Instructor: Mr.

Jumanne Basesa
 Corporate Finance Mind Map
MARKETS

NPV
PORTFOLIO THEORY

COST OF CAPITAL

AGENCY THEORY
INVESTMENTS

CAPITAL
DIVIDEND POLICY STRUCTURE

SHAREHOLDER
VALUE
08/04/24 18:48 3
 Meaning and Scope of Financial
Management
Corporate finance is mainly concerned with
procurement and allocation of funds to various
areas within the firm.
Corporate finance sometimes is referred to as
managerial finance or financial management.
Generally, Financial management can be defined
as the management of the finances of a business
or organisation in order to achieve financial
objectives.
08/04/24 18:48 4
 The role of the Financial Manager

Usually the financial manager is involved in

many financial decisions but the key aspects of
financial decision-making relate to:
 Investment,
 Financing and

 Dividend decisions.

a) The Investment Decision:

 Invest in assets and projects that yield a return
greater than the minimum acceptable hurdle rate.
08/04/24 18:48 5
 The Investment Decision(Cont…..)

The hurdle rate should be higher for riskier

projects and should reflect the financing mix
used - owners’ funds (equity) or borrowed money
(debt).
With regard to this type of decision, the financial

manager needs to identify the profitable

investment opportunities.

08/04/24 18:48 6
 b) The Financing Decision:
Choose a financing mix (debt and equity) that
maximizes the value of the investments made
and match the financing to nature of the assets
being financed.
financial manager is faced with challenges of

determining how the investments of the firm will

be financed.

08/04/24 18:48 7
 c) The Dividend Decision:
Ifthere are no profitable investments, return the
cash to the owners of the business. In the case of
a publicly traded firm, the form of the return -
dividends or stock buybacks - will depend upon
what stockholders prefer.
The financial manager needs to take into

considerations the following questions in order

to formulate the dividend pay out decisions.

08/04/24 18:48 8
 c) The Dividend Decision(Cont…)
Should the firm distribute high dividends and
finance the business growth through new issues
of equities or debt?
Should the firm distribute low dividends and use

the retained earnings to finance the business

expansions? or
Should the firm pay zero dividends and use the

whole earnings for profitable investment

opportunities?

08/04/24 18:48 9
 Forms of Business Organization
Three forms namely:
 soleproprietorship,
 partnership and

 a company.

Find details on the first two forms

08/04/24 18:48 10
 Corporation
A corporation (company) is a legal entity
which, while being composed of natural
persons, exists completely separately from
them. This separation gives the corporation
unique powers which other legal entities lack.

08/04/24 18:48 11
 Corporation...
A corporation or company is collectively owned
by the shareholders, but managed by directors.
A company must pay taxes on its profits.
A company may be categorised as a Public limited
company (plc) or a Private limited company (Ltd).

08/04/24 18:48 12
 Difference Between PLC vs. Ltd
PLC means Public Limited Company and Ltd
means a Private Limited Company.
PLC can quote the shares in a stock exchange
whereas the Ltd Company cannot.
The shares in a PLC can be bought and sold
through the stock exchange and there is no need to
consult the owners for selling and buying shares.
On the other hand, the shares of Ltd Company are
normally sold to close friends and others and that
can only be done if all the shareholders agree.
08/04/24 18:48 13
 Difference Between PLC vs. Ltd...
While an Ltd company thinks more of profit from
the business, the Public Limited Company cares
less of profit as it is concerned with services and
goods for the public.
If something goes wrong with a Public Limited
Company, it has very adverse impact on the
public.

08/04/24 18:48 14
 The Objectives of The Firm
Different organisations have different
objectives to accomplish depending upon the
nature and situation of the business. The
following can be considered as the objectives
of the firm;
Maximization of shareholders wealth
Maximization of profits

Maximization of sales

Minimizing costs

08/04/24 18:48 15
 Objectives (cont…..)
Survival of the firm
Creating an ever expanding empire
Maximization of managerial salaries
Maximization of personal objectives
Achieving the target market share, etc

08/04/24 18:48 16
 Objectives (Cont…..)
In practice, it is quite impossible for
companies to have all these objectives in place
at once.
In order to attain the goal congruence, the
most widely accepted objective of the firm is
the maximization of shareholders wealth
which is practically achieved by increasing the
market value of share.

