Course:

Introduction to Finance

Course
Code:

FIN 201

Type of Course:

Lecture with Exercises &

Presentations

Status:

Compulsory

Teaching
Periods:

ECTS:

Semester:

Prerequisites
:

ECO 102

Course Description
This is an introductory course to finance and investments. It provides an intuitive but
rigorous understanding of the theory and practice of financial markets, illustrating the
concepts through examples and cases drawn from the public, private, and non-profit
sectors. Topics covered include: present value analysis and discounting,
diversification, the tradeoff between risk and return, market efficiency, pricing of
stocks and bonds, the capital asset pricing model, term structure of interest rates, the
principle of arbitrage, pricing of derivative securities (forwards, futures, and options),
the use of derivatives for hedging, risk management, and the regulation of financial
markets.
Textbook and Other Required Materials
Main Course texts
Principles of finance. Besley, S. Brigham, E. Thomson Learning, 2003
Finance; Brumfitt, K. Nelson Thornes., 2001
Supplementary Text
Extensive Class handouts
Regular reading of financial news in publications such as The Wall Street Journal,
The Financial Time & The New York Times is recommended.
Course Objectives
To introduce students to principles and practices of finance and investments.
Learning Outcomes
Upon successful completion of this course, the student should be able to:
Analyze economic theory including introductory basic principles of economics,
National Income Accounting, aggregate demand and supply, price fluctuations,
employment, federal government fiscal and monetary policy, and international
trade
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 Demonstrate knowledge of role of money in society and relate it to banking

system
Compare and contrast current macroeconomic issues for significance on the
overall U.S. economy, and its impact on the student's life, present and future
Understand historical evolution of the concepts of economics from the classical
school through the post- Keynesian era;
Methods of Instruction
Teaching is made by means of lectures and class discussions. Students will hand-in
home exercises which will be discussed in class. Student participation is part of the
course.
Attendance Policies
Attendance in all lectures is required.
Methods of Evaluation
Readings and Assignments: Students will be expected to have completed the assigned
readings before class and review them after class. Weekly problem sets will be
assigned throughout the course to illustrate and reinforce the concepts presented in
class as well as in preparation of the case discussions to follow.
Examinations
There will be in-class, closed book and closed notes midterm and final exams.
Final Grade
The final Grade is calculated on the following scores:
Class Participation
10%
Written assignments
20%
Midterm Exam
30%
Final Exam
40%

Course Outline
A. Introduction to Financial Management

An Overview of Financial Management

Financial Statements, Cash Flow, and Taxes
Analysis of Financial Statements
Financial Planning and Forecasting
The Financial Environment: Markets, Institutions, and Interest Rates

B. Fundamental Concepts in Financial Management

Risk and Rates of Return
Time Value of Money
C. Financial Analysis
Bonds and Their Valuation
Stocks and Their Valuation
D. Investing in Long-Term Assets: Capital Budgeting

The Cost of Capital

The Basics of Capital Budgeting
Cash Flow Estimation and Risk Analysis
Other Topics in Capital Budgeting

E. Capital Structure and Dividend Policy

Capital Structure and Leverage
Distribution to Shareholders: Dividends and Share Repurchases
F. Working Capital Management
Managing Current Assets
Financing Current Assets

CHAPTER 1 Introduction to Finance

What is Finance?
Finance is the study of how individuals, institutions, governments, and business acquire,
spend, and manage money and other financial assets.

Basic definitions
Financial institutions: The organizations or intermediaries that help the financial system
operate efficiently and transfer funds from savers and investors to individuals, businesses, and
governments that seek to spend or invest the funds in physical assets (inventories, buildings,
and equipment).
Examples: Banks, insurance companies, investment companies.
Financial markets: The physical locations or electronic forums that facilitate the flow of
funds among investors, businesses, and governments.
Investments area: This involves the sale or marketing of securities, the analysis of securities,
and the management of investment risk through portfolio diversification.
Financial management: This involves the financial planning, the asset management, and the
fund-raising decisions to enhance the value of business.
Financial management in business involves making decisions relating to the efficient use of
financial resources in the production and sale of goods and services. The goal of the financial
manager in a profit-seeking organization is to maximize the owners wealth. This is
accomplished through effective financial planning and analysis, asset management, and the
acquisition of financial capital.

Six principles of finance

Finance is founded on six important principles. The first five relate to the economic behavior
of the individuals, and the sixth focuses on ethical behavior.

Money as a time value

Higher returns are expected for taking on more risk
Diversification of investment can reduce risk
Financial markets are efficient in pricing securities
Manager and stockholder objectives may differ
Reputational (ethical) matters

Time value of money: A specific amount of money today, values/worth more than the same
amount of money in a point later in the future.

