Financial Distress 24.3 Management of Corporate Failure 24.3.1 Determinants of the Mode of Handling Failure 24.3.2 Contingency Planning 24.3.3 Voluntary Settlements 24.3.4 Reorganisation 24.3.5 Liquidation 24.4 Management of Financial Distress in India Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems References Select Further Readings Chapter 25: International Financial Management 25.1 Exchange Rate Regime 25.1.1 Pegged versus Floating Exchange Rate Regime 25.1.2 Independent and Managed Floating 25.2 Exchange Rate Quotation 25.2.1 Direct and Indirect Quote 25.2.2 Buying and Selling Rate 25.2.3 Forward Rates 25.2.4 Cross Rates 25.3 Determination of Exchange Rate in Spot Market 25.3.1 The Process of Determination 25.3.2 Factors Influencing Exchange Rate 25.4 Exchange Rate Determination in Forward Market 25.4.1 Interest Rate Parity Theory 25.4.2 Covered Interest Arbitrage 25.5 Foreign Exchange Market 25.5.1 Distinctive Features 25.5.2 Major Participants 25.5.3 Currency Arbitrage in Spot Market 25.5.4 Arbitrage, Hedging and Speculation in Forward Market 25.6 Market for Derivatives 25.6.1 Market for Currency Futures 25.6.2 Market for Currency Options Summary Points to Remember Descriptive Questions Objective–type Questions Numerical Problems Solved Numerical Problems References Select Further Readings Answers Glossary Mathematical Tables Author Index Subject Index