CU-BCOM-SEM-IV-Financial Management-Second Draft

BACHELOR OF COMMERCE SEMESTER IV FINANCIAL MANAGEMENT

CHANDIGARH UNIVERSITY Institute of Distance and Online Learning SLM Development Committee Prof. (Dr.) H.B. Raghvendra Vice- Chancellor, Chandigarh University, Gharuan, Punjab:Chairperson Prof. (Dr.) S.S. Sehgal Registrar Prof. (Dr.) B. Priestly Shan Dean of Academic Affairs Dr. Nitya Prakash Director – IDOL Dr. Gurpreet Singh Associate Director –IDOL Advisors& Members of CIQA –IDOL Prof. (Dr.) Bharat Bhushan, Director – IGNOU Prof. (Dr.) Majulika Srivastava, Director – CIQA, IGNOU Editorial Committee Prof. (Dr) Nilesh Arora Dr. Ashita Chadha University School of Business University Institute of Liberal Arts Dr. Inderpreet Kaur Prof. Manish University Institute of Teacher Training & University Institute of Tourism & Hotel Management Research Dr. Manisha Malhotra Dr. Nitin Pathak University Institute of Computing University School of Business © No part of this publication should be reproduced, stored in a retrieval system, or transmitted in any formor by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the authors and the publisher. SLM SPECIALLY PREPARED FOR CU IDOL STUDENTS 2 CU IDOL SELF LEARNING MATERIAL (SLM)

First Published in 2021 All rights reserved. No Part of this book may be reproduced or transmitted, in any form or by any means, without permission in writing from Chandigarh University. Any person who does any unauthorized act in relation to this book may be liable to criminal prosecution and civil claims for damages. This book is meant for educational and learning purpose. The authors of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the event, Authors has/ have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action. 3 CU IDOL SELF LEARNING MATERIAL (SLM)

CONTENT Unit-1 Introduction ............................................................................................................... 5 Unit-2 Finance Functions .................................................................................................... 26 Unit-3 Time Value Of Money ............................................................................................. 44 Unit-4 Capital Budgeting .................................................................................................... 56 Unit-5 Investment Evaluation Criteria ................................................................................. 73 Unit-6 Capital Structure .................................................................................................... 102 Unit-7 Theories Of Capital Structure I............................................................................... 117 Unit-8 Theories Of Capital Structure Ii.............................................................................. 128 Unit-9 Cost Of Capital Part I ............................................................................................. 143 Unit-10 Cost Of Capital Part Ii.......................................................................................... 160 Unit-11 Leverage .............................................................................................................. 178 Unit-12 Dividend Policy ................................................................................................... 196 Unit-13 Working Capital Management.............................................................................. 209 Unit-14 Inventory Management......................................................................................... 222 4 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-1 INTRODUCTION STRUCTURE 1.0 Learning Objectives 1.1 Introduction 1.2 Evolution 1.3 Meaning 1.4 Scope of Financial Management 1.5 Objectives of Financial Management 1.6 Profit Maximization 1.7 Shareholder’s Wealth Maximization (SWM) 1.8 Summary 1.9 Keywords 1.10 Learning Activity 1.11 Unit End Questions 1.12 References 1.0 LEARNING OBJECTIVES After studying this unit, you will be able to  Explain the concept of financial management.  Illustrate the scope of financial management.  Explain the objectives of financial management. 1.1 INTRODUCTION Companies do not work in a vacuum, isolated from everything else. It interacts and transacts with the other entities present in the economic environment. These entities include Government, Suppliers, Lenders, Banks, Customers, Shareholders, etc. who deal with the organisation in several ways. Most of these dealings result in either money flowing in or flowing out from the company. This flow of money (or funds) has to be managed so as to result in maximum gains to the company. Managing this flow of funds efficiently is the purview of finance. So we can define finance as the study of the methods which help us plan, 5 CU IDOL SELF LEARNING MATERIAL (SLM)

raise and use funds in an efficient manner to achieve corporate objectives. Finance grew out of economics as a special discipline to deal with a special set of common problems. Financing could be through two ways: debt (loans from various sources like banks, financial institutions, public, etc.) and equity (capital put in by the investors who are also known as owners/ shareholders). Shareholders are owners because the shares represent the ownership in the company.Financial Management Funds are raised from financial markets. Financial markets is a generic term used to denote markets where financial securities are teat. These markets include money markets, debt market and capital markets. Figure 1.1: Financial Management 6 CU IDOL SELF LEARNING MATERIAL (SLM)

We will understand them in detail later in the 3rd chapter. Financing and investing decisions are closely related because the company is going to raise money to invest in a project or assets. Those who are going to give money to the company (whether lenders or investors) need to understand where the company is investing their money and what it hopes to earn from the investments so that they can assure themselves of the safety of their money. The questions that you may thinking about right now are \"Why do we need to learn finance? Shall we not leave it to the people who are going to specialise in finance? Finance won't help me in the area that I am going to work in, so why learn?\" This is to say that the knowledge of finance does not add any value to you. Is it so? Think about it. When you get your pocket money from your parents, you do not go out and blow the whole lot in one day because if you do, your parents are not going to give you more money to last through that month. You quickly learn that you need to plan your expenditure so that the money lasts throughout the month and you may actually plan to save some of it. Those who do not get enough to meet their requirements, think about some clever means to raise more money. Alternatively if they need more money for the month because of certain special eventsthey can plan to borrow money for a month and repay in the next month. So you plan, raise and efficiently utilise funds that are your disposal (or at least try to). That a business organisation also needs to do the same can hardly be overemphasised. The scale of operations is much bigger and to efficiently manage funds at this scale, decisions cannot be taken without sound methodology. Finance teaches you this terminology. For managing these funds the first thing you would need is information. External information has to be collected from the environment and accounting provides internal information about the firm's operations. Accounting can be defined as an information and measurement system that identifies, records, and communicates relevant information about a company's economic activities to people to help them make better decisions. You would now agree that a company needs to manage its own funds efficiently but your question still remains \"Why am I concerned with it?\" Further arguing, you say that, \"I am going to specialise in Marketing/ Information Technology/ Human Resource Management/ Operations Management and there is no need for me to learn finance. Also Finance is a separate function in my organisation (or the organisation that I am going to work for) and I am hardly going to use finance to work in my respective department.\" Introduction to Financial Management think again. Everything that you do has an impact on the profitability of the company (including drinking ten cups of coffee in a day!). So if you want to grow up to be the CEO of the company in a few years 7 CU IDOL SELF LEARNING MATERIAL (SLM)

from now (which I undoubtedly think that you would love to) you should take the advice of the top CEOs. Howard and Uptron in his book Introduction to Business Finance defined, “as that administrative area or set of administrative function in an organization which relate with the arrangement of cash and credit so that the organization may have the means to carry out its objectives as satisfactorily as possible”. 1.2 EVOLUTION The present study discusses the changing role of the financial management function in order to contribute to a more in-depth understanding of its dynamics and its relation to economic cycles. Discussion of this nature requires great care, lest one fails to consider that currently concepts are the result of built-up prior knowledge and experience. A review of the state of the art is therefore required, and, according to Brennanone is advised to recognize the influence of the limitations of the paradigms of each period. In order for this to be understood, Westonproposes the acceptance of three assumptions: - The first states that the evolution of economic thought reflects the most pressing problems of each period. Analogously, this concept may be applied to study of the financial management function, as new solutions are developed in response to workaday challenges. The second explains that advances in the field of finance are related to the development of theories and instruments in correlated fieldsso that mounting knowledge and technical evolution in correlated areas is a key factor for innovation in the financial management function; and - The third mentions that, in the development of financial theory, the constant transformation of economic and managerial circumstances allowed certain aspects of its content to be given little attention in certain periods, and taken into due consideration during others. We thus begin the present study with a review of the literature on the evolution of the financial management function, from the early 20th to the early 21st century, relating it to historical facts that characterized each period. We then discuss the changing role of the financial management function, including the influences of ethical debate. This is followed by our final considerations, in which we mention some trends of finance studies as to measurement of the impact of social and environmental responsibility to the company’s value to shareholders, as well as the application of psychology and neuroscience concepts to finance. The analytical approach adopted for this article is based upon the work of Archer and D’Ambrosio, Weston, Smithand Famá and Galdão. Contributions by other authors are mentioned in the text as relevant. Belowsummarizes the developments of this portion of the study. The financial management in the early 20th century was characterized by the traditional approach, focusing on the main events of corporate financial life, rather than routine 8 CU IDOL SELF LEARNING MATERIAL (SLM)

