B.N.M.

Institute of
Technology
EPMF – VII SEM – 2024-2025

MODULE - 4
Introduction to Project Finance

By,
Ms. Kruthi Jayaram
Assistant Professor
Dept of EEE, BNMIT
Introduction
Definition: Financial management "is the operational
activity of a business that is responsible for obtaining
and effectively utilising the funds necessary for
efficient operations"

Financial management is concerned with three key

activities namely:
Anticipating financial needs
Acquiring financial resources
Allocating funds in business
functions of Financial Management
• Financial management as an academic discipline
has undergone fundamental changes with regard to
its scope and coverage.

• In the earlier years, it was treated synonymously

with the raising of funds.

• In the later years, its broader scope, included in

addition to the procurement of funds, efficient use
of resources.
functions of Financial Management
• The principal contents of the modern approach to
financial management can be said to be:
• (i) How large should an enterprise be, and how fast
should it grow?
• (ii) In what form should it hold assets?
• (iii) What should be the composition of its
liabilities?
• The three questions posed above cover the major
financial problems of a firm.
functions of Financial Management
• financial management, in the modern sense of the
term, can be broken down into three major
decisions as functions of finance:
• (i) The investment decision
• (ii) The financing decision
• (iii) The dividend policy decision.
 Goals or Objectives of Financial
Management—Profit Maximization vs.
Wealth Maximization
Traditional Approach—Profit Maximization
• It has been traditionally argued that the objective of a company is to earn profit. This
means that the finance manager has to make decision in a manner that the profit is
maximised. Each alternative, therefore, is to be seen as from the stand point of its
ability to maximise profit for the firm.
• (Firm refers to any business entity that is engaged in selling goods and services)
Points in favor of profit maximization
• Profit is a barometer through which performance of a business unit can be
measured.
• Profit ensures maximum welfare to the shareholders, employees and prompts
payment to creditors of a company.
• Profit maximization attracts the investors to invest their savings in securities.
• Profit indicates the efficient use of funds for different requirements
• Profit max increases the confidence of management in expansion
Profit maximization objective gives rise to a number of problems as below:
1.Profit maximization concept should be considered in relation to risks involved.
There is a direct relationship between risk and profit. Many risky propositions
yield high profit. Higher the risk, higher is the possibility of profits. If profit
maximization is the only goal, then risk factor is altogether ignored.
2.Profit maximization, as an objective does not take into account time value of
returns. Example: Proposal A may give a higher amount of profits compared to
proposal B, yet if the returns begin to flow say, 10 years later, proposal B may be
preferred, which may have lower overall profits but the returns flow is earlier
and quicker.
3.Profit maximization, as an objective is too narrow. It fails to take into account
the other obligations of the business to various factors such as - interests of
workers, consumers, society as well as ethical trade practices. Further, most
business leaders believe that adoption of ethical standards strengthen their
competitive positions.
4.Profits do not necessarily result in cash flows available to the stockholder.
Shareholders receive cash flow in the form of either cash dividend paid to them
or proceeds from selling their shares for a higher price than paid initially.
Modern Approach—Wealth Maximization
Wealth maximisation refers to maximising the net wealth of the
company's shareholders. Wealth maximisation is means company aims
to pursue such policies that would increase the market value of shares
of the company. This is also known as Value Maximization. Wealth or
Value is represented by the market price of the company’s equity
shares. Prices in the share market at a given point of time, are the
result of many factors like general economic outlook, particularly if the
companies are under consideration, technical factors and even mass
psychology. However, taken on a long-term basis, the share market
prices of a company’s shares do reflect the value, which the various
parties put on a company.

If the company earns a higher rate of earning per share through risky
operations or risky financing pattern, the investors will not look upon
its shares with favour. To that extent, the market value of the shares of
such a company will be impacted. However, if a company invests its
fund in risky ventures, the investors will put in their money if they get
higher return as compared to that from a low risk share.
• Role of stakeholders