Risk Vs Returns: A trade-off exists between risk and expected returns in all types of
investments. Risk is the uncertainty about the outcome or payoff of an investment in the
future. Rational investors choose an investment only if they feel that the expected is high
enough to justify the associated risk.
Diversification of risk: While higher returns are expected for taking on more risk, all
investment risk is not the same. In fact, some risk can be removed or diversified by investing
in several different assets or securities.
Financial markets are efficient: A financial market is said to be information efficient if at
any point the prices of securities reflect all information available to the public. When new
information becomes available, prices quickly change to reflect that information. This
informational efficiency of financial markets exists because a large number of professionals
are continually searching for mispriced securities.
Management Vs Owner objectives: Owners or equity investors want to maximize the
returns on their investments but often hire professional managers to run their firms. However,
managers may seek to meet other objectives (also known as the principal-agent problem). To
bring manager objectives in line with owner objectives, it is often necessary to tie manager
compensation to measures of performance beneficial to owners.
Reputation matters: This has to do with ethical behavior. Ethical behavior is how an
individual or organization treats others legally, fairly, and honestly. Of course, the ethical
behavior of organizations reflects the ethical behaviors of their representatives (directors,
officers, managers). For institutions, or businesses to be successful, they must have the trust
and confidence of their various constituencies, including customers, employees, and owners,
as well as the community and society within which they operate. All would agree that firms
have an ethical responsibility to provide safe products and services, to have safe working
conditions for employees, and not to pollute or destroy the environment. Laws and
regulations exist to ensure minimum levels of protection and the difference between unethical
and ethical behavior.

TEST YOUR UNDERSTANDING

Question 1
Which of the followings are financial institutions?
A. A bank
B.

An insurance company

C.

Both (a) and (b)

D. Neither (a) nor (b)

Question 2
Finance is founded on six important principles. Write and explain four of them.

Question 3
A company belongs to its managers.
A. TRUE
B.

FALSE

Question 4
Finance is the study of how individuals, institutions, governments, and business acquire,
spend, and manage money and other financial assets.
A. TRUE
B.

FALSE

CHAPTER 2 Financial Analysis

All financial decisions must be carefully planned and executed. You are in position to choose
the best course of action, only if you have the required information and you are able to read
correctly this information.
Therefore, you have to be able to perform an adequate financial analysis.

What is Financial Analysis?

Financial analysis is the process of turning financial data into meaningful information. Is the
ability to understand, compare, evaluate and come up with useful information.
Based on this information, the financial manager will assess different financial opportunities
and will decide which one is the most appropriate.

Where do you find financial data?

Financial data can be collected from many different sources, accordingly to what you are
searching for the specific decision. For example, data for an organization are found in its
financial statements and its management accounts, data for stock prices are found in the stock
exchange, data for interest rates are found in banks and financial papers, etc.

Financial statements
An organizations financial statements comprise from the following:

Profit & Loss Account (or Statement of Comprehensive Income per IFRSs)
Balance Sheet (or Statement of Financial Position per IFRSs)
Cash-flow statement
Statement of changes in equity
Notes

Note that an organizations financial statements provide historical data, usually for a period of
twelve months.

What is a financial statement analysis and how it can help?

The real usefulness of the financial statements comes from the help they provide in predicting
the firms future earnings and dividends along with the risks associated with these variables.
Financial statement analysis can affect non-finance operations of a firm. For example, an
analysis that indicates excessive levels of inventories could lead to a change in the firms
pricing and marketing strategies, and it could affect the firms production plan, even leading
to worker layoffs.

A firms management reviews its financial statements to determine if progress is being made
toward companys goals. Internal documents based on this analysis inform division managers
of the status of their divisions and product lines and how these results compare to the years
plan.
Many individuals and organizations analyze firms financial statements. A firm that seeks
credit, either from a supplier firm or from a bank, typically must submit financial statements
for examination. Potential investors will examine financial statements as they are an
excellent source of firm information.
Therefore, the users of financial information are all those who hold an interest in the firm.
These are categorized into internal and external stakeholders:
Internal stakeholders: Employees & Managers of the firm
External stakeholders: Shareholders, Potential investors, Financiers, Governmental
authorities, Suppliers, Customers & Society
Financial data are analyzed and compared through the use of Ratios.

Categories of financial ratios

Financial ratios are grouped in four main categories. These are:
1.

Profitability ratios

2.

Liquidity ratios

3.

Gearing ratios

4.