08/04/24 18:48 17
 The Agency Problem
This constitutes:
 Agency problem
 Agency theory

 Agency costs

Agency problems arise when there is a conflict

between the interests of the agent (e.g. the managers)
and those of the principal (e.g. shareholders).
Agency costs are the costs associated with the agency
problem and arise mainly due to the conflict of
interest between the managers and the shareholders.
08/04/24 18:48 18
 Agency Theory
An agency relationship exists when one or more
persons, called principals (shareholders),
 hires one or more persons, called agents (directors),
to perform some service,
And delegates decision-making authority to them.

08/04/24 18:48 19
 Ways to reduce agency conflict:
Mitigate agency problems through:
Threat of firing or Sackings
Threat of takeover and selling shares

Granting share options to directors and senior

managers
Maintaining good relationship

Profit related pay

Direct intervention by shareholders.

08/04/24 18:48 20
08/04/24 18:48 21
 Time Value of Money
Basic Problem:
How to determine value today of cash flows
that are expected in the future?
Time value of money refers to the fact that a
dollar in hand today is worth more than a dollar
promised at some time in the future
Which would you rather have [TZS1,000,000
today or TZS1,000,000 in 5 years]?
Obviously, TZS1,000,000 today; why?
08/04/24 18:48 22
 Time Value of Money…
A dollar received today is worth more than a dollar
received tomorrow:
This is because a dollar received today can be invested to
earn interest
Another reason behind this concept is that, future cash
flows are not only subject to risk but also inflation.
Money received sooner rather than later allows one
to use the funds for investment or consumption
purposes. This concept is referred to as the Time
value of money!!
TIME allows one the opportunity to postpone
consumption and earn Interest.
08/04/24 18:48 23
 Simple and Compound Interests
 Simple Interest
Is interest paid or earned only on the principal.
The Principal is the original amount of money
you deposit or borrow. Refer to QM 711 notes.
 Compound Interest
Is interest earned not only on the principal, but
also on the interest that has already been
earned, i.e. earning interest on interest.
08/04/24 18:48 24
 Types of TVM Calculations
There are many types of TVM calculations
The basic types that will be covered in this class
include:
Present value of a lump sum
Future value of a lump sum
Present and future value of cash flow streams
Present and future value of annuities
Keep in mind that these forms can, should, and
will be used in combination to solve more
complex TVM problems.
08/04/24 18:48 25
 Compounding and Future value
Compounding is the way to determine the future
value of a sum of money invested now:
For example in a bank account, where interest is left in
the account after it has been paid.
Interest is earned on re-invested interest in the
future.
Future value is calculatedt using the formula:
FVt  P0 (1  r ) or FVt  P0  FVIFr ,t

Where: (1+r)n is called the compounding factor

08/04/24 18:48 26
 Future Value of a Lump Sum
Future value determines the amount that a
sum of money invested today will grow to
in a given period of time
The process of finding a future value is
called “compounding” (hint: it gets larger)
Example
How much money will you have in 5 years
if you invest $100 today at a 10% rate of
return?
08/04/24 18:48 27
 Future Value of a Lump Sum
Example
Formula: FVt = P0 × (1+r)t
FV5 = $100 × (1+0.1)5
FV5 = $161.051
1. Kathy wants to know how large her deposit of $10,000 today will
become at a compound annual interest rate of 10% for 5 years.
years
2. If you invest $1,000 today at an interest rate of 10 percent, how
much will it grow to be after 5 years?
3. If you invest $11,000 in a mutual fund today, and it grows to be
$50,000 after 8 years, what compounded, annualized rate of
return did you earn?
08/04/24 18:48 28
 Present Value of a Lump Sum
Present value calculations determine what the
value of a cash flow received in the future would
be worth today (time 0)
The process of finding a present value is called
“discounting” (hint: it gets smaller)
The interest rate used to discount cash flows is
generally called the discount rate
FVt
PV  PV  FVt  PVIFr ,t
(1  r ) t

08/04/24 18:48 29
 Present Value of a Lump Sum
Example
How much would $100 received five years from
now be worth today if the current interest rate is
10%?
PV = FVt / (1+r)t
PV = 100 / (1 + .1)5
PV = $62.09