management problems. During this phase, development of the financial management function occurred as the result of the corporate consolidation and U.S. domestic market growth brought about by the construction of major railway networks in the late 1880s. Furthermore, as large industrial conglomerates requiring voluminous financial resources to fund their operations appeared, manager’s concerns turned to capital structure-related decisions Dewing concluded that the focus of financial managers was to protect the company from bankruptcy and promote its financial restructuring. Figure 1.2: Evolution The 1920s and 1930s saw the development of new industries and an intensification of merger activity. Although this was a period of growth, price fluctuations and a scarcity of resources reinforced the relevance of managing the capital structure, and studies on liquidity, budgeting techniques, and financial recovery stood out, particularly after the effects of the 1929 crash. This so-called traditional approach would remain the predominant one until the end of World War II, manifest as an interest in matters concerning capital structure and the funding process. In this sense, emphasis was placed on sources of resources. However, the early 1950s brought rapid economic expansion, pushing internal controls for accounts receivable, accounts payable, and inventory into the spotlight. The post-war period therefore saw a change of focus in finance studies, which began to feature the dominance of internal routines and the concern with organizational structure that characterize the administrative approach, according to Archer and D’Ambrosio. In addition to the raising of resources, the management of cyclic assets gained importance during this economic phase that required firms to improve their organizational performance, and financial management was forced to evolve in this aspect. Between the late 1950s and the early 1960s, corporate profitability was reduced, and the appearance of new companies meant that resources became scarce for traditional firms. The study of capital costs with a view to analysing the feasibility of investments also gained 9 CU IDOL SELF LEARNING MATERIAL (SLM)

importance, as did trying to deepen understanding of the international economy; it was a time to search for new markets. Project viability analysis and internationalization, the latter as a means of seeking out new investment opportunities, brought the financial management function closer to the concepts of economic theory. It bears stressing that, until the 1950s, the study of the financial management function was normative, in that it focused on defining improved investment and funding policies; there was no emphasis on the effect of these policies on company value. Only after the 1950s did a change in focus occur in the finance literature, towards a positive approach, when scholars sought to understand the consequences of these decisions on company value. This advancement represented the understanding of the relationship between funding and investment decisions. 1.3 MEANING 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. Financial management may be defined as the area or function in an organization which is concerned with profitability, expenses, cash and credit, so that the \"organization may have the means to carry out its objective as satisfactorily as possible;\"the latter often defined as maximizing the value of the firmforstockholders.Financial managers(FM) are specialized professionals directly reporting tosenior management, often the financial director (FD); the function is seen as 'Staff', and not 'Line'. Figure 1.3: SMART 10 CU IDOL SELF LEARNING MATERIAL (SLM)

In words of Solomon, “Financial management aims to effectively use the capital funds which also happens to be a significant economic resource.” Financial management definition by different author – Phillippatus has given a more amplified meaning of financial management. According to him “Financial Management is concerned with the managerial decisions that results in the acquisition and financing of short and long term credits for the organizations”. In views of Howard and Upton, “Financial management should be considered as an application of general managerial principles to the area of financial decision-making.” According to Weston and Brigham, “Financial management is province of financial decision- making, harmonizing individual motives and enterprise goals”. Financial management is the core of entire finance study. The term financial management also has lots of definitions. Out of all the definitions most popular and widely accepted definition of financial management is delivered by S.C. Kuchhal. According to him, “Financial Management deals with procurement of funds and their effective utilization in the business.” In simple concept financial management means, if you save me today – I will save you tomorrow. In this competitive era, funds are acquired from several sources. The procurement of these funds has always been reckoned as a stumbling block. The characterization of funds procured from different sources varies in terms of cost, risk, management and control. A smart manager will know that the funds should be procured at minimum cost, at a balanced risk and control factors. In order to meet the needs of investors, often organizations and firm sign multiple option convertible bonds. For example, funds can be generated from abroad as well. The two prominent sources of capital from abroad are – Foreign Direct Investment (FDI) and Foreign Institutional Investors (FII). Other contributors amongst foreign based investors are American Depository Receipts (ADR’s) and Global Depository Receipts (GDR’s). Proper analysis of utilization of those procured funds is the job of a financial manager. He is responsible for informing the firm or an individual that whether or not their funds are optimally allocated. To accomplish this task, the financial manager is expected to be knowledgeable, tactful and witty. He should understand the demands and requirement of the individual or the firm and should come up with some strategically rationalized plan so that the latter one can enjoy optimally. 1.4 SCOPE OF FINANCIAL MANAGEMENT Financial management helps a particular organisation to utilise their finances most profitably. This is achieved via the following three conducts. Investment Decision 11 CU IDOL SELF LEARNING MATERIAL (SLM)

Investment decision depicts investing in a fixed asset; it is also referred to as capital budgeting. Investment decisions can be of either long-term or short-term basis. Long-term investment decisions allow committing funds towards resources like fixed assets. Long-term investment decisions determine the performance of a business and its ability to achieve financial goals over time. Short-term investment decisions or working capital financing decisions mean committing funds towards resources like current assets. It occupies funds for a shorter period, including investments in inventory, liquid cash, etc. Short-term investment decisions directly affect the liquidity and performance of an organisation. The investment decision involves the evaluation of risk, measurement of cost of capital and estimation of expected benefits from a project. Capital budgeting and liquidity are the two major components of investment decision. Capital budgeting is concerned with the allocation of capital and commitment of funds in permanent assets which would yield earnings in future. Capital budgeting also involves decisions with respect to replacement and renovation of old assets. The finance manager must maintain an appropriate balance between fixed and current assets in order to maximise profitability and to maintain desired liquidity in the firm. Capital budgeting is a very important decision as it affects the long-term success and growth of a firm. At the same time it is a very difficult decision because it involves the estimation of costs and benefits which are uncertain and unknown. Financing Decision This scope of financial management indicates the possible sources of raising finances from various resources. They are of 2 different types. Financial planning decisions attempt to estimate the sources and possible application of accumulated funds. A proper financial planning decision is crucial to ensure the availability of funds whenever required. Capital structure decisions involve identifying various sources of funds. It facilitates the selection of the best external sources for short or long-term financial requirements. While the investment decision involves decision with respect to composition or mix of assets, financing decision is concerned with the financing mix or financial structure of the firm. The raising of funds requires decisions regarding the methods and sources of finance, relative proportion and choice between alternative sources, time of floatation of securities, etc. In order to meet its investment needs, a firm can raise funds from various sources. The finance manager must develop the best finance mix or optimum capital structure for the enterprise so as to maximise the long- term market price of the company’s shares. A proper 12 CU IDOL SELF LEARNING MATERIAL (SLM)

