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Creating Value Through Financial Management . Presented by - Zil Shah eMBA-81
Creating Value Through Financial Management.
Presented by - Zil Shah eMBA-81
introduction
• The ultimate objective of financial management is value creation.
• A business proposal creates value only if its net present value is positive.
• The fundamental finance principle can be applied to major corporate decisions
• Profit is essential for a firm to sustain long-term growth.
ROLE OF FINANCIAL MANAGEMENT
• Efficient and effective management of money • how to raise the capital• how to allocate capital • Not only long term but the short term budgeting is done.• It also deals with the dividend policies.• Processing data only once in order to reduce cycle times.• Structuring data so that it provides information • Leveraging people and technology to improve transaction
processing.
THE FUNDAMENTAL FINANCE PRINCIPLE
Before making a business decision manager should ask : Will the decision create\raise value for the firm?
It can be answered with the help of the fundamental finance principle - A business proposal such as:• a new investment• the acquisition of another company• a restructuring plan
will raise the firm’s value only if its net present value is
positive
MEASURING VALUE CREATION
• Net present value• Time value of money
Principle of compoundingPrinciple of discounting
• Cost of capital
Cost of capital
Weighted average cost of capital or WACC
= (weight of debt × cost of debt)+(weight of equity × cost of equity)
WACC = [6% × 50%] + [16% × 50%]
= 3% + 8% = 11%
Capital budgeting
• Capital budgeting is also known as investment decision.• Capital budgeting means a decision relating to planning for capital assets as to whether or not money should be invested in long term projects.
Capital budgeting method
• Payback period• Average rate of return• Net present value• Internal rate of return
Pay-back period
Project Original investment
Cash inflow 1
Year 2 3
Payback period Rank
A 5000 5000 250 250 1 year 1
B 5000 2500 2500 2500 2 year 2
C 5000 1000 1500 1500 2year 4months 3
It can be defined as number of year required to recover the cost of the investment
Pay back period = original investment annual net cash inflow
Average rate of return• It is an attempt to measure the rate of return on
investment on the basis of the accounting information contained in financial statements.
• ARR = × 100 C NARR(A)=( 5000+250+250)-5000 × 100 = 3.33% 3 5000ARR(B)=16.67%ARR(C)=26.67%
∑𝑛=1
𝑁
𝑅𝑛−𝐶
Net present value• NPV is difference between a project value and its cost.
• NPV= - C (1+r)n
NPV(A)= 5000+ 250 + 250 -5000= Rs. -60 1.1 1.21 1.331 NPV(B)= Rs.1217NPV(C)= Rs.2070
Internal rate of return
C = N Rn ∑ n=1 (1+r)n• Discount rate which equates the present value
of an investment cash inflow & outflow• IRR is rate at which NPV=0• IRR > Market rate of interest • Project with higher IRR is preferred.
Sources of Value Creation in a Business Proposal
• Capital structure• Business acquisition• Foreign investment• Financial markets• Equity markets• Business cycle
BUSINESS CYCLE
FINANCIAL ACCOUNTING
PROFITABILITY OF FIRM
• THE PROFITABILITY OF EQUITY CAPITAL
Return on equity (ROE) = Earnings after tax(EAT)
Owners’ equity• THE PROFITABILITY OF INVESTED CAPITAL
Return on invested capital (ROIC)
= After tax operating profit
Invested capital
market value added
• This net present value is usually referred to as the firm’s market value added or MVA.
• If MVA is positive, the firm is creating value because the market value of its capital exceeds the amount of capital invested in it.
• If MVA is negative, the firm is destroying value.
Economic value added
EVA = After-tax operating profit – (Capital employed × WACC) = $120 million – $1,000 million × 10% = $120 million – $100 million = $20 million
Or EVA = (ROIC – WACC) × Invested capital L&T’s ROIC in year 2013 is 12 %EVA= [12% – 10%] × $1,000 million= 2% × $1,000 million = $20 million
