CAVENDISH UNIVERSITY

UGANDA
MBA715 FINANCE FOR MANAGERS

SATURDAY @ 2:30- 5:30PM

 LEARNING OUTCOMES
In order to pass this course, students should be able to demonstrate
ability to:
• Discount cash flows using the concepts of the time value of money
• Price equities, fixed income securities, and derivatives;
• Understand the concepts of risk and required return;
• Gain an understanding of portfolio theory;
• Analyze a set of investment opportunities, identifying what creates
shareholder value;
• Structure the financial claims on the firm between debt and equity
securities so as to maximize shareholder value; and
• Gain an understanding of a firm’s dividend policy.
 TOPIC ONE : Introduction to Finance for
Managers
• The term finance for managers is generically
used to refer to subject descriptions as
managerial finance, corporate finance or
business finance.

• This is the study and practice of raising,

allocating, utilizing and monitoring of funds to
attain firm’s objectives
 Continued
• The task of finance for managers is to assist,
advise and support management in four
important areas of decision making :
investment; financing; working capital and
dividend decisions.
• There are two major roles of finance for
managers :
– Raising of funds
– Allocation of funds/utilization
 Raising of funds

• Funds can be raised from owners of the

business (equity) and from outsiders (debt).
When funds are raised from equity or debt,
you create what is known as the financing mix
e.g. 80% equity: 20% debt.
• This financing mix will determine the
financing risk.
• Financing risk is the possible variability in
return as a result of the method of financing
used by the firm.
• It involves repayment of fixed financing
obligations that come in form of interest and
debt redemption i.e. payment of principal.
 Allocation of funds

• The allocation of funds determines the asset

mix of the firm.
• The asset mix defines the nature of the firm
which in turn shapes the business risk.
Business risk will vary with the nature of the
business e.g. a service firm and manufacturing
firm will not have the same business risk.
THE SCOPE OF FINANCE FOR MANAGERS / MAJOR FINANCE DECISIONS

• The investment decision (the capital budgeting

decision) i.e. the decision to invest in long
term assets.
• Working capital management decisions i.e. the
decision to invest in short term assets.
 Continued
• The financing decision i.e. the acquisition of
long term and short term funds to finance
capital expenditure and working capital
respectively
• The dividends decision (earnings management
decision) i.e. the decision to determine
whether earnings of the firm should be paid
out as dividends or retained in the firm.
 THE OBJECTIVE OF A FIRM

• Maximization of profits: This objective

requires a firm to maximize its revenue as it
minimizes its costs.
• Profit maximization ignores the concept of
time value of money.
• The objective is in conflict with interests of
other stakeholders e.g. employees, suppliers,
consumers, etc.
• Financial managers focus on the objective of
wealth maximization.
• Wealth maximization – Wealth is the net cash flow
expected from all the assets in which resources of the firm
have been invested; These cash flows have to be discounted
to their present worth using a discount rate that takes into
account all stakeholders interests in the business.

n
Wealth max. = Σ A1 _ _ l 0
i=1 (1 + K)1
• Wealth maximization = Discounted Cash inflows – Outflows.
A1 – expected cash flow invested in period 1
K - discount rate/factor
I0 - initial cash flow
i - period over which a firm is expected to
acquire resources and invest.
NB: i)Cash flows are different from profits.
• Wealth maximization focuses on cash flows
and not accounting profits
• This objective is oriented towards benefiting
shareholders in an exclusive way.
• Where stake holders are not owners there
may be conflict of interests
• Stakeholders in the firm:
• Owners / investors, government,
management, employees and their unions and
society
 Exercise 1
• Tam co. ltd is investing in machinery that costs
shs 50,000,000, it expects to earn shs
20,000,000 in year 1, shs 35,000,000 in year 2
and shs 40,000,000 in year 3; the required rate
of return is 20%.
How much wealth will this company have
accumulated at the end of year 3?
 Other Objectives of the firm:

2. ‘Maximization of market share.

3. Maximization of earnings per share
4. Maximization of employee welfare
5. Social responsibility.
 TIME VALUE OF MONEY

• Time value for money refers to the preference

to have money now than later.
• It is a concept that as a rational economic unit
(individual or firm) you prefer earlier cash flows
to later cash flows (i.e. prefer a sum of money
today than later).
• The fact that earlier cash flows are preferred to
later ones means that you attach a higher value
to them.
 Reasons for time preference for money