balance between debt and equity is required so that the return to equity shareholders is high and their risk is low. Use of debt or financial leverage effects both the return and risk to the equity shareholders. The market value per share is maximised when risk and return are properly matched. The finance department has also to decide the appropriate time to raise the funds and the method of issuing securities. Dividend Decision In order to achieve the wealth maximisation objective, an appropriate dividend policy must be developed. One aspect of dividend policy is to decide whether to distribute all the profits in the form of dividends or to distribute a part of the profits and retain the balance. While deciding the optimum dividend pay-out ratio (proportion of net profits to be paid out to shareholders The finance manager should consider the investment opportunities available to the firm, plans for expansion and growth, etc. Decisions must also be made with respect to dividend stability, form of dividends, i.e., cash dividends or stock dividends, etc. It involves decisions taken with regards to net profit distribution. It is divided into two categories.  Dividend for the shareholders.  Retained profits (usually depends on a particular company’s expansion and diversification plans). Working Capital Decision Working capital decision is related to the investment in current assets and current liabilities. Current assets include cash, receivables, inventory, short-term securities, etc. Current liabilities consist of creditors, bills payable, outstanding expenses, bank overdraft, etc. Current assets are those assets which are convertible into a cash within a year. Similarly, current liabilities are those liabilities, which are likely to mature for payment within an accounting year. 1.5 OBJECTIVES OF FINANCIAL MANAGEMENT Financial management is that managerial activity that is involved in planning and controlling of firm’s financial resources. It is concerned with acquiring, financing, and managing assets to accomplish the overall goal of a business enterprise. Every beginner needs to start a business or a company with financial knowledge and management strategies. Finance is directly linked to various departments like marketing, production, and personnel. For any business, it is important that it expects the investments to be made in such a manner that returns are higher than the cost of finance. 13 CU IDOL SELF LEARNING MATERIAL (SLM)

In a nutshell, financial management reduces the cost of finance, ensures sufficient availability of funds, and effective utilization of funds. J.E. Brandley defines financial management as that area of business management devoted to judicious use of capital and a careful selection of the source of capital in order to enable a spending unit to move in the direction of reaching the goals.  Profit maximization: This is the main objective of financial management. The finance manager strives to achieve optimal profit in the short term and long-term course of business. The finance manager shall try to achieve as high as profits. The company makes a decent profit in the long run if the finance manager makes the proper decisions using the various methods and tools available.  Wealth maximization - It means shareholders’ value maximization. Wealth maximization means earning maximum wealth for shareholders. So, the finance manager tries to give maximum dividends to shareholders. The dividend declaration and pay-out policy are decided by financial management. Dividend decisions include a proper dividend policy regarding the distribution or retaining of company profits. This is related to the performance of the company. Better the performance, the higher is the market value of shares. In nutshell, the finance manager tries to maximize shareholders’ value.  Proper mobilization: Mobilization of finance is an important objective of financial management. It means utilizing effectively the sources of finance. The finance manager can manage various sources of funds such as shares, debentures, after estimating the financial requirements, the finance manager must decide about the sources of finance.  Increase efficiency: Financial management tries to increase the efficiency of all sections of the company. Proper distribution of finance to all departments increases the efficiency of the entire company.  Proper estimation of total financial requirements: This means that the finance manager would be able to estimate the financial requirements of the company. He should be able to compute how much financing is required to start and run the business/ He shall estimate the fixed and working capital requirements of the company. If not, there will be a shortage or surplus of finance. The finance manager shall use various factors like the technology used by the company, the number of employees used, the scale of operations, and legal requirements.  Proper utilization of finance: The finance manager must make optimum utilization of finance. This can be done by using various financial tools as managing receivables, effective payment policy in hand, and better inventory management. 14 CU IDOL SELF LEARNING MATERIAL (SLM)

 Maintaining proper cash flow: The financial manager shall ensure that there is a regular supply of liquidity in the company monitoring closely all the cash inflows and outflows reducing the instances of underflow and overflow of cash. The finance manager is entrusted with the responsibility to maintain an optimum level of liquidity. Healthy cash flow improves the chances of survival and success of the company.  Survival of company: The company must survive in this competitive business world. Hence, the finance manager shall take all the decisions intuitively. The big decisions shall be taken with proper due diligence and consultancy with consultants.  Creating reserves: The higher the reserves, the better it will be for the company to overcome uncertainty. The company shall have an optimal dividend pay-out policy that will help itself to create reserves over the year. It must also keep the profits as reserves. The reserves can be used for the expansion of the company and overcoming uncertainty. It can also be used to face contingencies in the future.  Reduce the cost of capital: This includes risk evaluation, measuring the cost of capital, and estimating benefits out of a particular project. Managers are responsible for deciding how available funds should be invested in fixed or current assets to get the best available returns.  Reduce operating risks: The company goes through various risks and uncertainties. The finance manager must take steps to reduce these risks. This can be done by avoiding high-risk allocation of capital for expansion All the decisions shall be taken with proper consultancy.  Prepare capital structure: This means bringing a proper balance between the different sources of capital. This balance is necessary for liquidity, economy, flexibility, and stability. 1.6 PROFIT MAXIMIZATION In the supply and demand graph, the output of Q* is the intersection point of MR and MC. The firm produces at this output level can maximize profits. (MR=MC) When produced less than Output of equilibrium quantity (Q*), as the red part showed, MR is greater than MC. The firm produce extra output because the revenue of gaining is more than the cost to pay. So, total profit will increase. However, if the output level is greater than Q*, MR<MC as the blue part showed. The firm profit will decrease because the extra unit level increase the cost which is greater than the revenue. So, total profit will decrease. There are several perspectives one can take on profit maximization . First, since profit equals revenue minus cost, one can plot graphically each of the variables revenue and cost as functions of the level of output and find the output level that maximizes the difference (or this can be done with a table of values instead of a graph). Second, if specific functional forms are 15 CU IDOL SELF LEARNING MATERIAL (SLM)

known for revenue and cost in terms of output, one can use calculus to maximize profit with respect to the output level. Third, since the first order condition for the optimization equates marginal revenue and marginal cost, if marginal revenue (mr) and marginal cost(mc) functions in terms of output are directly available one can equate these, using either equations or a graph. Fourth, rather than a function giving the cost of producing each potential output level, the firm may have input cost functions giving the cost of acquiring any amount of each input, along with a production function showing how much output results from using any combination of input quantities. In this case one can use calculus to maximize profit with respect to input usage levels, subject to the input cost functions and the production function. The first order condition for each input equates the marginal revenue product of the input (the increment to revenue from selling the product caused by an increment to the amount of the input used) to the marginal cost of the input. For a firm in a perfectly competitive market for its output, the revenue function will simply equal the market price times the quantity produced and sold, whereas for a monopolist, which chooses its level of output simultaneously with its selling price. In the case of monopoly, the company will produce more products because it can still make normal profits. To get the most profit, you need to set higher prices and lower quantities than the competitive market. However, the revenue function takes into account the fact that higher levels of output require a lower price in order to be sold. An analogous feature holds for the input markets: in a perfectly competitive input market the firm's cost of the input is simply the amount purchased for use in production times the market-determined unit input cost, whereas a monopsonist’s input price per unit is higher for higher amounts of the input purchased. The principal difference between short-run and long-run profit maximization is that in the long run the quantities of all inputs, including physical capital, are choice variables, while in the short run the amount of capital is predetermined by past investment decisions. In either case there are inputs of labour and raw materials. Limitations of profit maximization The limitations of the concept of profit maximization are low, and any behaviour will not only bring a certain level of profit. On the contrary, there can produce many different profit levels, and each profit level can happen. Any costs incurred by a firm may be classed into two groups: fixed costs and variable costs. Fixed costs, which occur only in the short run, are incurred by the business at any level of output, including zero output. These may include equipment maintenance, rent, wages of employees whose numbers cannot be increased or decreased in the short run, and general upkeep. Variable costs change with the level of output, increasing as more product is generated. Materials consumed during production often have the largest impact on this category, which also includes the wages of employees who can be hired and laid off in the short-run span of time under consideration. Fixed cost and variable cost, combined, equal total cost. 16 CU IDOL SELF LEARNING MATERIAL (SLM)

