Mini MBA B10 - 03 Financial Management - Day 03 PDF

Financial Management
MINI MBA Program

DAY 03 | 10 Mar 2022
Mini MBA
BINUS BUSINESS
– BINUS SCHOOL
BUSINESS
Executive
SCHOOLEducation
Executive Education 2022
Financial Management
Session Day Topic Learning Focus
• Basic Concept of Financial
Management
1 Intro to Financial Management
Day 1 • Accounting vs Finance
Gatot Soepriyanto • Maximizing Shareholder Wealth
8 Mar 2022 • Balance Sheet
Understanding Financial
2 • Incomes Statement
Statements
• Statement of Cash Flows
• Fixed Cost & Variable Costs
3 Cost Structures • Direct Material, Direct Labor and
Manufacturing Overhead
Day 2
Gatot Soepriyanto • Liquidity Ratios
9 Mar 2022 • Debt Management Ratios
4 Financial Ratio Analysis (Solvency)
• Asset Management Ratios
• Profitability Ratios
• Time Value of Money Concept
Capital Budgeting
5 • Discounted Cash Flows
Day 3 (Investments Decision Analysis)
• Cost of Capital (WACC)
Humprey Tjia
10 Mar 2022 • Payback Period
Capital Budgeting
6 • Net Present Value
(Investments Decision Analysis)
• Internal Rate of Return
Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 2
This presentation material is strictly for class discussion purpose only, and can not be used, copied and
distributed for other purposes.
Intro to Capital
Budgeting
• Financial Statements
• Balance Sheet
• Income Statement
• Financial Decision Making
BS & PL
BALANCE SHEET
Current Assets
Current Liabilities
▪ Cash
▪ Short-Term Debt
▪ Receivable
▪ Account Payable
▪ Inventory
Fixed Assets Long-Term Debt

▪ Tangible fixed assets
▪ Intangible fixed assets Shareholders’ Equity
BS & PL
INCOME STATEMENT
Net Revenues
-/- Cost of Revenues
Gross Profit
-/- Selling expenses

-/- General & administrative expenses
-/- Total Operating Expenses
Income from Operations
+/+ Interest income

-/- Interest expense & other financial charges
-/+ Others
Other Income (Expenses)
Income before Taxes
-/- Income tax
Net Income
Financial Decision Making

• Working Capital Management
• Capital Budgeting
• Capital Structure (& Dividend Policy)
Session 5
CAPITAL BUDGETING (1)

(Investment Decision
Analysis)
Basic Finance Concept
• Time Value of Money
• Discounted Cash Flow/ DCF
• Weighted Average Cost of Capital/
WACC
Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022
Present and Future Value

Future Value
Amount to which an
investment will grow
after earning interest
Present Value
Value today of a
future cash
flow
Future Values
Future Value of $100 = FV
FV = $100  (1 + r ) t
Future Values
FV = $100  (1 + r ) t
Example - FV
What is the future value of $100 if interest is
compounded annually at a rate of 7% for two years?
FV = $100  (1.07)  (1.07) = 114.49

FV = $100  (1 + .07) 2 = $114.49
Future Values with Compounding
1800
1600 0%
1400 5%
10%
1200
FV of $100
15%
1000
Interest Rates
800
600
400
200
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Number of Years
Present Value
Present Value = PV
PV = discount factor  C1
Present Value
Discount Factor = DF = PV of $1
DF = 1
(1+ r ) t
Discount Factors can be used to compute the present value of any cash flow.
Present Value
• PV formula has many applications. Given any variables in
the equation, you can solve the remaining variable. Also, you
can reverse prior example
PV = DF2  C2
PV = 1
(1+.07 ) 2
114.49 = 100
Present Values with Compounding
120
Interest Rates
100
0%
5%
80
PV of $100
10%
60 15%
40
20
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Number of Years
Valuing an Office Building

Step 1: Forecast cash flows
Cost of building = C0 = 370,000
Sale price in Year 1 = C1 = 420,000
Step 2: Estimate opportunity cost of capital