• Generally, the future is associated with risk and

uncertainty because of changes in the business
environment.
• Any rational consumer prefers current
consumption to future consumption.
• Investment opportunities. The amount of
money received earlier can be invested to earn
more return in the future. By waiting for later
cash flows, the investor foregoes this return.
 Continued
• If investors prefer money today, than the same
amount at a future date, then for the investor
to part with his/her money today, they need
to be compensated for the opportunity cost
associated with future receipts.
• This compensation is known as interest or
rate of return on investment (RR).
 PRESENT VALUE AND FUTURE VALUE
Time value of money may refer to the future and present value.
1. FUTURE VALUE
i) Future value is the value at some future time of a present
amount of money evaluated at a given interest rate. It expresses
today’s cash flows into their worth in future.
FVn = PVo(1 + i)n
FVn - Future value at end of n years.
PVo - Present value today
i - interest rate
n - period in years.
ii) At times, interest is compounded more than once during
the year.
Thus,
FVnm - PVo (1 + i )nm
m
FVnm - Future value compounded m times a year.
m - Number of times interest is compounded in a year.
Example; Suppose in the previous example the interest is
compounded quarterly, then the future value would be.
•  
• FVnm = PVo (1 + i )nm
m
= 75,000,000 (1+0. 12/4)6*4
= 152,459,558
2. If you invested shs 55,650 in a bank, which
was paying a 15% rate of interest for a 10 year
deposit, how much would the deposit grow at
the end of 10 years?
Note: Interest may be computed (compounded):
• Annually – One time a year (at the end)
• Every 6 months – 2 times a year (semi-annual)
• Every quarter – 4 times a year (quarterly)
• Every Month – 12 times a year (monthly)
• Every Day – 365 times a year (daily)
 2. PRESENT VALUE

• Present value refers to the value of future cash

flows of an investment when discounted using
an appropriate discount rate to bring them
back to their present worth.
• PV= FVn
(1 + i)n
• Suppose an investor wants to find out the
present value of shs. 50,000,000 to be
received after 15 years. Her interest is 9%.
• The PV will be:
• 50,000,000
• ( 1+0.09)15
• =13,726,902.07
 
• Using tables, PV= 50,000,000 X 0.275
=13,750,000
 
 3. ANNUITIES

• An annuity is an equal cash flow paid or

received in uniform time interval within a
given period e.g. equal loan repayments
(amortized loan), lease rentals and annual
interest on a bond.
• Annuities are categorized as: Annuity Due and
Regular/Differed/Ordinary Annuity.
• Annuity Due is a uniform cash flow accruing at
the start of each.
• Regular/Deferred/Ordinary Annuity is a
uniform cash flow accruing at the end of each
period e.g. monthly interest or rent paid at
end.
 Future Value of Multiple Payment Streams

• 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.

4-3
 4.2 Future Value of an Annuity Stream
• Annuities are equal, periodic outflows/inflows at regular intervals, e.g. rent,
lease, mortgage, car loan, and retirement annuity payments.

• An annuity stream can begin at the start of each period (annuity due) as is true
of rent and insurance payments or at the end of each period, (ordinary
annuity) as in the case of mortgage and loan payments.

• The formula for calculating the future value of an ordinary annuity stream is as
follows:
FV = PMT x (1+r)n -1
r
• where PMT is the term used for the equal periodic cash flow, r is the rate of
interest, and n is the number of payments, one at the end of each period
(ordinary annuity).
4-31
4.2 Future Value of an Annuity Stream
Example: Future Value of an Ordinary
Annuity Stream
Jill has been faithfully depositing 2,000 at the
end of each year over the past 10 years into
an account that pays a guaranteed 8% per
year. How much money has she have
accumulated in the account?

4-32
4.2 Future Value of an Annuity Stream
Example Answer (via the long way)

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
4-10
Example Answer (short way)

4.2 Future Value of an Annuity Stream

FORMULA METHOD
FV = PMT x (1+r)n -1
r
where, PMT = $2,000; r = 8%; and n=10.
FVIFA =[((1.08)10 - 1)/.08] = 14.486562,
FV = 2000 x 14.486562 = 28,973.13
 
USING A FINANCIAL CALCULATOR
N= 10; PMT = -2,000; I/Y = 8; PV=0; CPT FV = 28,973.13
4-11
Example Answer (short way)
FORMULA METHOD
FV = PMT x (1+r)n -1
r
where, PMT = $2,000; r = 8%; and n=10.
FVIFA =[((1.08)10 - 1)/.08] = 14.486562,
FV = 2000 x 14.486562 = 28,973.13
 
USING A FINANCIAL CALCULATOR
N= 10; PMT = -2,000; I/Y = 8; PV=0; CPT FV = 28,973.13
 4.2 Future Value of an Annuity Stream

USING AN EXCEL SPREADSHEET

 
Enter =FV(8%, 10, -2000, 0, 0); Output = 28,973.13
Rate = 0.08, Nper = 10, Pmt = -2,000, PV =0, and
Type is 0, for ordinary annuities

USING FVIFA TABLE (A-3), page 575

Find the FVIFA in the 8% column and the 10 period row; FVIFA =
14.4866
FV = 2000 x 14.4866 = 28.973.20 (off by 7 cents)

4-36
 4.3 Present Value of an Annuity
To calculate the value of a series of equal periodic cash
flows at the current point in time, we can use the
following simplified formula:
  1 
1   
  1  r  n

PV  PMT  
r
The last portion of the equation is the
Present Value Interest Factor of an Annuity (PVIFA).