Revenue is the amount of money that a company receives from its normal business activities, usually from the sale of goods and services (as opposed to monies from security sales such as equity shares or debt issuances). The five ways formula is to increase leads, conversation rates, average dollar sale, average number of sales and average product profit. Profits can be increased by up to 1000 percent, this is important for sole traders and small businesses let alone big businesses but none the less all profit maximization is a matter of each business stage and greater returns for profit sharing thus higher wages and motivation. Marginal cost and marginal revenue, depending on whether the calculus approach is taken or not, are defined as either the change in cost or revenue as each additional unit is produced, or the derivative of cost or revenue with respect to the quantity of output. For instance, taking the first definition, if it costs a firm $400 to produce 5 units and $480 to produce 6, the marginal cost of the sixth unit is 80 dollars. Conversely, the marginal income from the production of 6 units is the income from the production of 6 units minus the income from the production of 5 units. 1.7 SHAREHOLDER’S WEALTH MAXIMIZATION (SWM) From the various objectives proposed for a business concern, shareholders’ wealth maximization is considered the most appropriate and sustainable objective for a business concern. Shareholder’s wealth maximization criterion proposes that a business concern should only consider the decisions that maximize the market value of the share or the shareholders’ wealth. The market value of share is treated as an indicator of efficiency and effectiveness of the firm. Finance theory asserts that shareholders’ wealth maximization is the single substitute for shareholders’ utility. When the firm maximizes the shareholders’ wealth, the individual shareholder can use this wealth to maximize his individual utility. It means that by maximizing shareholders’ wealth the firm is consistently operating towards maximizing shareholders’ utility. Although this criterion has proved superior to objectives proposed earlier, yet it does not find significant use in the industry primarily due to its complexity in understanding, calculation and application. The article does not recommend any new conceptual model or framework but provides an elementary base for an imminent exhaustive exploration of the said objective in present business context, as the shareholders’ wealth maximization is intensely an interdisciplinary and multidisciplinary concept in its philosophical underpinnings. The modern finance theory operates on the assumption that the only objective of a business concern should be to maximize the market value of the share or shareholders’ wealth. 17 CU IDOL SELF LEARNING MATERIAL (SLM)

Shareholders’ wealth is expressed by the relation; SW (Shareholders’ Wealth) = n x MV (Number of Shares held x Market Value Per Share). It is clear from the expression that given the number of shares held, the shareholders’ wealth can be maximized by maximizing the market value per share. Hence conferring to this objective, every business decision should ultimately lead to maximization of the market value of the share. According to the shareholders’ wealth maximization (SWM) criterion a business concern should undertake only those projects whose Net Present Value (NPV) is positive i.e. present value of cash inflows should be greater than present value of cash outflows. Hence, SWM is often translated as maximizing the Net Present Value (NPV) of a course of action to shareholders. Figure 1.4: SWM The projected net cash flows; EBDAT (Earnings before depreciation and after tax) are converted to their respective present values by discounting them with an appropriate discount rate (K). As per the contemporary finance theory, the best rate to discount the cash flows of a firm is the Opportunity Cost of Capital (K). The Opportunity Cost of Capital (K) is the rate of return on alternative investments of equivalent risk or the rate of return on the next best alternative investment. The expected cash flows of risky investments are discounted at a higher rate while that of a safer investment are discounted at lower rate. Projects or investments whose NPV is positive are recommended as they increase the market value of the 18 CU IDOL SELF LEARNING MATERIAL (SLM)

shares, hence increasing the shareholders’ wealth, while investments with negative NPV reduces the shareholders’ wealth and hence should be rejected. A firm would be indifferent regarding projects with zero NPV as they keep the shareholders’ wealth unchanged. Further, in accordance with SWM criterion, in all the financial decisions; investment, financing and dividend, the risk relationship must be optimized (Risk-Return Trade-off) i.e. maximizing return while minimizing risk, as presented in Figure II. For instance new or innovative investments can fetch above average returns for a firm but they also expose the firm to higher risk while safer investments can only fetch average profits for the firm while reducing risk exposure. Hence, a financial manager has to ensure best returns for an investment while minimizing the risk exposure. If a firm employs financial leverage for financing its investments, it will be able to retain its control and minimize its overall cost of capital on account of lower cost of debt and interest tax shield, but it is simultaneously exposed to greater financial risk. Financial risk in this case is created due to the fact that the obligations of debt-holders or creditors are legal. Creditors have priority claims on income and assets of a firm. If their claims in terms of payment of interest or principal are not met, they may enforce the firm to liquidate its assets. Equity financing on the other hand does not expose the firm to financial risk as shareholders will not liquidate a firm due to their residual claims on income and assets and due to their priority claims on ownership of the business concern. But due to high cost and the tax burden associated with it, equity financing increases the overall cost of capital of the firm. Further it dilutes the ownership of a business concern. Keeping in view the risk and return associated with financing decision, here the manager has to ensure an optimal capital structure i.e. best mix of debt and equity funds which minimizes the overall cost of capital and maximizes the market value of share. Similarly, in dividend decision a firm faces the risk and return trade-off. In dividend decision, the financial manager has to strike a balance between pay out and retention of dividend and also the issue of bonus shares. A higher dividend pay-out may convince the shareholders of a concern but due to external financing its cost of capital will increase hence reducing the profitability. As an alternative, if the concern retains the dividend and reinvests it, the cost of capital will significantly reduce while increasing the profitability. But such a decision will increase the risk for the firm so far as the shareholders are concerned. Hence in dividend decision a manager has to ensure optimum pay-out and retention ratio in consideration with the risk and return associated with them. Finally, in the short term investment or liquidity or working capital management decision also risk return trade-off exists. Here this trade-off is expressed 19 CU IDOL SELF LEARNING MATERIAL (SLM)

in terms of the relation between liquidity and profitability. If a business concern keeps higher liquidity level i.e. increases the level of cash and cash equivalents, it will be timely able to cover its liabilities thus reducing risk, but due to increased idle funds it will lose profitable opportunities. Now if the liquidity level is decreased, funds will be mobilized from savings to investment which will increase the returns for the concern, but due to decreased level of cash and cash equivalents the firm is exposed to higher degree of risk. Hence, there is wedge between liquidity and profitability in terms of risk and return which must be optimized in terms of an optimum level of cash and cash equivalents. The shareholder wealth maximization (SWM) principle states that the immediate operating goal and the ultimate purpose of a public corporation is and should be to maximize return on equity capital. The SWM specification of what is often termed the corporate objective makes operating goal and ultimate purpose the same: Managers and investors should focus narrowly on SWM. The question of whether the corporate objective can be a strict emphasis on SWM or must recognize significant differences between the operating goal for managers and investors and the ultimate social purpose of the public corporation lies at the intersection of three literatures. In economics and finance literature, SWM is a standard assumption. This SWM operating goal is expected to yield the most socially efficient allocation of capital. Business ethics, corporate social responsibility, and stakeholder theory literature emphasizes significant differences between an operating goal of SWM and the ultimate social purpose of the public corporation. Corporation law addresses duties, responsibilities, and rights of both financial and nonfinancial stakeholders. In the United States, the business judgment rule and in various states corporate constituency statutes permit relaxation in SWM as an operating goal in favour of stakeholder and social considerations. This chapter addresses ethical considerations concerning the SWM principle and its managerial implications. A key factor in understanding SWM is that the public corporation is simultaneously private property, a web or nexus of contracts, a governmentally licensed and traded securities registrant, a social benefits entity, and a locus of stakeholder relationships. This introduction explains some basic points of general relevance. The second section discusses the historical background of SWM and some technical considerations including measurement issues. The third section explains justifications for SWM. The fourth, fifth, and sixth sections explicate three critiques of SWM arising from (1) business ethics and corporation law, (2) corporate social responsibility (CSR), and (3) stakeholder theory. The chapter concludes with a summary of the arguments for and against SWM and their implications for managers. 20 CU IDOL SELF LEARNING MATERIAL (SLM)

