Role of Financial management in organization:

1. Introduction
Financial Management means planning, organizing, directing and controlling the financial activities such
as procurement and utilization of funds of the enterprise. It means applying general
management principles to financial resources of the enterprise.

1.1 What is Financial Management?

Financial management is concerned with acquisition, financing and management of assets with
someoverall goal in mind. Thus the decision function of financial management can be broken down into
threemajor areas: the investment, financing and assets management decisions.

1.2The Goals of Financial Management

• Primary goal is to maximize the long-term wealth of the company’s shareholders (owners) by
increasing the market value (price) of their shares
• This may conflict with
– social / ethical goals (for example, pollution control)
– interests of management (for example, short-term compensation)
• Management can encourage an increase in share price by earning an attractive return at an acceptable
level of risk.

1.3 Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of financial
resources of a concern. The objectives can be

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning capacity, market
price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in
maximum possible way at least cost.
4.To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequaterate of
return can be achieved.
5.To plan a sound capital structure-There should be sound and fair composition of capital so that
a balance is maintained between debt and equity capital.

1.4 Roles of Financial Management

The financial management will give information about:

- the interest rates which the company is willing to take loans at;
- the future cash flow needs;
- the recommendations of long-term debt increase, of shares’ issue or a combination between these
two;
- recommendations about taking short-term loans or about self-financing;
- the availability of risk management techniques;
- the economic units’ productions and the impact on the existing and planned projects

Administrator of Business are MBA:

In a big organization, the general manger or the managing director is the overall incharge of the
organization but they gets all the activities done by delegating all or some of their powers to men in the
middle or lower management, who are supposed to be specialists in the field so that better results may
be obtained. For example, management and control of production may be delegated to a man who is
specialist in the techniques, procedures, and methods of production. We may designate him
“Production Manager'. So is the case with other branches of management, i.e., personnel, finance, sales
etc.

Managers of the department are responsible for the wealth maximization of their respective domain.
Importance of management cannot be over-emphasized. It is, indeed, the key to successful business
operations. Without proper administration of business, no business enterprise can reach its full
potentials for growth and success. Managers are keen lubricant who keeps the enterprise dynamic-
develops product, keeps men and machines at work, encourages management to make progress and
creates values. 
Exercise 2-14

Washington-Pacific invests $4 million to clear a tract of land and to set out some young
pine trees. The trees will mature in 10 years, at which time Washington-Pacific plans to
sell the forest at an expected price of $8 million. What is Washington-Pacific’s expected
rate of return?

Exercise 2-15

A mortgage company offers to lend you $85,000; the loan calls for payments of
$8,273.59 per year for 30 years. What interest rate is the mortgage company charging
you?

Exercise 2-16

To complete your last year in business school and then go through law school, you will
need $10,000 per year for 4 years, starting next year (that is, you will need to withdraw
the first $10,000 one year from today). Your rich uncle offers to put you through school,
and he will deposit in a bank paying 7 percent interest a sum of money that is sufficient
to provide the four payments of $10,000 each. His deposit will be made today.

a. How large must the deposit be?

b. How much will be in the account immediately after you make the first withdrawal?
After the last withdrawal?

Exercise 2-17

While Mary Corens was a student at the University of Tennessee, she borrowed
$12,000 in student loans at an annual interest rate of 9 percent. If Mary repays $1,500
per year, how long, to the nearest year, will it take her to repay the loan?

Exercise 2-18

You need to accumulate $10,000. To do so, you plan to make deposits of $1,250 per
year, with the first payment being made a year from today, in a bank account which
pays 12 percent annual interest. Your last deposit will be less than $1,250 if less is
needed to round out to $10,000. How many years will it take you to reach your $10,000
goal, and how large will the last deposit be?

Exercise 2-19

What is the present value of a perpetuity of $100 per year if the appropriate discount
rate is 7 percent? If interest rates in general were to double and the appropriate
Exercise 2-20

Assume that you inherited some money. A friend of yours is working as an unpaid intern
at a local brokerage firm, and her boss is selling some securities that call for four
payments, $50 at the end of each of the next 3 years, plus a payment of $1,050 at the
end of Year 4. Your friend says she can get you some of these securities at a cost of
$900 each. Your money is now invested in a bank that pays an 8 percent nominal
(quoted) interest rate but with quarterly compounding. You regard the securities as
being just as safe, and as liquid, as your bank deposit, so your required effective
annual rate of return on the securities is the same as that on your bank deposit. You
must calculate the value of the securities to decide whether they are a good investment.
What is their present value to you?

