Capital budgeting techniques for Financial Management and Policy MCOM sem 2 Delhi University

Capital budgeting techniques for Financial Management and Policy MCOM sem 2 Delhi University Delhi University Complete syllabus

Objective: To make students understand various issues involved in financial management of a firm and equip them with advanced analytical tools and techniques that are used for making sound financial decisions and policies.

Contents:

Unit I- Introduction: Nature, scope and objectives of financial management. Financial decision making and types of financial decisions. Finance as a strategic function. Role of finance manager. Agency problem. Stock price maximization and agency costs. Alternatives to stock price maximization. Stakeholders’ wealth maximization. Risk-return framework for financial decision making.

Unit II- Capital Budgeting: Nature, significance and kinds of capital budgeting decisions. Cash flow estimation. Capital budgeting techniques- ARR, Payback period, Discounted payback period, NPV, Equivalent annual NPV, IRR, Incremental IRR and Modified IRR. Capital budgeting decisions under constraints and with multiple objectives using mathematical programming models (Linear programming and Integer Programming). Capital rationing. Capital budgeting decision under inflation. Capital budgeting decision under uncertainty. Techniques for incorporating risk and uncertainty in capital budgeting decisions- RADR, Certainty equivalent method, DCF Break even analysis, Simulation method, Probability distribution method, Decision tree analysis, Sensitivity analysis and Scenario analysis. Real options.

Unit III- Capital Structure: An overview of cost of capital- Specific and WACC. Financial leverage and evaluation of financial plans (EBIT-EPS analysis). Theories of capital structure- NI, NOI, MM Hypothesis without and with corporate taxes, Merton Miller argument with corporate and personal taxes, Trade off theory, Pecking order theory, Signaling theory and effect of information asymmetry on capital structure. Optimal capital structure. Determinants of Capital structure in practice.

Unit IV- Dividend Policy: Forms of dividends. Theories of relevance and irrelevance of dividend in firm valuation (Walter’s model, Gordon’s Model, MM Hypothesis, Bird-in-hand theory and Dividend signaling theory).Relevance of dividend policy under market imperfections. Traditional and Radical position on dividend. Issues in dividend policy. Types of dividend polices in practice (constant rupee dividend policy, constant dividend payout policy, smooth stream dividend policy etc.) Determinants of dividend policy. Lintner’s Model on corporate dividend behavior.

Unit V- Working Capital Planning and Management: Concept and types of working capital. Operating and cash cycle. Estimation of working capital requirement. Working capital financing. Determinants of working capital. Components of working capital management. Cash management- Baumol’s Model and Miller-Orr Model of managing cash. Receivables management- dimensions of credit policy of a firm and evaluation of credit policies; credit analysis. Inventory management.

Unit VI- Corporate Restructuring and Contemporary Issues in Financial Management: Corporate restructuring. Mergers and Acquisitions- types, sources of takeover gains, valuation and financing of M&As. Leveraged buyouts; Spin offs; demerger. Contemporary issues in financial management

Capital budgeting techniques for Financial Management and Policy MCOM sem 2 Delhi University

Financial management refers to the efficient and effective management of money (funds) in such a manner as to accomplish the objectives of the organization. It is the specialized function directly associated with the top management. The significance of this function is not seen in the ‘Line’ but also in the capacity of ‘Staff’ in overall of a company. It has been defined differently by different experts in the field.

The term typically applies to an organization or company’s financial strategy, while personal finance or financial life management refers to an individual’s management strategy. It includes how to raise the capital and how to allocate capital, i.e. capital budgeting. Not only for long term budgeting, but also how to allocate the short term resources like current liabilities. It also deals with the dividend policies of the share holders.

Objectives of Financial Management

• Profit maximization occurs when marginal cost is equal to marginal revenue. This is the main objective of Financial Management.

• Wealth maximization means maximization of shareholders’ wealth. It is an advanced goal compared to profit maximization.[3]

• Survival of company is an important consideration when the financial manager makes any financial decisions. One incorrect decision may lead company to be bankrupt.

• Maintaining proper cash flow is a short run objective of financial management. It is necessary for operations to pay the day-to-day expenses e.g. raw material, electricity bills, wages, rent etc. A good cash flow ensures the survival of company.

• Minimization on capital cost in financial management can help operations gain more profit.

Scope of Financial Management

• Estimating the Requirement of Funds: Businesses make forecast on funds needed in both short run and long run, hence, they can improve the efficiency of funding. The estimation is based on the budget e.g. sales budget, production budget.

• Determining the Capital Structure: Capital structure is how a firm finances its overall operations and growth by using different sources of funds.[4] Once the requirement of funds has estimated, the financial manager should decide the mix of debt and equity and also types of debt.

Investment Fund: A good investment plan can bring businesses huge returns.

Capital budgeting techniques for Financial Management and Policy MCOM sem 2 Delhi University

Capital Budgeting Techniques A collection of methods allowing the manager to choose among a variety of investment projects. Methods:

• Average Accounting Return
• Payback
• Discounted payback
• Internal Rate of Return
• Modified Internal Rate of Return
• Net Present Value
• Profitability Index

Capital Budgeting Techniques for Analysis of projects :

A . Discounting technique (use time value of money )

Methods :

• Net present value

• profitability index

• Internal Rate of return

• Modified internal rate of return

• Discounted payback period

• Net present value index

B . Non- Discounting Technique (ignores time value of money )

Methods :

• Payback period

• Accounting rate of return or average rate of return

Management of fixed capital, capital budgeting decision or investment decision is the process of long range planning involving investment of funds in various long term activities whose benefit are expected over a series of year .

Need of Capital budgeting Decision

these decisions affects the long term growth & survival of business, these decision have long term implication for the enterprises because the effect of investment decision extend in to the future

these decision involve large investment in various long term asset , thus planned after careful evaluation of various project

involve risk & uncertainty associated with the future cash flow of the project,since the actual cash flow may not match expected cash flow the rate of earning may fluctuate & he firm may become more risky

decision once taken cannot be easily reversible without incurring heavy losses , these decisions are very important for any organization

Steps in capital Budgeting :

• project planning

• project evaluation

• project selection

• project implementation

• project control

• project review

Capital budgeting techniques for Financial Management and Policy MCOM sem 2 Delhi University

Capital Budgeting: Choosing an investment with satisfactory cash flows and rate of return i.e., allocation of company’s funds into long-term investments.

For instance, Delhi Metro Rail Corporation buys 10 Metro Rails today for Rs. 100 crore million.

Following characteristics make them significant for any organization:-

• Substantial Funds

• Capital budgeting decision involve huge outlay of funds; therefore, should be taken after assessing each and every minute detail of the project/ proposal. It also involves an opportunity cost; had this huge amount not invested here,must have been invested elsewhere, yielding decent returns.

• Long-term Implications

• It has long-term consequences and implications. They affect the risk-return composition of the organization for long time, which makes the decision so crucial. If this decision is not taken effectively, the company may have to absorb huge losses.

• Ability to compete in the market

• Such decisions also affect the company’s ability to face competition. A timely taken capital budgeting decision may lead to monopoly of the company while a delayed decision may endanger the survival of company in the market.

Capital budgeting techniques for Financial Management and Policy MCOM sem 2 Delhi University

Master of Commerce (MCom or M Comm; sometimes Magister Commercii) is a postgraduate master’s degree focusing on commerce-, accounting-, management- and economics-related subjects. Like the undergraduate Bachelor of Commerce, the degree is offered in Commonwealths nations.

Capital budgeting techniques for Financial Management and Policy MCOM sem 2 Delhi University