1.8 SUMMARY  Shareholder wealth maximization focuses on the motives and behaviours of financial stakeholders. The thesis of separation of ownership and control (Berle and Means 1932) posits that principals (or shareowners) employ agents (or management) who must have some reasonable discretion (e.g., the business judgment rule). At law, officers and directors have a fiduciary duty to safeguard the financial interests of the shareholders (or shareowners).  The SWM principle can be stated, however, in two forms. The stronger form argues that, within any set of legal and ethical constraints, the corporate objective is and should be strictly SWM. The operating goal and ultimate purpose of the public corporation are the same. Fiduciary duty ought therefore to be tightly focused on SWM. From this viewpoint, CSR activity is inappropriate wealth-decreasing altruism unless it yields future positive returns to the firm.  This strong form associates with the views that legal and ethical constraints on corporate activity ought to be minimal and that institutions (including common law and social norms) should be market-facilitating. A multinational corporation may be able to select sets of legal and ethical constraints, varying by country, within which it will operate. There may be a significant difference between management’s operating goal and the ultimate social purpose of the public corporation.  A weaker form therefore relaxes the strict formulation to a more nuanced argument that the corporate objective is and should be primarily SWM. A relaxation admits, beyond legal and ethical constraints, consideration of CSR and interests of nonfinancial stakeholders. The relaxation understands that managerial responsibility is more complicated than mere fiduciary duty. The relaxation accepts that legal and ethical constraints are and ought to be stronger than minimalist (Windsor 2008). One must decide which view to accept.  One way to combine strong and weak forms is to argue that shareowners can and do make pragmatic choices that best protect their financial interest. A combined approach retains the financial goal and market context of the strong form but expects shareowners to figure out how best to address agents, nonfinancial stakeholders, and gatekeepers. The shareowners may decide to act in accord with the weak form in order to advance the SWM goal posited in the strong form.  This chapter explains three key objections to a strong SWM formulation of the corporate objective. These objections are logically admitted by any nuanced statement of SWM as a primary rather than as a singular goal for managers. As previously explained, a goal and a purpose need not be the same. The narrow (but socially penultimate) goal of investors is to maximize financial return. The broader (and 21 CU IDOL SELF LEARNING MATERIAL (SLM)

ultimate) purpose of a public corporation, a rationale for government licensing, is generation of social benefits.  Both corporate social performance (CSP) and financial performance should be positive. The three objections are as follows. First, business ethics functions as a set of supralegal constraints on managerial conduct to avoid wrong acts and social harms. Second, CSR is a justification for corporate contribution of social goods in addition to legal compliance and business ethics. Third, stakeholder theory argues that any business must be a multiple-constituency and a social entity. A continuing debate concerns whether these three objections (business ethics, CSR, and stakeholder theory) justify basic changes in corporate governance principles and/or corporate purpose.  Two competing views about multiple principles can be articulated. A monotonic SWM view is that any two or more principles must be strictly hierarchical. Legal and ethical constraints can be antecedent conditions. “Sometimes the aims of the business and rational self-interest will clash with ethics, and when they do, those aims and interests must give way”. Considerations of CSR and stakeholder satisfaction would be subordinate to SWM and function as strategic variables only. A competing view is that two or more corporate goals should be pursued simultaneously. The firm serves a diverse set of social goals. Either there is some win-win combination of goals or else multiple goals must be balanced in some way. An ongoing controversy concerns whether observable varieties of capitalism, addressing these matters differently, will converge or continue to diverge. 1.9 KEYWORDS  Abatements: A term referring to the refund of previously paid property taxes due to the over-valuation of property.  Accrual Basis: The basis of accounting under which revenues are recorded when earned and expenditures are recorded as soon as they result in liabilities for benefits received.  Accrued Interest: Interest accrued on a bond or other fixed income security since the last interest payment was made. At the time of a sale, the buyer of a bond pays the market price plus accrued interest to the seller. Exceptions are bonds that are in default (termed to be ‘trading flat’). Accrued interest is calculated by multiplying the coupon rate by the number of days that have elapsed since the last payment.  Adjusted Gross Income (AGI): Total income from all taxable sources less certain expenses incurred in earning that income. 22 CU IDOL SELF LEARNING MATERIAL (SLM)

 Adopted Budget: Refers to the budget amounts as originally approved by the county’s legislative body. 1.10 LEARNING ACTIVITY 1. Create a survey on financial management. ___________________________________________________________________________ ___________________________________________________________________________ 2. Create a session on objective of financial management. ___________________________________________________________________________ ___________________________________________________________________________ 1.11 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is the financial management? 2. Why financial management need for business? 3. Define finance? 4. What is profit maximization? 5. What is wealth maximization? Long Questions 1. Explain the functions of financial management. 2. Elaborate the scope of financial management. 3. Illustrate the objectives of financial management. 4. Discusson the evolution of financial management. 5. Examine the concept of SWM. B. Multiple Choice Questions 1. What is the basic objective of financial management? a. Maximization of profit b. Maximization of shareholder’s wealth c. Ensuring Financial discipline in the firm d. All of these 23 CU IDOL SELF LEARNING MATERIAL (SLM)

2. What does financial structure refer to? a. Short-term resources. b. All the financial resources. c. Long-term resources. d. All of these 3. What is the market value of the firm is the result of? a. Dividend decisions b. Working capital decisions. c. Capital budgeting decisions. d. Trade- off between risk and return 4. What is Cost of capital? a. Lesser than the cost of debt capital b. Equal to the last dividend paid to the equity shareholders. c. Equal to the dividend expectations of equity shareholders for the coming year. d. None of these 5. What does D stands for in Walter model formula? a. Dividend per share b. Direct dividend c. Direct earnings d. None of these Answers 1-b, 2-b, 3-d, 4-d, 5-a 1.12 REFERENCES References  Abor, J& Biekpe, N. (2005). What determines the capital structure of listed firms in Ghana? African Finance Journal.  Adam, T. & Goyal, V, K. (2008). The investment opportunity set and its proxy variables. The Journal of Financial Research. 24 CU IDOL SELF LEARNING MATERIAL (SLM)