If equally risky investments in the capital market
offer a return of 5%, then
Cost of capital = r = 5%
Valuing an Office Building
Step 3: Discount future cash flows
C1
PV = (1+r ) = 420 , 000
(1+ .05 ) = 400,000
Step 4: Go ahead if PV of payoff exceeds investment
NPV = 400 ,000 − 370 ,000

= 30 ,000
Discounted Cash Flows/ DCF
For multiple periods, Discounted Cash Flow (DCF)

formula is:
PV0 = C1
(1+ r ) 1 + (1+Cr2 ) 2 + .... + (1+Crt )t
T
NPV0 = C0 +  (1+Crt )t
t =1
DCF – application of NPV
- $370,000
$20,000 $ 420,000
Present Value Year

0 1 2
Year 0
-$370,000
20,000/1.12 = $17,900
420,000/1.122 = $334,800
Total = - $17,300
Short Cuts
• Sometimes there are shortcuts that make it very easy to
calculate present value of asset that generates cash in
multiple periods. These tools allow us to cut through
calculations quickly.
Short Cuts
Perpetuity – a financial concept that refers to cash flow

that is generated (theoretically received) forever
cash flow
Return =
present value
C
r=
PV
Present Values
Example
What is present value of $1 billion every year for eternity if
you estimate discount rate at 10%??
PV = $1 bil
0.10 = $10 billion
Present Values
Example - continued
What if the investment/ project does not start making
money for 3 years?
PV = $1 bil
0.10  ( ) = $7.51 billion
1
1.103
Short Cuts
Annuity - An asset that pays fixed amount every year for a
number of years
Asset Year of Payment Present Value

1 2…..t t+1
Perpetuity (first C
payment in year 1) r
C  1
Perpetuity (first payment  
 r  (1 + r )
t
in year t + 1)
Annuity from year  C   C  1 

  −   
t 
1 to year t  r   r  (1 + r ) 
Present Values
Example
Tiburon Autos offers you “easy payments” of $5,000 per year for 5
years. If interest rate is 7% p.a. what is the cost of the car?
5,000 5,000 5,000 5,000 5,000

Year
Present Value 0 1 2 3 4 5
at year 0
5,000 / 1.07 = 4,673
5,000 / (1.07 ) = 4,367
2
5,000 / (1.07 ) = 4,081

3
5,000 / (1.07 ) = 3,814

4
5,000 / (1.07 ) = 3,565

5
Total NPV = 20,501
Short Cuts
Annuity - An asset that pays fixed amount every year

for a number of years
1 1 
PV of annuity = C   − t
 r r (1 + r ) 
Annuity Short Cut
Example
You agree to lease a car for 4 years at $300 per month.
You are not required to pay any money up front or at the
end of your agreement. If your opportunity cost of capital
is 0.5% per month, what is the cost of the lease?
Annuity Short Cut
Example - continued
You agree to lease a car for 4 years at $300 per
month. You are not required to pay any money up
front or at the end of your agreement. If your
opportunity cost of capital is 0.5% per month,
what is the cost of the lease?
 1 1 
Lease Cost = 300   − 48 
 .005 .005(1 + .005) 
Cost = $12,774.10
Annuity Short Cut
Example
The state lottery advertises a jackpot prize of $295.7
million, paid in 25 installments over 25 years of $11.828
million per year, at the end of each year. If interest rates
are 5.9% what is the true value of the lottery prize?
 1 1 
Lottery Value = 11.828   − 25 
 .059 .059(1 + .059) 
Value = $152,600,000
FV Annuity Short Cut
Future Value of an Annuity – Future value of an asset

that pays fixed amount every year for a number of
years
 (1 + r )t − 1
FV of annuity = C   
 r 
Annuity Short Cut
Example
What is the future value of $20,000 paid annually in the
following 5 years, assuming your investment returns 8%
per year?
 (1 + .08)5 − 1
FV = 20,000   
 .08 
= $117,332
Constant Growth Perpetuity
C1
PV0 =
r−g
g = the annual growth rate of the
cash flow
NOTE: This formula can be used

to value a perpetuity at any point
in time
C t +1
C1 PVt =
PV0 =
r−g r−g
Example
What is the present value of $1 billion paid annually in
perpetuity, assuming rate of return of 10% and constant
growth rate of 4%?
1
PV0 =
.10 − .04
= $16.667 billion
Effective Interest Rates
Effective Annual Interest Rate - Interest rate that is

annualized using compound interest.
Annual Percentage Rate - Interest rate that is

annualized using simple interest.