Investors ratios

Profitability ratios
Return on capital employed (ROCE) (result is presented on percentages - %)
ROCE = (PBIT / LT Debt +Equity) x 100
Shows: How profitable the company is compared to the capital employed

Net profit margin (NP Margin) (result is presented on percentages - %)

NP Margin = (PBIT / Revenue) x 100
Shows: The %age of revenue that is net profit for the company

Net asset turnover (NAT) (result is presented in times)

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NAT = Revenue / (Total Assets Current Liabilities )

Shows: How many times a companys revenue covers its net assets

Gross profit margin (GP Margin) (result is presented on percentages - %)

GP = GP / Revenue
Shows: The %age of GP over the companys revenues

Liquidity ratios
Working capital (or current) ratio (result is presented in times)
WC Ratio = Current assets / Current liabilities
Shows: How many times current assets cover current liabilities
Should be above 1 preferable between 1,5 and 2

Quick (Acid test) ratio (result is presented in times)

Quick ratio = (Current assets Stock) / Current liabilities
Shows: How many times current assets, excluding stocks, cover current liabilities
Should be close to 1

Debtors collection period (result is presented in days/ weeks/ months)

Debtors Period = (Trade debtors / Credit sales) x 365 or 52 or 12
Shows: In how many days/ weeks/ months the debtors pay the company

Creditors payment period (result is presented in days/ weeks/ months)

Creditors Period = (Trade creditors / Credit purchases) x 365 or 52 or 12
Shows: In how many days/ weeks/ months the company pays its creditors

Gearing ratios

 Debt to Equity ratio (result is presented in percentage -%)

Gearing = (LT Liabilities / Equity) x 100
OR
Gearing = [LT Debt / (LT Debt + Equity)] x 100
Shows: How much of the companys capital is financed by debt
The higher the gearing ratio, the riskier the company!

Investors ratios
Interest cover ratio (ICR) (result is presented in times)
IC Ratio = (PBIT / Interest expense)
Shows: The ability of the company to pay its interest expense out of its profits
Ideally the ratio should be above 2

Earnings per share ratio (EPS ratio) (result is presented in absolute numbers)
EPS Ratio = (Distributable Earnings / Number of issued shares)
Shows: How many earnings are allocated to each share

Price earnings ratio (PE ratio) (result is presented in times)

PE Ratio = (Share price / EPS)
Shows: How many times the price of the companys share is higher than EPS
Dividend cover ratio (result is presented in times)
Dividend Cover Ratio = (EPS / Dividend per share)
Shows: The number of times a company could have paid its current dividend

Dividend yield ratio (result is presented in percentage - %)

Dividend Yield Ratio = (Dividend per share / Share price) x 100
Shows: The return to the shareholder on the capital invested

Example 1

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Below you can see the summarised financial statements for the year ended 31 March 2008 for
Sunny Beach Hotel Ltd.
Income Statement
2008

2007

(000)

(000)

4,000

5,050

Cost of sales

(3,450)

(4,100)

Gross profit

550

950

(370)

(420)

180

530

40

Finance charges

(20)

(215)

Profit before tax

200

315

Income tax expense

(50)

(80)

Profit for the period

150

235

2008

2007

(000)

(000)

550

580

Revenue

Operating expenses

Profit on disposal of land

Statement of Financial Position

Non-current assets
Property, plant and equipment

Current assets
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Inventory

250

180

Trade receivables

360

375

1,160

1,135

Equity shares of 25 cents each

100

100

Retained earnings

380

145

480

245

200

180

Bank overdraft

10

15

Trade payables

430

630

40

65

1,160

1,135

Total assets

Equity and Liabilities

Non-current liabilities
Loan payable

Current liabilities

Current tax payable

Total equity and liabilities
Requirement:

Calculate all possible financial ratios for both years (2007 & 2008). Explain the meaning of
each ratio calculated and interpret your results.

Show all the relevant calculations supporting your answers.

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TEST YOUR UNDERSTANDING

Question 1
Which of the followings ratios are the liquidity ratios?
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A. Return on Capital Employed (ROCE)

B.

Net Profit Margin

C.

Both (a) and (b)

D. Neither (a) nor (b)

Question 2
Write what the Debtors Collection Period Ratio and the Earnings per Share Ratio show?

Question 3
Financial statements provide a good source of financial data.
A. TRUE
B.

FALSE

Question 4
The financial manager of a company will base his/her financial decisions on a number of data.
A. TRUE
B.