08/04/24 18:48 30
 Present Value of a Lump Sum
More Examples
1. Assume that you need to have exactly $4,000
saved 10 years from now. How much must
you deposit today in an account that pays 6%
interest, compounded annually, so that you
reach your goal of $4,000?
2. Joann needs to know how large of a deposit
to make today so that the money will grow to
$2,500 in 5 years. Assume today’s deposit will
grow at a compound rate of 4% annually

08/04/24 18:48 31
 Present Value of a Cash Flow Stream
A cash flow stream is a finite set of payments that an
investor will receive or invest over time.
The PV of the cash flow stream is equal to the sum of
the present value of each of the individual cash flows
in the stream.
The PV of a cash flow stream can also be found by
taking the FV of the cash flow stream and discounting
the lump sum at the appropriate discount rate for the
appropriate number of periods.

08/04/24 18:48 32
 Example of PV of a Cash Flow Stream
Joe made an investment that will pay $100 the
first year, $300 the second year, $500 the third
year and $1000 the fourth year. If the interest rate
is ten percent, what is the present value of this
cash flow stream?
You can use a timeline:

08/04/24 18:48 33
 PV of a Cash Flow Stream
Example …
Draw a timeline:
100 300 500 1000

0 1 2 3 4
?
?
r = 10%
?
?
PV = $90.91 + $247.93 + $375.66 + $683.01
PV = $1397.51
PV= [FV1/(1+r)1]+[FV2/(1+r)2]+[FV3/(1+r)3]+[FV4/(1+r)4]
08/04/24 18:48 34
 Future Value of a Cash Flow Stream
The future value of a cash flow stream is equal to
the sum of the future values of the individual cash
flows.
With unequal periodic cash flows, treat each of
the cash flows as a lump sum and calculate its
future value over the relevant number of periods.
Sum up the individual future values to get the
future value of the multiple payment streams.

08/04/24 18:48 35
 FV of a Cash Flow Stream
Time Line

08/04/24 18:48 36
 FV of a Cash Flow Stream
Example: Future Value of an Uneven Cash Flow
Stream
Jim deposits $3,000 today into an account that pays
10% per year, and follows it up with 3 more deposits at
the end of each of the next three years. Each
subsequent deposit is $2,000 higher than the previous
one. How much money will Jim have accumulated in
his account by the end of three years?

08/04/24 18:48 37
 FV of a Cash Flow Stream
Example…
FV of Cash Flow at T0 = $3,000 x (1.10)3 = $3,000 x 1.331= $3,993.00
FV of Cash Flow at T1 = $5,000 x (1.10)2 = $5,000 x 1.210 = $6,050.00
FV of Cash Flow at T2 = $7,000 x (1.10)1 = $7,000 x 1.100 = $7,700.00
FV of Cash Flow at T3 = $9,000 x (1.10)0 = $9,000 x 1.000 = $9,000.00
Total = $26,743.00
Note:
Be aware that some CFs occur at the beginning of
each period while others occur at the end of each
period.

08/04/24 18:48 38
 FV of a Cash Flow Stream
Exercise
Joe made an investment that will pay $100 the
first year, $300 the second year, $500 the third
year and $1000 the fourth year. If the interest rate
is ten percent, what is the future value of this cash
flow stream if each cash flow occur
i. At the beginning of each period
ii. At the end of each period

08/04/24 18:48 39
 Annuity Streams
An annuity is a cash flow stream in which the cash
flows are all equal and occur at regular intervals.
Annuity can be categorized as:
 Annuity Due: Payments or receipts occur at
the beginning of each period; e.g. house rent
 Ordinary Annuity: Payments or receipts occur
at the end of each period; e.g. salary.

08/04/24 18:48 40
 Future Value of Ordinary Annuity
Compounding and summing for each payment.
 The formula for calculating the future value of an
annuity stream is as follows:
(1  r )  1
n
FV A  A[ ] FVA  A  FVIFA r ,n
r

08/04/24 18:48 41
 FV of Ordinary Annuity
example
Example: Future Value of an Ordinary Annuity
Stream
Jill has been faithfully depositing $2,000 at the end of
each year for 10 years into an account that pays 8% per
year. How much money will she have accumulated in
the account?