• Role of ethics

• Agency Problem
 Interface of Financial Management with
other functional areas
Relation to Economics
• The field of finance is closely related to economics. Financial
managers must be able to use economic theories as guidance
for efficient business operation. Example: supply-demand
analysis, profit-maximizing strategies, and price theory.
• The primary economic principle used in managerial function is
marginal analysis, the principle that financial decisions should
be made and actions taken only when the added benefits
exceed the added costs.
• Nearly all financial decisions ultimately come down to an
assessment of their marginal benefits and marginal costs.
Financial managers must understand the economic framework
and be alert to the consequences of varying levels of economic
activity and changes in economic policy.
 Interface of Financial Management with
other functional areas
Relation to Accounting
The firm’s finance (treasurer) and accounting (controller) activities are closely related and
generally overlapped. Normally, managerial finance and accounting are not often easily
distinguishable. In small firms, the controller often carries out the finance function and in
large firms many accountants are also involved in various finance activities. There are two
basic differences between finance and accounting:
1.Emphasis on cash flows: The accountant’s primary function is to develop and report
data for measuring the performance of the firm, assuming its financial position and paying
taxes using certain standardized and generally accepted principles. The accountant
prepares financial statements based on accrual basis. The financial manager places
primary emphasis on cash flows, the inflow and outflow of cash.
2.Use of decision-making: Accountants devote most of their operation to the collection
and presentation of financial data. The primary activities of the financial manager in
addition to ongoing involvement in financial analysis and planning are making investment
decisions and making financing decisions. Investment decisions determine both the mix
and the type of assets held by the firm. Financing decisions determine both the mix and
the type of financing used by the firm. However, the decisions are actually made on the
basis of cash flow effects on the overall value of the firm.
In short, accounting provides input required for financial decision making.
 Interface of Financial Management with
other functional areas
Relation to Marketing, Production and Statistics
• Apart from economics and accounting, finance also draws—for its day-
to-day decisions—on supportive disciplines such as marketing,
production and quantitative methods.
• For instance, financial managers should consider the impact of new
product development and promotion plans made in marketing area
since their plans will require capital outlays and have an impact on the
projected cash flows.
• Similarly, changes in the production process may necessitate capital
expenditures which the financial managers must evaluate and finance.
And, finally, the tools of analysis developed in the quantitative methods
area are helpful in analysing complex financial management problems.
• The marketing, production and quantitative methods are, thus, only
indirectly related to day to-day decision making by financial managers
and are supportive in nature while economics and accounting are the
primary disciplines on which the financial manager draws substantially.
 Time value of money
• Concerned with interest rates and their effects on the
value of money
• Interest rates have widespread influence over
decisions made by businesses and by us in personal
lives
• Corporations pay lakhs of rupees in interest each year
for the use of money they have borrowed.

• Money available at present is more valuable than

money value in future.
 Time value of money
• Interest - The compensation for waiting is the time value of
money is called interest. Interest is a fee that is paid for
having the use of money.

• Example: Interest on mortgages (home loans) for having the

use of bank’s money. Similarly, the bank pays us interest on
money invested in savings accounts or certificates of deposit
because it has temporary access to our money. The amount
of money that is lent or invested is called principal. Interest is
usually paid in proportion and the period of time over which
the money is used. The interest rate is typically stated as a
percentage of the principal per period of time.

• Example: 18 per cent per year or 1.5 per cent per month.
 Time value of money
• Simple Interest - Interest that is paid solely on the
amount of the principal is called simple interest.

• Simple interest is usually associated with loans or

investments that are very short- term in nature.

• The computation of simple interest is based on the

following formula:
• Simple interest = Principal × Interest rate per time
period × Number of time period
Time value of money

• Compound Interest: Compound Interest occurs when interest

earned during the previous period itself earns interest in the
next and subsequent periods

If 1000 is placed into savings account paying 6% interest per year,

interest accumulates as follows:

Principal invested in the first year 1000.00

Interest for first year ( 1000 × 0.06 × 1) 60.00
Amount available at end of first year 1060.00
Interest for second year ( 1060 × 0.06 × 1) 63.60
Amount available at end of second year 1123.60

The interest earned in the second year is greater than 60 because

it is earned on the principal plus the first year’s interest.
Time value of money

If the savings account pays 6% interest compounded

quarterly, 1.5% interest is added to the account each quarter, as follows:
Principal invested in the first year 1000.00
Interest for first quarter ( 1000 × 0.06 × 1 × 1/4) 15.00
Amount available at end of first quarter 1015.00

Interest for second quarter ( 1015 × 0.06 × 1 × 1/4) 15.23

Amount available at end of second quarter 1030.23
Interest for third quarter ( 1030.23 × 0.06 × 1 × 1/4) 15.45
Amount available at end of third quarter 1045.68

Interest for fourth quarter ( 1045.68 × 0.06 × 1 × 1/4) 15.69

Amount available at end of first year 1061.37

With quarterly compounding, the initial investment of 1000 earned 1.37 more
interest in the first year than with annual compounding.
Future Value of single cash flow (one-time
payment/receipt)

• A sum of money invested today at compound interest

accumulates to a larger sum called the amount or future
value.
• The future value of 1000 invested at 6% compounded
annually for 2 years is 1123.60.
• The future value includes the original principal and the
accumulated interest.
• The future value varies in accordance with the interest
rate, the compounding frequency and the number of
periods.
Future Value of single cash flow (one-time
payment/receipt)

• For example, at 8% interest per period, a principal

investment of Re. 1 accumulates as follows:

Future value of 1 at 8% for 1 period = 1.00000 × 1.08 =

1.08000
Future value of 1 at 8% for 2 periods = 1.08000 × 1.08 =
1.16640
Future value of 1 at 8% for 3 periods = 1.16640 × 1.08 =
1.25971
 Future Value of single cash flow (one-time
payment/receipt)
The general formula for the future value of any amount is -
FV= PV (1+ r)n

PV – Present value
FV – Future value after ‘n’ period
n - the number of compounding period
r - rate of interest

Using this formula, future values can be calculated for any interest rate and any
number of time periods.