FALSE

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CHAPTER 3 Long-term Financial Planning

Financial ratios and financial statement relationships can be used to analyze firms and their
competitors, as we have seen. But they have a second important practical use; managers can
use them to assist in the firms financial planning process.
To plan, it is necessary to look forward. Long-range plans covering several years must be
prepared to project growth in sales, assets, and employees.
First, a sales forecast needs to be made that includes expected developments in the economy
and reflects possible competitive pressures from other businesses. The sales forecast then
must be supported by plans for an adequate investment in assets. For example, a
manufacturing firm may need to invest in plant and equipment to produce an inventory that
will fill forecasted sales orders.
After determining the size of the necessary investment, plans must be made for estimating
the amount of financing needed and how to acquire it. Financing sources can be generated
internally or externally.

Methods of evaluating asset investments

A. Payback Period
This method is used in order to calculate how much time will be required to receive back
(through the returns of an investment) the original amount spent.
Example 1
ABC Ltd wants to undertake Project A, for which it will have to invest 20.000.
The returns from this investment are expected to be as following:

Year 1:
Year 2:
Year 3:
Year 4:
Year 5:

2.000
3.000
5.000
10.000
25.000

Calculate the Payback Period for Project A

Example 2

16

Instead of Project A, ABC Ltd can undertake Project B at the cost of 20.000.
The returns from this investment are expected to be as following:

Year 1:
Year 2:
Year 3:
Year 4:

10.000
10.000
10.000
10.000

Calculate the Payback Period for Project B & Advice ABC Ltd on which of the two
projects to invest

A. Net Present Value (NPV)

This method is used in order to translate future inflows/outflows into todays values
and calculate the profit/loss of an investment. In order to achieve this, all future cashflows need to be discounted back to present values using the appropriate discounting
rate.
The formula for discounting future values is the following:

n:
i:
FV:

Is the time (in years) of the future cash flow

Is the discount rate to be used (i.e. the rate of return that could be earned on an
investment in the financial markets with similar risk, or the opportunity cost of
capital)
Is the net cash flow (the amount of cash, inflow minus outflow) at time n.

Example 3
ABC Ltd wants to undertake Project A, for which it will have to invest 20.000. The
discounting rate is 12% per annum.
The returns from this investment are expected to be as following:

Year 1:
Year 2:
Year 3:
Year 4:
Year 5:

2.000
3.000
5.000
10.000
25.000

Calculate the Net Present Value for Project A

17

Example 4
Instead of Project A, ABC Ltd can undertake Project B at the cost of 20.000. The
discounting rate is 12% per annum.
The returns from this investment are expected to be as following:

Year 1:
Year 2:
Year 3:
Year 4:

10.000
10.000
10.000
10.000

Calculate the Net Present Value for Project B& Advice ABC Ltd on which of the two
projects to invest

Note: When future cash flows are the same for all years (as in example 4), discounting can
be done using the following formula

n:
i:
A:

Is the time (in years) of the future cash flow

Is the discount rate to be used (i.e. the rate of return that could be earned on an
investment in the financial markets with similar risk, or the opportunity cost of
capital)
Is the annual net cash flow (the amount of cash, inflow minus outflow)

A. Discounted Payback Period

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As simple Payback Period A above this method is used in order to calculate how
much time will be required to receive back (through the returns of an investment) the
original amount spent.
The only difference is that now we calculate the Payback Period based on the discounted
future cash flows.
Example 5
Using data from examples 3 & 4, calculate the Discounted Payback Period of Project A
and Project B & Advice ABC Ltd which one to choose.

B.

Internal Rate of Return (IRR)

This method gives us the discounting rate at which the present values of a projects total
cash outflows equal its total cash inflows.
Therefore, if cost of investment is lower than the investments IRR, the company will be
benefited (i.e. have a profit out of the specific project). On the other hand, if cost of
investment is equal or higher than its IRR the company will have no gain from that
project (i.e. will either break-even or make a loss).
Calculation of IRR is not part of your syllabus.

Funding sources
As already mentioned a company can raise finance for its future needs from:
Internal sources
External sources

Internally generated financing

Internally generated funds come from the companys profits.
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Example 6
ABC Ltd estimates that in the forthcoming year it will need 100.000 for asset investment.
The average Profit Margin of the last three years was 8% and sales are expected to be
increased by 15%, to 1.150.000. Profit margin is expected to hold.
Examining the dividend records of ABC Ltd, we learn that the firm pays about 20% of
earnings to shareholders as dividends.
Requirement:
Can ABC Ltd finance its asset investment through internally generated funds, and to what
extent?

Externally generated financing

Externally generated funds come from outside the company. Funds might be raised from
issuing more shares, from issuing long-term debentures or from receiving loans.
Which one should a company choose?
This depends on the cost of financing and the companys behavior towards risk.

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