Example
Given a monthly rate of 1%, what is the Effective Annual
Rate(EAR)? What is the Annual Percentage Rate (APR)?
Example
Given a monthly rate of 1%, what is the Effective Annual
Rate(EAR)? What is the Annual Percentage Rate (APR)?
EAR = (1 + .01)12 - 1 = r
EAR = (1 + .01)12 - 1 = .1268 or 12.68%
APR = .01 x 12 = .12 or 12.00%
Company’s Cost of Capital

• A firm’s value is sum of the value of its various assets
Firm value = PV(AB) = PV(A) + PV(B)
Company’s Cost of Capital
BALANCE SHEET
Current Assets
Current Liabilities
▪ Cash
▪ Short-Term Debt
▪ Receivable
▪ Account Payable
▪ Inventory Cost of Debt
Fixed Assets Long-Term Debt +/+

▪ Tangible fixed assets
▪ Intangible fixed assets Shareholders’ Equity Cost of Equity
Company Cost of Capital
• A company’s cost of capital can be compared to the

CAPM required return
SML
Required
return 3.8
Company Cost of
Capital
0.2
0
Project Beta
0.5
Company Cost of Capital
rassets = COC = rdebt ( VD ) + requity (VE )
V = D+E IMPORTANT
D = Market Value of Debt E, D, and V are all
E = Market Value of Equity market values of
Equity, Debt and Firm
Value
rdebt = YTM on bonds

requity = rf + B(rm − rf )
Weighted Average Cost of Capital
 WACC is the traditional view of capital

structure, risk and return.
WACC = (1 − Tc )rD ( VD ) + rE (VE )
Capital Project Adjustments
1. Adjust the Discount Rate
• Modify the discount rate to reflect capital structure,
bankruptcy risk, and other factors.
2. Adjust the Present Value

• Assume an all equity financed and then make adjustments to
value based on financing.
After Tax WACC
Tax Adjusted Formula
D  E
WACC = rD  (1 − Tc)    +  rE  
V   V
After Tax WACC
Example - Sangria Corporation
The firm has a marginal tax rate of 35%. The cost of

equity is 12.4% and the pretax cost of debt is 6%.
Given the book and market value balance sheets,
what is the tax adjusted WACC?
After Tax WACC
Example - Sangria Corporation - continued
Balance Sheet (Book Value, millions)

Assets 1,000 500 Debt
500 Equity
Total assets 1,000 1,000 Total liabilities
After Tax WACC
Balance Sheet (Market Value, millions)

Assets 1,250 500 Debt
750 Equity
Total assets 1,250 1,250 Total liabilities
After Tax WACC

Debt ratio = (D/V) = 500/1,250 = .4 or 40%
Equity ratio = (E/V) = 750/1,250 = .6 or 60%
D  E
WACC = rD  (1 − Tc)    +  rE  
V   V
After Tax WACC
D  E
WACC = rD  (1 − Tc)    +  rE  
V   V
WACC = .06  (1 − .35)(.40) + .124(.60)

= .090
= 9.0%
After Tax WACC
The company would like to invest in a perpetual

crushing machine with cash flows of $1.731 million per
year pre-tax.
Given an initial investment of $12.5 million, what is the

value of the machine?
After Tax WACC
year pre-tax. Given an initial investment of $12.5
million, what is the value of the machine?
Cash Flows
Pretax cash flow 1.731
Tax @ 35% 0.606
After-tax cash flow $1.125 million
After Tax WACC

year pre-tax. Given an initial investment of $12.5
million, what is the value of the machine?
C1
NPV = C0 +
r−g
1.125
= −12.5 +
.09
=0
After Tax WACC
Example - Sangria Corporation – continued
Perpetual Crusher project
Balance Sheet - Perpetual Crusher (Market Value, millions)

