Chapter One
Overview
of
Fundamentals of Finance
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
1
What is Finance?

At the macro level, finance is the study of financial
institutions and financial markets and how they
operate within the financial system in global
economies.

At the micro level, finance is the study of financial
planning, asset management, and fund raising for
businesses and financial institutions.

What is Business Finance

What is Financial Management
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
2
Scope of finance
Managerial Function
Investment
Decision
Routine Function
Financing
Decision
Dividend
Decision
Capital
Budgeting
Working
capital
Management
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
3
Major decisions taken by financial
manager

Investment Decision
• Working Capital Management
• Capital budgeting

Financial Decision

Dividend Decision
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
4
Role of Financial Manager

Financial Planning

Forecasting cash flow

Source Identification

Forecasting future profits

Raising of fund

Managing Assets

Investment of fund

Cost control

Protection of capital

Pricing

Distribution of profit

Time Schedule

Managing fund
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
5
Principles of Finance/Financial
Manager

Principles of Risk and Return.

Principles of Time value of Money.

Principles of Cash Flow.

Principles of Profitability and Liquidity.

Hedging Principles.

Principles of Diversity.

Principles of Business Cycle.
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
6
Goal of a firm/Goal of financial manager
Economic welfare of common shareholders (owners of the firm)
Profit Maximization
Wealth Maximization
(example)
(example)
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
7
Profit Maximization

NP
Year-2007
200
year-2008
210
year-2009
215
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
year-2010
220
8
Profit maximization in



3 ways
By reducing cost
•
If firm use the component perfectly, cost of production
will be reduced and profit will be maximized.
By providing quality goods and services
•
Quality raw material, effective manpower, efficient
management can reduce production cost.
By creating additional demand
•
It can be ensured by producing better products,
advertisement, effective investment decision, efficient
management etc.
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
9
Profit Maximization as the goal of
a firm

Profit is the yardstick to measure
efficiency

Proper utilization of resources

Social welfare
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
10
Criticism of Profit Maximization
a) Ambiguity or Vague
b) Timing of profit and time value of
money are ignored
c) It ignores risk
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
11
Wealth Maximization
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
12
Wealth maximization
The net present value or wealth can be defined more explicitly in the following way:
V = W = NPV =
Example:
 A1
An 
A2


















2
n  - C
(
1

K
)
(
1

K
)
(
1

K
)


Assume that project X costs Rs 2500 now and is expected to generate year-end
cash inflows of Rs 900, Rs 800, Rs 700, Rs 600 and Rs 500 from year 1 to year 5.
The opportunity cost of the capital is assumed to be 10 percent.
W= NPV= (Rs 900/(1+0.10)+ Rs 800/(1+0.10)2 +Rs 700/(1+0.10)3 +Rs 600/(1+0.10)4
+ Rs 500/(1+0.10)5] – Rs 2500
= [818.18+661.15+525.92+409.80+310]-2500
= 2725-2500
= 225.
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
13
Wealth Maximization as the goal of
a firm

Clear Concept

It considers timing of return, time value of
money, and risk

Focus on market price of share
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
14
Clear Concept
It considers timing of return, time value of money, and risk
The net present value or wealth can be defined more explicitly in the following way:
V = W = NPV =
 A1
An 
A2


















2
n  - C
(
1

K
)
(
1

K
)
(
1

K
)


W= NPV= (Rs 900/(1+0.10)+ Rs 800/(1+0.10)2 +Rs 700/(1+0.10)3 +Rs 600/(1+0.10)4
+ Rs 500/(1+0.10)5] – Rs 2500
= [818.18+661.15+525.92+409.80+310]-2500
= 2725-2500
= 225.
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
15
Factors that influence Financial Decision
Internal Factors
External Factors

Size of Business

Nature of Business

The Form of Legal Organization

Situation of Business Cycle

Assets Structure

Regularity and Adequacy of Income

Economic Life of Business

Terms of Credit

Management Philosophy
• Govt. regulations
• Tax system
• Economic condition of the country
• Condition of money market and
capital market
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
16
Agency Issues:
The Principal-Agent Problem

Whenever ownership is independent of
management there exists potential problem of
conflicts.

The owner’s goals for the firm are best
described as maximizing shareholder wealth.

Managers are also concerned with personal
wealth, job security, lifestyle, and benefits. These
concerns may conflict with shareholder interests.
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
17
Types of Agency Problems

Shareholders & Board of Directors

Board of Directors & Managers

Managers & Staff

Owners & Other parties
Tanzina Hossain,Lcturer, Daffodil
International University, Dhaka
18