Future value can also be computed using the appropriate factor from the Future
Value table (FVIF table).
FV = PV (FVIF r,n)
 Intra-year compounding or discounting
(frequency is less than one year)
• If the frequency of cash flow is less than one year – half-yearly, quarterly,
monthly or weekly, the compounding/discounting happens at the end of every
period.
• In this case, the ‘n’ will be the number years multiplied with frequency per
year;

• Half-yearly or bi-annually – ‘n’ to be multiplied by 2

• Quarterly – ‘n’ to be multiplied by 4
• Monthly – ‘n’ to be multiplied by 12

• Rate of interest or compounding rate will be divided by the number of

frequency per year.
• E.g. if the rate of interest per year is 10% but the compounding cycle is half-
yearly, then ‘r’ will be 5% for each period (10% divided by 2)
Nominal and effective interest rate
• If interest rate is paid on an annual basis
(compounded annually) it is known as nominal
interest rate; If compounding is done more than
once a year, the actual annualised rate of interest
would be higher than the nominal interest rate and
it is known as effective interest rate

• Effective interest rate = (1 + r/m ) m -1

• r = annual interest rate

• m = frequency per year
 Present Value of single cash flow or lupmsum

• If 1 can be invested at 8% today to become 1.08 in the future, then 1 is the present
value of the future amount of 1.08. The present value of future receipts of money is
important in business decision-making. It is necessary to decide how much future
receipts are worth today in order to determine whether an investment should be made
or how much should be invested. Finding the present value of future receipts involves
discounting the future value to the present. Discounting is the opposite of
compounding. It involves finding the present value of some future amount of money
that is assumed to include interest accumulations.

• For example, assuming 8% interest per period, present values of Re. 1 can be
constructed as follows:

• Present value of 1 discounted for 1 period at 8% = 1.0/1.08 = 0.92593 Present value of 1

discounted for 2 periods at 8% = 0.92593/1.08 = 0.85734 Present value of 1 discounted
for 3 periods at 8% = 0.85734/1.08 = 0.79383

• Formula for computing present value of any amount is -

• PV = FV (PVIF r,n)
Annuities
• An annuity is a written contract typically between you
and a life insurance company in which the insurance
company makes a series of regularly spaced payments
to you in return for a premium or premiums you have
paid.

• Hint – Any expense or income incurred more than once

on a regular or periodic basis and each cash flow
amount is even (uniform), it should be considered as an
annuity and apply the annuity formula;

• If the expense or income is one-time, apply the lump-

sum formula for it
 Future Value of Annuity (Uniform
cash flows)

Alternatively, it can also be computed by referring to

the future value interest factor for annuity table -

FVA = A (FVIFA r, n)
FVA = Future Value of Annuity A = Annuity
FVIFA = Future value interest factor for annuities
Present value of annuity (Uniform cash
flows)

• Alternatively, it can also be computed by referring to

the present value interest factor for annuity table -

• PVA = A (PVIFA r,n)

• PVA = Present value of annuity

• FVIFA = Present value interest factor for annuities
(table)
Loan Amortization
• Loan is an amount raised from outsiders at an interest and
repayable at a specified period. Payment of loan in the
form of installment is known as amortization. Installment
amount needs to be first computed using the present value
of annuity formula, as installment is a form of annuity.

• PVA = A (PVIFA)

• PVA = Annuity or Installment amount PVIFA

• Once the installment is found out, amortization schedule is
to be prepared in a tabular format like below; At end the
end of the last year/month, the outstanding balance
should be Nil.
Amortization schedule
format
Yea Beginnin Annual/ Interest Principal Outstandin
r/ g loan Monthly Amount Repaymen g loan
Mo amount Installmen (Rs.) t (Rs.) balance
nth (Rs.) t (Rs.) (Rs.)
Present value of perpetuity
Perpetuity is an annuity (either expense or income)
of infinite duration – incurred continuously/ forever/
perpetually.

Present value of a perpetuity = Perpetual Annuity

Amount/Interest rate
PV of a perpetuity = A / r
THANK YOU