Assets 12.5 5.0 Debt
7.5 Equity
Total assets 12.5 12.5 Total liabilities
After Tax WACC

After tax interest = rD (1 − TC ) D = .06  (1 − .35)  5 = .195
Expected equity income = C − rD (1 − TC ) D = 1.125 − .195 = 0.93
After Tax WACC
expected equity income

Expected equity return = rE =
equity value
0.93
= = .124 or 12.4%
7.5
After Tax WACC

• Preferred stock and other forms of financing must be
included in the formula
D  P  E 
WACC = (1 − Tc)  rD  +   rP  +   rE 
V  V  V 
After Tax WACC
Calculate WACC given preferred stock is $25 mil of total
equity and yields 10%.
Balance Sheet (Market Value, millions)

Assets 125 50 Debt
25 Preferred Equity
50 Common Equity
Total assets 125 125 Total liabilities
 50   25   50 
WACC = (1 − .35)  .08  +   .10  +   .146 
 125   125   125 
= .1104
= 11.04%
Exercises
• If the present value of $600 expected to be received one year from
today is $400, what is the one-year discount rate?
A. 15%
B. 20%
C. 25%
D. 50%
• If the one-year discount factor is 0.90, what is the present value of

$120 to be received one year from today?
A. $100
B. $96
C. $108
D. None of the above
Exercises
• You would like to have enough money saved to receive an $80,000 per
year perpetuity after retirement so that you and your family can lead a
good life. How much would you need to save in your retirement fund to
achieve this goal (assume that the perpetuity payments starts on the day
of retirement. The interest rate is 10%)?
A. $1,500,000 C. $800,000
B. $880,000 D. None of the above
• The market value of Charcoal Corporation's common stock is $20 million,

and the market value of its risk-free debt is $5 million. The beta of the
company's common stock is 1.25, and the market risk premium is 8%. If
the Treasury bill rate is 5%, what is the company's cost of capital?
(Assume no taxes.)
A. 15%
B. 14.6%
C. 13%
Discussions
• The after-tax weighted average cost of capital (WACC) is calculated
using the formula:
A. WACC = (rD) (D/V) + (rE) (E/V) where: V = D + E
B. WACC = (rD) (1 - TC ) (D/V) + (rE) (E/V) where: V = D + E
C. WACC = (rD) (D/E) + (rE) (E/D)
D. none of the above
• What is the present value of the following cash flow at a discount rate of
9%?
Year 1: $ 100,000 Year 2: $ 150,000 Year 3: $ 200,000
A. $372,431.81
B. $450,000
C. $405,950.68
Session 6
CAPITAL BUDGETING (2)

(Investment Decision
Analysis)
Decision Making Tools
• Net Present Value/ NPV
• Internal Rate of Return/ IRR
• Payback Period (& Discounted Payback Period)
• Profitability Index/ PI
• Accounting Rate of Return/ ARR
Capital Budgeting Decision

• Every possible investment/ project shall be evaluated, and
the one that generates optimum net cash flow for company is
the one that shall be selected
• Noting that a company has limited resources – hence should
prioritise and choose → Capital Rationing decision
Net Present Value 
NPV = PV - required investment
C1
NPV = C0 +
1+ r
Risk and Present Value

• Riskier projects require higher rate of return
• Higher required rate of return will lower PVs
PV of C1 = $420,000 at 5%
420,000
PV = = 400,000
1 + .05
Risk and Present Value
PV of C1 = $420,000 at 12%
420,000
PV = = 375,000
1 + .12
PV of C1 = $420,000 at 5%
420,000
PV = = 400,000
1 + .05
Risk and Net Present Value
NPV = PV - required investment
NPV = 375,000 - 370,000