 Akinboade, O, A&Makina, D. (2006). Financial sector development in South Africa, 1970-2002. Studies in Economics and Econometrics. Textbooks  Al Najjar,B. (2011). Empirical modelling of capital structure: Jordanian evidence. Journal of Emerging Market Finance.  Ameer, R. (2003). Financial liberalisation and capital structure dynamics in developing countries: evidence from emerging markets of South East Asia. ABS Finance Working Paper.  Anderson, T, W& Hsiao, C. (1982). Formulation and estimation of dynamic models using panel data. Journal of Econometrics. Website  https://www.researchgate.net/publication/331465338_Shareholders_Wealth_Maximiz ation_Objective_of_Financial_Management_Revisited/link/5c7a2ced299bf1268d30b 730/download  https://www.economicsonline.co.uk/Definitions/Profit_maximisation.html  https://www.vedantu.com/commerce/scope-of-financial-management 25 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-2 FINANCE FUNCTIONS STRUCTURE 2.0 Learning objective 2.1 Introduction 2.2 Investment Decision 2.3 Financing Decision 2.4 Dividend Decisions 2.5 Finance Function 2.6 Organization Structure 2.7 Summary 2.8 Keywords 2.9 Learning Activity 2.10 Unit End Questions 2.11 References 2.0 LEARNING OBJECTIVE After studying this unit, you will be able to  Explain the idea of investment decision.  Illustrate the concept of financing decision.  Explain the perception of dividend decision. 2.1 INTRODUCTION In general, finance is defined as the provision of money at the time It is required. Specifically it is defined as procurement of funds and their effective utilisation. Financial management is defined as the management of flow of funds in a firm. All business decisions have financial implications and therefore financial management is inevitably related with every aspect of business operations. Rip Van Winkle had gone to sleep in the early 1970s and woken up 30 years later, he would recognise little of today’s financial landscape. True, there are companies with shareholders, and banks and stock exchanges; and there are still plenty of lawyers and bankers who help to transfer money from one pocket to another so that companies can raise the finance they need and business may be done. But the way the money is raised and the speed with which it is 26 CU IDOL SELF LEARNING MATERIAL (SLM)

done have changed virtually beyond recognition. Thirty years ago, banks were still the main source of finance for most big companies, especially in Japan and continental Europe. Today, for the most part, banks play second fiddle to the equity and bond markets for big companies; even in Germany and Japan, the part played by banks has diminished. Equity and bond markets have become more international and have extended their influence in ways that would have been unimaginable 30 years ago. Compared with their counterparts of even a decade ago, today’s financial institutions are not only more diverse, both geographically and in terms of their businesses, they are also better capitalised. In 1990, the biggest financial firms were commercial banks, most of them Japanese, whose main function was the taking of deposits and the making of loans. At that time, banks in continental Europe were typically engaged in a broader range of activities than their US counterparts which, under the Glass- Steagall Act, since repealed, had to choose between commercial banking, investment banking and specialist financial services such as insurance. Nowadays, by far the largest firms are financial-services conglomerates. These combine commercial banking with a range of other financial services, such as underwriting bond and equity issues and advising on mergers and acquisitions. They also provide consumer finance and sell on loans to other investors, for example, by arranging syndicates, buying and selling derivatives, and issuing securities backed by mortgages, credit-card receivables and the like. In 1990, the list of the top 15 financial firms by market capitalisation was dominated by Japanese banks, the largest of which had a stock market capitalisation of $57 billion. A decade later, partly because of a spate of mergers among such firms, international financial-services groups took up most of the places; and the biggest (Citigroup) was then capitalised at more than $250 billion. The sheer size of the conglomerates has undoubtedly helped them to withstand the shocks that have beset the banking system since the dotcom boom turned to bust and stock markets began to slide. Between 1998 and 2001, according to the Federal Reserve, America’s central bank, telecommunications firms worldwide alone borrowed around $1 trillion. Many of these loans have since had to be written off because their borrowers went bankrupt. In quick succession in the United States, Enron, WorldCom, Global Crossing and others collapsed. Yet in contrast to previous setbacks following similar bouts of overexuberance and overinvestment, banks were able to continue lending to companies that needed money. The growth of sophisticated debt markets also helped to reduce companies’ reliance on bank credit and equity to finance their operations. As a result, the US economy in particular was able to maintain a faster pace of growth than many had feared. That J.P. Morgan Chase was able to absorb the billions of dollars in losses that resulted from the collapse at the end of 2001 of Enron, an energy-trading company, speaks volumes not just about the size of J.P. Morgan Chase’s balance sheet, but also about its ability to spread the risk by selling derivatives to other investors. In the 1980s, a loss on the scale of Enron, then one of the world’s biggest companies, might have toppled Texas’s banking system. In the event, Texas was spared by the deregulation of state banking laws that subsequently took place, which allowed J.P. Morgan Chase (itself an amalgam of two big banking groups) to buy Texas Commerce Bank, 27 CU IDOL SELF LEARNING MATERIAL (SLM)

one of Enron’s biggest lenders. It is true that banks have successfully shifted a large proportion of their risk on to others, and this has helped them to withstand a welter of shocks internationally. But are banks really as adept at diversifying this risk as they like to think? Are those to whom they are passing the risk capable of managing it, particularly if markets remain volatile? In short, could the shift from a system reliant on banks to one based largely on markets contain dangers of its own? One worry is that insurance companies – not always the most sophisticated of investors – have taken on part of the risk that banks and other intermediaries in the financial markets are shedding. Swiss Re and Munich Re, two of the world’s biggest insurers, between them account for a large proportion of credit derivatives outstanding. Credit derivatives are securities that allow banks to pass on to other investors the risk that some of their borrowers will default. Insurance companies have also been big buyers of asset-backed securities, financial instruments backed by pools of loans and other forms of debt. If insurance companies were unable to meet their liabilities and went bust, there is a danger that the problems would rebound on the banks. Another worry is that, with fewer and larger international banks, the pressure to succeed on even the best-managed banks may reach a point where they make mistakes on a colossal scale. Consolidation also brings dangers of its own. Take the foreign-exchange markets. 2.2 INVESTMENT DECISION This thesis is concerned with the investment decision-making process in small manufacturing enterprises, focusing specifically on the printing and clothing industries and the extent to which investment decisions in these firms are based on previous learning experiences of owner-managers. It is also concerned with how capital investment is financed in these industries. Previous researchhas emphasised how these two industries have very different technology bases and different levels of expenditure. This has potential implications for the investment decision-making process faced by owner-managers of these industries in terms of the scale of investment and the level of uncertainty involved. The focus on manufacturing enterprises is justified because they are more likely to be active in introducing changes in production processes and investing in more modem technology than firms involved in service activity. There is also the belief that it is this sector which is of crucial importance to the achievement of long-term sustainable economic growth in local and regional economiesand in which more substantial investment is required compared to services. The study is justified on many grounds. Firstly, the majority of decision-making studies attempt to explain behaviour using assumptions and methods which do not take into consideration the actual motives of the actors themselves. More specifically, Deakinspoint out that despite the increased attention paid to owner-managers in the small firm sector, little is known about the process of financial management and decision-making in small firms and the entrepreneurship process. Therefore, this study attempts to shed light on the process issue by 28 CU IDOL SELF LEARNING MATERIAL (SLM)

investigating how small manufacturing enterprises behave compared with what the theories and the literature have suggested about investment decision-making. It uses a methodological approach that incorporates the actual motives, values, beliefs and intentions of owner- manager. Figure 2.1: Investment Decisions Secondly, investment is the key to the success of any business organisation, be it large or small, helping towards the creation of jobs in the economy and the achievement of competitiveness through innovation and quality factorsas well as through cost reduction, new product development and product differentiation. For example, the ability of new manufacturing technologies to produce smaller batches at low cost and the enhanced greater flexibility of manufacturing operations means that small manufacturing enterprises are able to benefit from \"faster customer response, quick production, more 'customisation! and greater variety\". 29 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 2.2: Invest Small manufacturing enterprises (especially small printing firms) are increasingly facing competition within the UK and in Europe which means that their responsiveness to customer demand is an important factor influencing their competitiveness. This in turn has potential implications for investment. Barkhamargue that \"competition has removed whole industries and reduced once mighty firms to shadows of their former selves\" and that \"deep recessions have made it difficult to plan and to commit large-scale capital investment Yet very few manufacturing firms can survive without incurring some capital expenditure each year. Harvey-Jonespoints out that \"there is an intrinsic impermanence in industry, and indeed the management task is to recreate the company in a new form every year\". Capital investment is the main means by which the company is 'recreated' year by year, but such decisions require a clearly understood process. Thirdly, investment decisions designed to match equipment purchases closely to market requirements are essential if investment is to be cost-effective. Therefore, to encourage small manufacturing enterprises in their investment decisions, it is necessary to understand first the barriers faced by these firms and the motivations of owner managers. These barriers are inherent in the small firm sector and range fi-om, limited resources (including investment finance and managerial expertise) to varied objectives and 30 CU IDOL SELF LEARNING MATERIAL (SLM)

