Module -2 FM Financial Management means planning, organizing

Financial Management means planning, organizing, directing and controlling the financial activities of the enterprise. It means applying general management

1. Module -2 Investment Decisions

2. Meaning of Investment decision: Investment Decisions refer to decisions relating to utilization of funds. Deciding upon where to invest, when to invest, on what to invest, how much to invest, for how long to invest, etc., form the crux of investment decisions Investment Decisions are broadly of two types Long-term Investment Decisions and Short-term Investment Decisions.

3. Long-term Investment Decisions are decisions relating to investments in projects, assets and resources which provide long term benefits. These decisions are also called Capital Budgeting Decisions .

4. Capital budgeting decisions involves the following: Deciding on whether to invest or not, given an investment opportunity (Accepting or Rejecting Independent Proposals). Deciding on the best investment alternative among mutually exclusive investment alternatives. Deciding on the extent and proportion of investment among various non-mutually exclusive investment alternatives (Capital Rationing).

5. IMPORTANCE OR SIGNIFICANCE OF CAPITAL BUDGETING Cost: Initial Investment is substantial. Hence, commitment of resources should be made properly. Time: The effect of decision is known only in the near future and not immediately. Irreversibility: Decisions are irreversible and commitment should be made on proper evaluation. Complexity : The decisions are based on forecasting of future events and inflows. Quantification of of future events involves application of statistical and probabilistic techniques. Careful judgment and application of mind is necessary

6. 5. Risk and Uncertainty involved in Appraisal: Evaluation of capital expenditure proposal involves projections of the future. Future is always uncertain

7. Characteristics of investment Liquidity Return Tax benefit Risk Investment objective Safety Cost efficiency Diversification Marketability

8. Process Analyze Financial Position:  For financial management, one has to understand the company or individual’s current financial condition. Define Investment Objective:  Then, investors must set up an investment objective—whether to invest short-term or long-term. They should also be aware of their  risk appetite  (level of risk they desire to take). Asset Allocation:  Based on the objective, investors must  allocate assets  into stocks, debentures, bonds,  real estate , options, and commodities. Select Investment Products:  After narrowing down on a particular  asset class , investors must further select a particular asset or security. Alternatively, this could be a basket of assets that fit the requirements. Monitor and Due Diligence:   Portfolio managers  keep an eye on the performance of each investment and monitor the returns. In case of poor performance, they must take prompt action.

9. The accrual method of accounting The accrual method of accounting is a way of recording business finances that's based on the matching principle of generally accepted accounting principles (GAAP). It's used by most large businesses. Accrual accounting differs from cash basis accounting, which records expenses when paid and revenue when cash is received. Instead, accrual accounting records revenue and expenses when they happen, even if payment hasn't occurred yet. 

10. Capital budgeting process:

11. TECHNIQUES OF CAPITAL BUDGETING Non-Discounted Cash Flow Techniques Discounted Cash Flow Techniques

12. 1. Non-Discounted Cash Flow Techniques These are the techniques which do not consider time value of cash inflow and outflows, Non-Discounted Cash Flow Techniques include Payback Period Average Rate of Return

13. 1. Payback period technique: Payback Period refers to the period in which the project will generate the necessary cash to recoup the Initial Investment. That is, Payback Period refers to the period required for the project to recover the investment.

14. Merits of Payback Period This method is simple to understand and easy to operate It clarifies the concept of profit or surplus, Surplus arises only if the initial investment is fully recovered. Hence there is no profit on any project unless the payback period is reached This method is suitable in the case of industries where the risk of technological obsolescence is very high and hence only those projects, which have shorter Payback Periods should be financed.

15. Limitations of Payback Period It stresses on capital recovery rather than profitability This method ignores the time value of money. This method becomes an inadequate measure of evaluating two projects where the Cash inflows are uneven.

16. Calculation of Payback Period A) In case of even cash flows ( When cash inflows are same for each year of the life of the project) Payback Period = Initial Investment (Cash Outflow) /Annual Cash Inflow

17. II. If annual cash flow are not uniform: Pay back period = Number of years+ Amount to be recovered/ Cash inflow of next year

18. 2. Average Rate of return ( Accounting rate of return) or return of investment Under this method the profitability of the projects is used as a criterion for decision making. The Average rate of return on investment generated by the project is the basic for decision making. Since the return ( i.e Profits) obtained as per accounting principles are considered for finding the rate of return, this method is called accounting rate of return.

19. Formulas Average Rate of Return = Average Annual income/ Average Investment X 100 Average annual income = Profit after tax and Depreciation Average investment = Original investment-Scrap value/2 +Scrap value + Net working capital

20. Merits: 1. It is simple to understand and easy to calculate 2. It uses the entire earnings of a project in calculating rate of return 3. As this method is based upon accounting concept of profit it can be readily calculated from financial data. 4. The project differing widely in character can be compared properly.

21. Demerits: 1. This method is like pay back period method, ignores the time value of money. 2. It does not take into consideration the cash flows which are more important than the accounting profits. 3. It ignores the timings of returns. 4. This method cannot be applied to situation where investment in a project is to be made in parts.

22. Criterion for decision Making: Given an independent proposal accept if the ARR is greater than hurdle rate or any other cut off rate. Given mutually exclusive alternatives, invest in the alternative with highest ARR.

23. Accounting Income Accounting income, also known as net income or profit, is the revenue earned by a business minus the expenses incurred to generate that revenue. In other words, it is the money left over after all expenses have been paid, including taxes and interest payments. Accounting income is a measure of a company’s profitability over a specific period, usually a quarter or a year There are three components of accounting income: revenue, expenses, and taxes. Revenue is the money earned by a business from the sale of goods or services. Expenses are the costs incurred by a business to generate revenue, including salaries, rent, and supplies. Taxes are the payments made by a business to the government.

24. Cash Flow Cash flow is the amount of money that flows in and out of a business over a specific period. It is a measure of a business’s liquidity and its ability to pay its bills on time. Cash flow includes all the money that comes into a business, such as revenue, loans, and investments, and all the money that goes out, such as expenses, loan payments, and dividends. Operating cash flow  is the cash generated by a business’s day-to-day operations, such as sales and collections from customers. Investing cash flow  is the cash used to purchase or sell assets, such as equipment or real estate. Financing cash flow  is the cash used to pay off debt or issue new shares.