= $5,000
Net Present Value Rule
• Accept investment/ project that generates positive NPV
Example
Use the original example. Should we accept the
project given a 10% expected return?
420,000
NPV = -370,000 + = $30,000
1.05
Payback Period 
• The payback period of a project is the number of years
required before the cumulative forecasted cash inflow
equals the initial outlay.
• The payback rule is to only accept project(s) that (a) has the
shortest payback period, and (b) payback period/ ‘break-
even’ time is in the desired time frame
• The main weakness of this method is primarily because it

ignores ‘Time Value of Money’ – and hence present value of
future cash flows.
Payback Period
Example
Examine three projects below – threshold: project will
payback period of 2 years or less
Payback
Project C0 C1 C2 C3 NPV@ 10%
Period
A - 2000 500 500 5000
B - 2000 500 1800 0
C - 2000 1800 500 0
Payback Period
Answer
One will make mistake if these are evaluated using threshold
of payback period of 2 years or less
Payback
Project C0 C1 C2 C3 NPV@ 10%
Period
A - 2000 500 500 5000 3 + 2,624
B - 2000 500 1800 0 2 - 58
C - 2000 1800 500 0 2 + 50
Internal Rate of Return 
Example
You can purchase a turbo powered machine tool gadget for
$4,000. The investment will generate $2,000 and $4,000 in
cash flows for two years, respectively. What is the IRR of
this investment?
Internal Rate of Return

Example
You can purchase a turbo powered machine tool gadget for
$4,000. The investment will generate $2,000 and $4,000 in
cash flows for two years, respectively. What is the IRR on
this investment?
2,000 4,000
NPV = −4,000 + + =0
(1 + IRR )1 (1 + IRR ) 2
IRR = 28.08%
2500
2000
1500
IRR=28%
1000
NPV (,000s)
500
0
-500 10 20 30 40 50 60 70 80 90 10
0
-1000
-1500
-2000
Discount rate (%)
Internal Rate of Return Rule

• Accept investment/ project that generate rate of return larger
than than its cost of capital (or opportunity cost)
Example
In the project listed below, the foregone
investment opportunity cost is 12%. Should we
do the project?
profit 420,000 − 370,000
Return = = = .135 or 13.5%
investment 370,000
Pitfall 1 - Lending or Borrowing?
• With certain cash flows (as noted below), NPV of a project
decreases as discount rate increases
• This is contrary to normal relationship between NPV and

discount rate
Project C0 C1 IRR NPV @ 10%

A − 1,000 + 1,500 + 50% + 364
B + 1,000 − 1,500 + 50% − 364

Pitfall 2 - Multiple Rate of Return
• Certain cash flows profile can generate two different discount
rates/ IRR.
• The following cash flow generates NPV=$A 253 million at

both IRR% of +3.50% and +19.54%.
Cash Flows (millions of Australian dollars)

C0 C1...... ......C9 C10
−3 1 1 − 6.5
• Certain cash flows can generate NPV=0 at two different
discount rates.
• The following cash flow generates NPV=$A 253 million at
both IRR% of +3.50% and +19.54%.

• It is possible to have a zero IRR and a positive NPV
Project C0 C1 C2 IRR NPV @ 10%

C + 1,000 + 3,000 + 2,500 None + 339
Pitfall 3 - Mutually Exclusive Projects
• IRR sometimes ignores magnitude of the project.
• The following two projects illustrate that problem.
Project C0 C1 IRR NPV @10%

D − 10,000 + 20,000 100% + 8,182
E − 20,000 + 35,000 + 75% + 11,818

• Pitfall 3 - Mutually Exclusive Projects
Pitfall 4 – What Happens When There is More than One
Opportunity Cost of Capital
• Term Structure Assumption
• We assume that discount rates are stable during the term of
the project.
• This assumption implies that all funds are reinvested at IRR.
• This is a false assumption.
Profitability Index 
• When resources are limited, profitability index (PI) provides a
tool for selecting among various project combinations and
alternatives
• A set of limited resources and projects can yield various
combinations.
• The highest weighted average PI can suggest which projects
to be selected.
Profitability Index
Cash Flows ($ millions)
@10%
Project C0 C1 C2 PV of cash inflows
A -10 +30 +5 32
B -5 +5 +20 21
C -5 +5 +15 17
D 0 -40 +60 13
Profitability Index
Cash Flows ($ millions)
Project Investment PV of CF PI
A 10 32 3.2
B 5 21 4.2
C 5 17 3.4
D 36 50 1.4
Profitability Index
Another Example
We only have $300,000 to invest. Which one do we
select?
Project PV of CF Investment PI
A 230,000 200,000 1.15

