Tuesday, November 21, 2017

Financial management Scope

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Object of financial management

Objective of financial management is to maximise shareholder wealth, it is measure by market capital of the company. Market capital is represented by number of share multiplied with share price.

Market capital = Number of share x Market share price

Shareholder is the owner of the company they appoint management the company, manager should manages the company in the best interest of shareholder. Management acquire fund at optimum cost and utilise it with the minimum risk to earn maximum return and distribute dividend to shareholder or retained earnings for further investment to generate maximum possible return.

THE cost of capital of a firm is the minimum rate of return which the firm must earn on its investments in order to satisfy the expectations of investors who provide funds to the firm. 
It is the weighted average of the cost of various sources of finance used by it. The method of computing the cost of capital is to compute the cost of each type of capital and then find the weighted average of all types of costs of capital. 

In other words, two steps are involved in determination of cost of capital of a firm: 

(i) computation of cost of different sources of capital, and 
(ii) determining overall cost of capital of the firm by weighted average or total cost divided by total fund.

Kc- kc would be weighted average of effective cost of debt and equity

Kc = weight of debt x post-tax cost of debt + weight of equity x cost of equity.

Kc= wd x post-tax kd + we x ke

Cost of debt is to be calculated as follows.

Irredeemable debt:

Annual interest (1 - Tax rate)

Cost of debt =————————————------× 100

Net proceeds of debt

For debt redeemable after certain period




fm,financial management,fmfunda


(iii)       Earning price ratio.

Price is how many times of Earning Per Share.

        Price= Earning Per Share X P/E ratio

P/E ratio = 1/ke, Ke = 1/PE ratio.

Component of interest (Required rate of return)

Rf ( Risk free real rate )= it is compensation for sacrifice of current consumption

Inflation premium = it is compensation for loss of Purchasing Power

Risk Premium = it is compensation for bearing risk.

All rate should be taken in to factor while calculation in below.

Risk free nominal rate = Rf ( Risk free real rate ) x Inflation Premium

Risk adjusted rate = Rf ( Risk free real rate ) x Risk Premium

Risk adjusted nominal rate = Rf ( Risk free real rate ) x Inflation Premium x Risk Premium

When we invest in a inflation protected security we donot demand inflation premium i.e, rate would be Rf real. When we invest in a corporate security, there is default risk involved therefor we demand risk premium.

All interest rate are combine in multiplication fashion except CAPM, RADR & Spread.
  
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