the concentration of decision making in the hands of one or two owners who are closely involved in the day to day operation of the business. It is also necessary to understand the uncertain and risky nature of the small firm operating environment. 2.3 FINANCING DECISION The field of finance is often divided into two parts: Corporate (or Managerial) Finance which deals with financial decisions made by managers of a company, and Investments, which focuses on how individuals or professional investment companies decide how to invest. This class will look at both parts of finance. While not everyone will be involved in the financial decisions of the company they work for, everyone in business needs to be able to talk to financial managers and understand what they are doing. An even if you are not involved in financial matters at work, you will certainly be making investment decisions over the course of your lifetime. While the situations seem different, they actually involve very similar kinds of financial decisions. In each case, the demander of funds needs to determine the options available for raising the funds, how much it will cost, and given that cost, whether it is worthwhile to borrow the money. For example, the company expanding into South America will have to weigh the costs and benefits of issuing stock or bonds or borrowing from a bank. Once they find the cost of raising the $200 million they will have to assess whether the expected profits from their South American operations outweigh the costs of the loan. The opposite of demanders of funds are the suppliers of funds. They provide the money that the borrowers want. Some examples of suppliers of funds, and the kinds of decisions they must make. In common language, risk usually means the chance that something bad will happen. In a financial context, risk often means the same as uncertainty; the chance that something other than expected will happen, whether it is better or worse. For example, in the context of stock prices, you might expect to get a return on your investment of 8%, but it could be less than that if stock prices fall (which is bad), or more than that if stock prices increase dramatically (which is good). The problem is that while you expect to earn around 8%, you are not sure exactly what you will get. That is financial risk. An interest rate is the cost of borrowing money, expressed as percentage of the amount borrowed. If you borrow $1,000 at a 10% interest rate it means that when you pay back the loan you must pay the $1,000 plus $100 in interest ($100 = $1,000*0.1). Interest rates show up all the time in financial transactions, even when the transaction doesn’t at first seem like a loan. When you deposit money in the bank, you are lending your money to the bank and the return you get is determined by the interest rate. But also, when you lease a car, you are paying for the use of the car over time, in essence, you are borrowing the money, and so built into you lease payments is an interest rate. 31 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 2.3: Finance What really matters for interest rates is not the borrowing and lending, but that the financial transaction is taking place over a period of time. When I lend you money, I won’t get it back until sometime later, and I could have been doing something else with my money during that time. Since I am giving up use of my money, you have to pay me for that. In effect, interest rates measure the value of time. Interest rates are the cost of a loan because loans take place over time. Anytime you have a financial transaction that takes place over time, look for an interest rate. When we talk about interest rates it can be a bit confusing, since we sometimes talk as if there is a single interest rate, and yet actually there are a variety of different interest rates. When we say “interest rates” talking about interest rates in general, or “the interest rate”, we mean the average interest rate. The statement “the interest rate was high in the late 1970s”, and “interest rates were high in the late 1970s”, mean the same thing: interest rates in general were higher in the 1970s (compared with other years) but all interest rates in the 1970s weren’t necessarily the same. Companies have two main ways of raising funds: by issuing stocks and bonds. Bonds are like a loan, or an IOU. An investor gives the company money and in exchange the company promises to pay back the money plus interest in the future. The basic difference between a loan and a bond is that the bond can be bought and sold in the market. So if I initially buy the bond from the company, I can later turn around and sell the bond to someone else. The company would then make the payments to that individual. Stock is a different way for companies to raise money. Like a bond, a company issues stock in exchange for funds. However, unlike a bond, stock doesn’t promise payments in the future. Instead, owning stock 32 CU IDOL SELF LEARNING MATERIAL (SLM)

gives you partial ownership of the company, which means that you can get part of the profits the company earns. The financial system is the part of the economy that connects the demanders and suppliers of funds. When this is done directly through financial markets, such as when a company wanting to raise funds sells a bond to a household wanting to make an investment, it is called direct finance. However, not all demanders of funds use direct finance. Sometimes financing is done indirectly as when a company borrows money from a bank that gets its money from household deposits. Fundamentally, the same thing is happening, money goes from the household to the firm. The difference is that a third party is always in the middle of the relationship. Institutions that do this, such as banks, are called financial intermediaries, because they are “between” the borrowers and lenders. When companies raise funds through financial intermediaries it is called indirect finance. 2.4 DIVIDEND DECISIONS Once a company makes a profit, it must decide on what to do with those profits. They could continue to retain the profits within the company, or they could pay out the profits to the owners of the firm in the form of dividends. The dividend policy decision involves two questions: 1) What fraction of earnings should be paid out, on average, over time? And, 2) What type of dividend policy should the firm follow? I.e. issues such as whether it should maintain steady dividend policy or a policy increasing dividend growth rate etc. According to the Institute of Chartered Accountants of India, dividend is \"a distribution to shareholders out of profits or reserves available for this purpose.\" \"The term dividend refers to that portion of profit (after tax) which is distributed among the owners / shareholders of the firm”. In other words, dividend is that part of the net earnings of a corporation that is distributed to its stockholders. It is a payment made to the equity shareholders for their investment in the company. Dividend is a reward to equity shareholders for their investment in the company. It is a basic right of equity shareholders to get dividend from the earnings of a company. \"Dividend policy determines the ultimate distribution of the firm's earnings between retention (that is reinvestment) and cash dividend payments of shareholders.\" \"Dividend policy means the practice that management follows in making dividend pay-out decisions, or in other words, the size and pattern of cash distributions over the time to shareholders.\" In other words, dividend policy is the firm's plan of action to be followed when dividend decisions are made. It is the decision about how much of earnings to pay out as dividends versus retaining and reinvesting earnings in the firm. Dividend policy must be evaluated in light of the objective of the firm namely, to choose a policy that will maximize the value of the firm to its shareholders. The dividend policy of a company reflects how prudent its financial management is. The future prospects, expansion, diversification mergers are effected by dividing policies and for a healthy and buoyant capital market, both dividends and retained 33 CU IDOL SELF LEARNING MATERIAL (SLM)