B 141,250 125,000 1.13
C 194,250 175,000 1.11
D 162,000 150,000 1.08
Select projects with the highest Weighted Avg PI
WAPI (BD) = 1.13(125) + 1.08(150) + 0.0 (25)

(300) (300) (300)
= 1.01
Profitability Index
Project PV of CF Investment PI
A 230,000 200,000 1.15

B 141,250 125,000 1.13
C 194,250 175,000 1.11
D 162,000 150,000 1.08
Select projects with the highest Weighted Avg PI

WAPI (BD) = 1.01
WAPI (A) = 0.77
WAPI (BC) = 1.12
Accounting Rate of Return 
• ARR is rate of return expected from investment/ project, by
comparing average annual profit to investment of the project
ARR = Average Annual Profit/ Investment
• Managers rarely use this measurement for decision making

as this reflects accounting calculation – does not take into
account cash flows
Capital Rationing
Capital Rationing - Limit set on the amount of funds available
for investment.
Soft Rationing - Limits on available funds imposed by
management.
Hard Rationing - Limits on available funds imposed by the
unavailability of funds in the capital market.
Exercises
• A company is investing in a giant crane. It is expected to cost 6.5 million in initial
investment, and it is expected to generate an end of year cash flow of 3.0 million
each year for three years. Calculate the IRR approximately.
A. 14.6 % C. 18.2%
B. 16.4 % D. 22.1%
• A company is investing in a giant crane. It is expected to cost 6.0 million in initial

investment, and it is expected to generate an end of year cash flow of 3.0 million
each year for three years. Calculate the NPV at 12% (approximately).
A. 2.4 million C. 0.80 million
B. 1.2. million D. 0.20 million
Exercises
• What would be the weighted average profitability index of the following two
investments, given the firm only has $250 to invest?
Project A: Cost = $120, NPV = 80
Project B: Cost = $100, NPV = 75
A. .62 C. .75
B. .67 D. .79
• Which of the following investment rules does not use the time value of the money
concept?
A. Net present value
B. Internal rate of return
C. The payback period
D. All of the above use the time value concept
Discussions
• What are some of the disadvantages of using the IRR method?
• A project will have only one internal rate of return if:
A. The net present value is positive
B. The net present value is negative
C. The cash flows decline over the life of the project
D. There is a one sign change in the cash flows

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Financial Management

MINI MBA Program

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 3

Fixed Assets Long-Term Debt

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 4

-/- Cost of Revenues

-/- Selling expenses

Income from Operations

+/+ Interest income

Income before Taxes

-/- Income tax

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 5

Financial Decision Making

• Capital Structure (& Dividend Policy)

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 6

CAPITAL BUDGETING (1)

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022

Present and Future Value

Future Value of $100 = FV

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 9

FV = $100  (1.07)  (1.07) = 114.49

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 10

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 12

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 13

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 14

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 15

Valuing an Office Building

Step 2: Estimate opportunity cost of capital

Mini MBA – BINUS BUSINESS SCHOOL Executive Education 2022 16

Step 3: Discount future cash flows

NPV = 400 ,000 − 370 ,000

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Discounted Cash Flows/ DCF

For multiple periods, Discounted Cash Flow (DCF)

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Present Value Year

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Perpetuity – a financial concept that refers to cash flow

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Asset Year of Payment Present Value

Annuity from year  C   C  1 

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5,000 5,000 5,000 5,000 5,000

5,000 / (1.07 ) = 4,081

5,000 / (1.07 ) = 3,814

5,000 / (1.07 ) = 3,565

Total NPV = 20,501

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Annuity - An asset that pays fixed amount every year

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Annuity Short Cut

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FV Annuity Short Cut

Future Value of an Annuity – Future value of an asset

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Constant Growth Perpetuity