Financial Management notes

Financial Management Revised and Updated notes

 GENERAL OBJECTIVE

This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to apply financial management principles in practice.

8.0       LEARNING OUTCOMES

A candidate who passes this paper should be able to:

  • Analyse the sources of finance for an organisation and evaluate various financing options
  • Evaluate various investment decision scenarios available to an organisation
  • Evaluate the performance of a firm using financial tools
  • Make appropriate capital structure decisions for a firm
  • Value financial assets and firms
  • Make appropriate liquidity and dividend decisions for a firm
  • Evaluate current developments in business financing strategies.

CONTENT

 8.1       Overview of financial management

  • Nature and scope of finance
  • Finance functions
  • Goals of a firm; financial and non-financial objectives, overlaps and conflicts among the objectives
  • Agency theory, stakeholder’s theory and corporate governance
  • Measuring managerial performance, compensation and incentives
  • Ethical issues in financial management
  • Corporate social responsibility (CSR) and financial management

 8.2       The financing decision

  • Nature and objectives of the financing decision
  • Factors to consider when making financing decisions
  • Sources of finances for enterprises; internally generated funds and the externally generated funds, long term sources, medium term and short term sources of finance
  • Evaluation of financing options
  • Methods of issuing ordinary shares – public issue, private placement, bonus issue, employee stock option plans (ESOPS) and rights issues

 8.3       Financial institutions and markets

  • Nature and role of financial markets
  • Classification of financial markets: primary and secondary securities market, money and the capital markets, over-the counter and organised market, derivatives market, mortgage market, forex market
  • The security exchange listing and cross border listing
  • Market efficiency – efficient market hypothesis
  • Stock market indices
  • The financial institutions and intermediaries: commercial banks, savings and loans associations and co-operative societies, foreign exchange bureaus, Unit trusts and mutual funds, insurance companies and pension firms, insurance agencies and brokerage firms, investment companies, investment banks and stock brokerage firms, micro-finance institutions and small and medium enterprises (SMEs)
  • The role of regulators in financial markets
  • Central depository system and automated trading system
  • Timing of investment at the securities exchange – Dow theory and Hatch system of timing

8.4       Time-value of money

  • Concept of time value of money
  • Relevance of the concept of time value of money
  • Time value of money versus time preference of money
  • Compounding techniques
  • Discounting techniques

8.5       Valuation models

  • Concept of value; book value, going concern value, substitution value, replacement value, conversion value, liquidation value, intrinsic value and market value
  • Reasons for valuing financial assets/business
  • Theories on valuation of financial assets; fundamental theory, technical theory, random walk theory and the efficient market hypothesis
  • Valuation of redeemable, irredeemable and convertible debentures and corporate bonds
  • Valuation of redeemable, Irredeemable and convertible preference shares
  • Valuation of ordinary shares; net asset basis, price earnings ratio basis, capitalisation of earnings basis, Gordon’s model, finite earnings growth model, Super-profit model, Marakon model, Walter’s model, Discounted free cash flow, residual income model
  • Use of relative measures such as Economic Value added (EVA) and Market Value Added (MVA)
  • Valuation of unit trusts and mutual funds
  • Valuation of private companies: income and market based approaches

8.6       Cost of capital

  • Firms capital structure and factors influencing capital structure decisions
  • Factors influencing firms cost of capital
  • Relevance of cost of capital
  • Component costs of capital
  • The firm’s overall cost of capital
  • Weighted average cost of capital (WACC)
  • Weighted marginal cost of capital (WMCC)
  • Introduction to break-points in weighted marginal cost of capital schedule
  • Operating and financial leverage – degree of operating leverage and operating risk; degree of financial leverage and financial risk
  • Combined leverage – degree of combined leverage and total risk

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 8.7       Capital budgeting decisions

  • The nature and importance of capital investment decisions
  • Capital investment’s cash flows – initial cash outlay, terminal cash flows and annual net operating cash flows, incremental approach to cash flow estimation
  • Capital investment appraisal techniques
  • Non-discounted cash flow methods – payback period and accounting rate of return
  • Discounted cash flow methods – net-present value, internal rate of return, profitability index, discounted payback period and modified internal rate of return (MIRR)
  • Strengths and weaknesses of the investment appraisal techniques
  • Expected relations among an investment’s NPV, company value and share price
  • Capital rationing – evaluation of capital projects and determination of optimal capital budget in situations of capital rationing for a single period rationing
  • Capital investment options – timing option, strategic investment option, replacement option and abandonment option
  • Problems/difficulties encountered when making capital investment decisions in reality

8.8       Financial analysis and forecasting

  • Users of financial statements and their information needs
  • Ratio analysis; nature of financial ratios, classification and calculation of financial ratios and limitation of financial ratios
  • Common size statements – Vertical and horizontal analysis
  • Financial forecasting; cash budgeting and percentage of sales method of forecasting

8.9       Working capital management

  • Introduction and concepts of working capital
  • Working capital versus working capital management
  • Factors influencing working capital requirements of a firm
  • Importance and objectives of working capital management
  • Working capital operating cycle; the importance and computation of the working capital operating cycle
  • Working capital financing policies aggressive, conservative and matching financing policy
  • Management of stock, cash, debtors and creditors

8.10    Dividend decision

  • Forms of dividend
  • How to pay dividends and when to pay dividends
  • How much dividend to pay
  • Firms dividend policy and factors influencing dividend decision
  • Why pay dividends
  • Dividend relevance theories; Bird in hand, Clientele effect, Information signaling theory, Walter’s model, Tax differential theory, Modigliani and Miller dividend irrelevance theory

8.11    Introduction to risk and return

  • Risk-return trade off/relationship
  • Distinction between risk free and risky assets
  • Expected return of an asset
  • Total risk of an asset
  • Relative risk of an asset
  • Expected return of a 2 asset-portfolio
  • The actual total risk of a 2-asset portfolio

8.12    Islamic finance

  • Justification for Islamic Finance; history of Islamic finance; capitalism; halal; haram; riba; gharar; usury
  • Principles underlying Islamic finance: principle of not paying or charging interest, principle of not investing in forbidden items such as alcohol, pork, gambling or pornography; ethical investing; moral purchases
  • The concept of interest (riba) and how returns are made by Islamic financial securities
  • Sources of finance in Islamic financing: muhabaha, sukuk, musharaka, mudaraba
  • Types of Islamic financial products:- sharia-compliant products: Islamic investment funds; takaful the Islamic version of insurance Islamic mortgage, murabahah,; Leasing – ijara; safekeeping – Wadiah; sukuk – islamic bonds and securitisation; sovereign – sukuk; Islamic investment funds; Joint venture – Musharaka, Islamic banking, Islamic contracts, Islamic treasury products and hedging products, Islamic equity funds; Islamic derivatives
  • International standardisation/regulations of Islamic Finance: case for standardisation using religious and prudential guidance, National regulators, Islamic Financial Services Board

8.13    Emerging issues and trends

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