Exercise 2-21

Assume that your aunt sold her house on December 31 and that she took a mortgage in
the amount of $10,000 as part of the payment. The mortgage has a quoted (or nominal)
interest rate of 10 percent, but it calls for payments every 6 months, beginning on June
30, and the mortgage is to be amortized over 10 years. Now, 1 year later, your aunt
must inform the IRS and the person who bought the house of the interest that was
included in the two payments made during the year. (This interest will be income to your
aunt and a deduction to the buyer of the house.) To the closest dollar, what is the total
amount of interest that was paid during the first year?

PV=$10,000

I=10%, compounded semiannual=5%

N=10 years => 20 periods of semiannual

=>

PMT= 1000/((1-(1+.05)^-20)/0.5) = 802.43

Period Beginning Payment Interest Principal

1 10,000 802.43 500 302.43

2 9,697.57 802.43 484.88 317.55

For the first year, total interest is 500 + 484.88 = $984.88

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Exercise 2-22

Your company is planning to borrow $1,000,000 on a 5-year, 15%, annual payment,

fully amortized term loan. What fraction of the payment made at the end of the second
year will represent repayment of principal?
PV=$1,000,000

I=15%

N=5

=> PMT=PV/[(1-(1+.15)^-5)-1)/.15]=1000000/3.35 = 298,315.55

=> Interest=Beginning x .15

=> Principle=payment - interest

Year Beginning Payment Interest Principal

1 1,000,000 298,315.55 150,000 148,315.55

2 851,684.45 298,315.55 127,752.67 170,562.89

Fraction of Principle of second year is $170,562.89/$298,315.55 = 0.5718 = 57.18%

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=

Exercise 2-23

a. It is now January 1, 2002. You plan to make 5 deposits of $100 each, one every 6
months, with the first payment being made today. If the bank pays a nominal interest
rate of 12 percent but uses semiannual compounding, how much will be in your account
after 10 years?

b. You must make a payment of $1,432.02 ten years from today. To prepare for this
payment, you will make 5 equal deposits, beginning today and for the next 4 quarters, in
a bank that pays a nominal interest rate of 12 percent, quarterly compounding. How
large must each of the 5 payments be?

Exercise 2-24

Anne Lockwood, manager of Oaks Mall Jewelry, wants to sell on credit, giving
customers 3 months in which to pay. However, Anne will have to borrow from her bank
to carry the accounts payable. The bank will charge a nominal 15 percent, but with
monthly compounding. Anne wants to quote a nominal rate to her customers (all of
whom are expected to pay on time) which will exactly cover her financing costs. What
nominal annual rate should she quote to her credit customers?

First we calculate EAR of bank:

EFF%=(1+(15%/12))^12=16.08%

Next we calculate Rnom compounding quarterly:

16.08% = ((1+(R/4)^4) – 1

=> 116.08% = (1 + R/4)^4

=> (116.08%)^(1/4) = 1+ R/4

=> Rnom = 15.18% ; Anne Lockwood should quote her customers with r=15.18%.

Exercise 2-25

Assume that your father is now 50 years old, that he plans to retire in 10 years, and that
he expects to live for 25 years after he retires, that is, until he is 85. He wants a fixed
retirement income that has the same purchasing power at the time he retires as
$40,000 has today (he realizes that the real value of his retirement income will decline
year by year after he retires). His retirement income will begin the day he retires, 10
years from today, and he will then get 24 additional annual payments. Inflation is
expected to be 5 percent per year from today forward; he currently has $100,000 saved
up; and he expects to earn a return on his savings of 8 percent per year, annual
compounding. To the nearest dollar, how much must he save during each of the next 10
years (with deposits being made at the end of each year) to meet his retirement goal?

Data for Barry Computer Co. and its industry averages follow.

a. Calculate the indicated ratios for Barry.

b. Construct the DuPont equation for both Barry and the industry.
c. Outline Barry’s strengths and weaknesses as revealed by your analysis.
d. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and
common equity during 2016. How would that information affect the validity of your ratio
analysis?