08/04/24 18:48 42
 FV of Ordinary Annuity
solution
Future Value of Payment One = $2,000 x 1.089 = $3,998.01
Future Value of Payment Two = $2,000 x 1.088 = $3,701.86
Future Value of Payment Three = $2,000 x 1.087 = $3,427.65
Future Value of Payment Four = $2,000 x 1.086 = $3,173.75
Future Value of Payment Five = $2,000 x 1.085 = $2,938.66
Future Value of Payment Six = $2,000 x 1.084 = $2,720.98
Future Value of Payment Seven = $2,000 x 1.083 = $2,519.42
Future Value of Payment Eight = $2,000 x 1.082 = $2,332.80
Future Value of Payment Nine = $2,000 x 1.081 = $2,160.00
Future Value of Payment Ten = $2,000 x 1.080 = $2,000.00
Total Value of Account at the end of 10 years $28,973.13
08/04/24 18:48 43
 FV of Ordinary Annuity
solution using formula
Using the formula

(1  0.08)  110
FV A  2,000[ ]
0.08
 $2,000 14.4866
 $28,973.1250

08/04/24 18:48 44
 FV of Ordinary Annuity
Exercise
Suppose you want to accumulate $500,000 at the
end of 30 years as your retirement money. The
interest rate you can make annual deposits is 8%.
How much should you deposit each year, so that
you will have $500,000 at the end of 30 years?
Assume that Sally owns an investment that will
pay her $100 each year for 20 years. The current
interest rate is 15%. What is the FV of this
annuity?

08/04/24 18:48 45
 Present Value of Ordinary Annuity
Discounting and summing for each payment.
The generalized formula is
n
1  (1  r )
PVA  A[ ] PVA  A  PVIFA
r

08/04/24 18:48 46
 PV of Ordinary Annuity
time line at r = 8%

08/04/24 18:48 47
 PV of Ordinary Annuity
example
Example: Present Value of an Annuity.
John wants to make sure that he has saved up
enough money prior to the year in which his
daughter begins college. Based on current
estimates, he figures that college expenses will
amount to $40,000 per year for 4 years (ignoring
any inflation or tuition increases during the 4
years of college). How much money will John
need to have accumulated in an account that
earns 7% per year, just prior to the year that his
daughter starts college?
08/04/24 18:48 48
 PV of Ordinary Annuity
solution
For; r = 7% and n = 4, PVIFA =3.3872
PVA = A*PVIFA = 40,000 × 3.3872
= $135,488

08/04/24 18:48 49
 Annuity Due
A cash flow stream such as rent, lease, and
insurance payments, which involves equal
periodic cash flows that begin right away or at the
beginning of each time interval, is known as an
annuity due.
An annuity due is calculated in reference to an
ordinary annuity. In other words, to calculate
either the present value (PV) or future value (FV)
of an annuity-due:
Annuity Due = Ordinary annuity x (1 + r)
08/04/24 18:48 50
 Annuity Due
example
Example: Annuity Due versus Ordinary
Annuity
Let’s say that you are saving up for retirement and
decide to deposit $3,000 each year for the next 20
years into an account that pays a rate of interest of
8% per year. By how much will your accumulated
nest egg vary if you make each of the 20 deposits at
the beginning of the year, starting right away,
rather than at the end of each of the next twenty
years?
08/04/24 18:48 51
 Annuity Due
solution
FV ordinary annuity = $3,000 × [((1.08)20 - 1)/.08]
= $3,000 × 45.76196
= $137,285.89
FV of annuity due = FV of ordinary annuity × (1+r)
FV of annuity due = $137,285.89 × (1.08)
= $148,268.76

08/04/24 18:48 52
 Evaluating Perpetuities
A series of constant cash flows expected to occur
at the end of each year for ever and ever into the
future is known as a perpetuity.

C
PVA 
r

08/04/24 18:48 53
 Perpetuity
Example
Example 5: PV of a Perpetuity
If you are considering the purchase of a consol
that pays $60 per year forever, and the rate of
interest you want to earn is 10% per year, how
much money should you pay for the consol?
Answer:
r=10%, A = $60, and PV = ($60/0.1) = $600.
So $600 is the most you should pay for the consol.

08/04/24 18:48 54
08/04/24 18:48 55