Practical applications include figuring out the nest egg needed

prior to retirement or lump sum needed for college expenses.
4-37
 4.3 Present Value of an Annuity
• Example problem for the four solution methods
– You are now holding the winning lottery ticket that will pay
the holder of the ticket 10,000 per year for the next 20
years. A friend has offered to buy the winning ticket from
you. What should you sell the ticket for assuming you have a
discount rate of 6% on future dollars (this is your
opportunity rate for the future cash flow)?
– Four ways to solve
• Formula
• Calculator
• Spreadsheet
• Table
4-#
4.3 Present Value of an Annuity
• Formula
– Inputs? N = 20, r = 0.06, PMT = 10,000 and
– Compute PV,
– PV = $10,000 x [1 – 1/(1.06)20] / 0.06 = 114,699.21
• Calculator
– Inputs? N = 20, I/Y = 6.0, PMT = 10,000, FV = 0
– Compute PV
– PV = -114,699.21

4-#
4.3 Present Value of an Annuity
• Spreadsheet, use PV function
– Inputs? Rate = 0.06, Nper = 20, Pmt = 10,000, Fv = 0
– PV = -114,699.21

• Table
– First find the PVIFA with n = 20 and r = 6.0% on page
576, PVIFA = 11.4699
– Calculate PV = 10,000 x 11.4699 = $114,699.00 (off
by 21 cents)
4-#
 4.4 Annuity Due and Perpetuity
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.

4-41
 4.4 Annuity Due and Perpetuity
Formula Adjustment
PV annuity due = PV ordinary annuity x (1+r)
FV annuity due = FV ordinary annuity x (1+r)
PV annuity due > PV ordinary annuity
FV annuity due > FV ordinary annuity
Can you see why?
Financial calculator
Mode set to BGN for annuity due
Mode set to END for an ordinary annuity
Spreadsheet
Type = 0 or omitted for an ordinary annuity
Type = 1 for an annuity due.
4-42
 4.4 Annuity Due and Perpetuity
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 which 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?
4-43
 Annuity Due and Perpetuity
Example Answer
Given information: PMT = -$3,000; n=20; i= 8%;
PV=0;
FV ordinary annuity = $3,000 x [((1.08) - 1)/.08]
20

= $3,000 x 45.76196
= $137,285.89

FV of annuity due = FV of ordinary annuity x (1+r)

FV of annuity due = $137,285.89 x (1.08) = $148,268.76

Difference is $10,982.87
4-44
 Amortised Loan
n = 5; I/Y = 10.0; PV=40,000; FV = 0;
CPT PMT= 10,551.89923

Total payments = 5 x $10,551.89923 = $52,759.50

Interest paid = Total Payments - Loan Amount

Interest paid = 52,759.50 - $40,000
Interest paid = 12,759.50

4-45
 Amortization Schedules
Tabular listing of the allocation of each loan payment towards interest and
principal reduction
Helps borrowers and lenders figure out the payoff balance on an outstanding
loan.

Procedure:
1) Compute the amount of each equal periodic
payment (PMT) using the ordinary annuity formula.
2) Calculate interest on unpaid balance at the end of
each period, minus it from the PMT, reduce the loan
balance by the remaining amount,
3) Continue the process for each payment period, until we
get a zero loan balance.

4-46
 Amortization Schedules

Example: Loan amortization schedule.

Prepare a loan amortization schedule for the amortized loan
option given in the previous Example with the five annual
payments for the 40,000 at 10% annual interest rate. What is
the loan payoff amount at the end of 2 years?

Step One, determine the annual payment:

PV = 40,000; n=5; I/Y=10.0; FV=0;

CPT PMT = 10,551.90 (rounded to nearest whole cent)

4-47
 Amortization Table
Year Beg. Bal Payment Interest Prin. Red End. Bal

1 40,000.00 10,551.90 4,000.00 6,551.90 33,448.10

2 33,448.10 10,551.90 3,344.81 7,207.09 26,241.01

3 26,241.01 10,551.90 2,264.10 7,927.80 18,313.21

4 18,313.21 10,551.90 1,831.32 8,720.58 9,592.64

5 9,592.64 10,551.90 959.26 9,592.64 0.00

The loan payoff amount at the end of 2 years is 26,241.01

4-48
PRACTICAL APPLICATION OF PRESENT
VALUE: LOAN AMORTIZATION.
• The present value concept has practical
applications in determining the payments
required under an installment type of loan.
• Loan amortization is the periodic repayments
of loans in equal installments or annuities of
both principal and interest. The idea of PVA
determines equal installment payments on
loans.
• Example: Suppose a firm borrows Shs.10m at
10% interest to be repaid in the next 5 years.
Equal installments are required at the end of
each year and these payments must be
sufficient to repay the principal sum together
with the interest. Draw up a loan amortization
schedule to show how the loan would be
repaid.
• Step 1:
• PVA = A (Present value annuity factor)
• 10,000,000 = A x 3.7908
• 2,637,966 =A
• Suppose you borrowed a 3 year loan of shs
10,000 at 9% from your employer to buy a
motorcycle and your employer requires 3
equal end of year repayments, what will your
annual instalment payment be
• Step 1: calculate the (PVFA 3, 0.09)
• 10,000= A X 2.531
• A= 3951
• Step 1:
• PVA = A (Present value annuity factor)
• 10,000,000 = A x 3.7908
• 2,637,966 =A