earnings are important factors. As we know in corporation, owners are shareholders but management is done through Board of directors. It is the Board of Directors to decide whether to pay dividend or retain earnings for future projects. It is a matter of conflict between shareholders and directors. Shareholders expect a quick return on their capital. On the other hand, directors have to consider a number of factors in determining divided policy. Most of the company follows some kind of dividend policy. The usual policy of a company is to retain a position of net earnings and distribute the remaining amount to the shareholders. Many factors have to be evaluated before forming a long term dividend policy. Figure 2.4: Dividend Decision Companies mostly pay dividends in cash. A Company should have enough cash in its bank account when cash dividends are declared. If it does not have enough bank balance, arrangement should be made to borrow funds. When the Company follows a stable dividend policy, it should prepare a cash budget for the coming period to indicate the necessary funds, which would be needed to meet the regular dividend payments of the company. It is relatively difficult to make cash planning in anticipation of dividend needs when an unstable policy is followed. The cash account and the reserve account of a company will be reduced when the cash dividend is paid. Thus, both the total assets and net worth of the company are reduced when the cash dividend is distributed. The market price of the share drops in most cases by the amount of the cash dividend distributed. An issue of bonus share is the distribution of shares free of cost to the existing shareholders, In India, bonus shares are issued in addition to the cash dividend and not in lieu of cash dividend. Hence, Companies in India may supplement cash dividend by bonus issues. Issuing bonus shares increases the number of 34 CU IDOL SELF LEARNING MATERIAL (SLM)

outstanding shares of the company. The bonus shares are distributed proportionately to the existing shareholder. Hence there is no dilution of ownership. The declaration of the bonus shares will increase the paid-up Share Capital and reduce the reserves and surplus retained earnings) of the company. The total net-worth (paid up capital plus reserves and surplus) is not affected by the bonus issue. Infect, a bonus issue represents a recapitalization of reserves and surplus. It is merely an accounting transfer from reserves and surplus to paid up capital. 2.5 FINANCE FUNCTION There are three ways of defining the finance function. Firstly, the finance function can simply be taken as the task of providing funds needed by an enterprise on favourable terms, keeping in view the objectives of the firm. This means that the finance function is solely concerned with the acquisition (or procurement) of short- term and long-term funds. However, in recent years, the coverage of the term ‘finance function’ has been widened to include the instruments, institutions and practices through which funds are obtained. So, the finance function covers the legal and accounting relationship between a company and its source and uses of funds. For example, in financial management, we discuss debt-equity ratio (determined by the government), as also various accounting and legal aspects of dividend policy. No doubt, the basic function of the finance manager is one of determining how funds can best be raised (i.e., at the minimum possible cost). In other words, the essence of finance function is keeping the business supplied with enough funds to fulfil its objectives. But such a definition is too narrow and is not of much practical use. No doubt, the finance function is much broader than mere procurement of short-term and long-term funds so that a firm’s working capital and fixed capital needs can be met. Another extreme view is that finance is concerned with cash. This definition is much too broad and thus is not really meaningful. The third view — based on a compromise between the two — is more useful for practical purposes. This definition treats the finance function as the procurement of funds and their effective utilisation in business. The finance manager takes all decisions that relate to funds which can be obtained as also the best way of financing an investment such as the installation of a new machinery inside the factory-or office building. The cost of the machinery may be financed by making a public issue of 8% cumulative preference shares. At the same time, he has to consider whether the additional return (cash flow) expected from the new machinery is sufficient to cover the cost of capital in terms of interest to be paid over a period of time. 35 CU IDOL SELF LEARNING MATERIAL (SLM)

In this case, the finance decision is based on an analysis of the alternative sources and uses of funds. To start with the finance manager has to draw a plan outlining the company’s need for funds. Such financial plan is based on forecasts of financial needs of the company. Such forecasts are based on sales forecasts. Determining Asset-Management Policies All finance functions are concerned with the control of both cash flows and non-cash assets. The reason is easy to find out. The finance managers must know how much cash will be ‘tied up’ in various kinds of non-cash (or non-liquid) assets. Without the information, it is not possible to estimate and arrange for necessary cash requirements. In fact, the formulation of sound and consistent asset management policies is an indispensable pre-requisite to successful financial management. Determining the Allocation of Net Profits This relates to retained earnings (corporate savings) and dividend policy. Most companies have to achieve balance between two alternatives, i.e., payment of dividends and the retention of earnings for acquiring additional assets. Estimating Cash Flow Requirements and Control of Such Flows An important responsibility of the finance manager is to ensure an adequate flow of cash as and when it is needed. Otherwise, the smooth operation of a company may not be possible. Since cash flow originates from sales and cash requirements are closely related to sales volume, adequate cash can be provided at the proper time only after forecasting cash needs. Taking Decision on Needs and Sources of new External Finance On the basis of sales forecasts, the financial managers will have to draw a plan to borrow funds from external sources. Such debt capital will add to the firm’s own cash resources and thus improve its financial position. External capital may be obtained by borrowing funds from commercial banks. The finance manager must be competent enough to determine exactly when additional funds from external sources will be needed. He (she) has also to judge how long they will be needed, how economically they can be raised (i.e., at the lowest possible cost) and from which sources will they be repaid. Carrying on Negotiations with Outside Financiers The finance manager has also to carry on negotiations with outsiders to be able to arrange for necessary external financing in required amount and on time. For obtaining working capital, a line of credit has to be established with commercial banks. Again sufficient time has to be devoted for completing arrangements for long-term financing. Long-term financing requires more skilful negotiations than short-term financing. 36 CU IDOL SELF LEARNING MATERIAL (SLM)

Checking upon Financial Performance It is also necessary for the finance manager to evaluate the wisdom and efficiency of financial planning. Such evaluation is to be based on past performance of the company. This will enable the finance manager to improve the standards, techniques and procedures of financial planning and control which are important aspects of the finance function. 2.6 ORGANIZATION STRUCTURE Conceptualization of organizational structure is the manifestation of systematic thought. The organization is composed of elements, relations between elements and structure as a generality composing a unit. Structure is high combination of the relations between organizational elements forming existence philosophy of organizational activity. Systematic view of organization to structure shows that structure is composed of hard elements on one side and soft elements on the other side. The review of literature views structural relations from various aspects. Munsterberg - Organizational structure is the framework of the relations on jobs, systems, operating process, people and groups making efforts to achieve the goals. Organizational structure is a set of methods dividing the task to determined duties and coordinates them. Hold and Antony. Structure is not a coordination mechanism and it affects all organizational process. Organizational structure refers to the models of internal relations of organization, power and relations and reporting, formal communication channels, responsibility and decision making delegation is clarified. Amold and Feldman. Helping the information flow is one of the facilities provided by structure for the organization. Organizational structure should facilitate decision making, proper reaction to environment and conflict resolution between the units. The relationship between main principles of organization and coordination between its activities and internal organizational relations in terms of reporting and getting report are duties of organization structure. Conceptualization of organizational structure is the manifestation of systematic thinking. Organization consists of elements, relations between elements and structure of relations as a generality composing a unit. Structure is high combination of the relations between organizational elements forming existence philosophy of organizational activity. Systematic view of organization to structure shows that structure is composed of hard elements on one side and soft elements on the other side. At the end of hard dimension, there are tangible elements as groups and hierarchy organizational units. The relations between these units and groups show soft element in organization structure. At the end of soft continuum dimension, judgment of organization people to structure can be observed. The review of literature views structural relations from various aspects. According to the study of Schineregarding the identification of three dimensions. 37 CU IDOL SELF LEARNING MATERIAL (SLM)

Simple structure: This is a set of flexible relations and due to limited separation, it has low complexity. The members of such organization can design organization chart with focusing on leaders and there is no need to formality. Considering the duties or management order is done by mutual agreement and coordination and supervision are direct and informal. Functional structure: The organization with increased complexity is managed based on simple structure. Normally, functional structure is used as a tool to fulfil the increasing needs of separation. This is called function as in this structure, the activities are classified based on logical similarity of work functions. The functions that are created based on dependent duties and shared goals. In functional structure, re-work of activities is limited and this structure is efficient. The aim of this plan is maximizing saving of specialization scale. Multidivisional structure: In organizational development path, if functional structure is developed, it is turned into multidivisional structure as a tool to reduce the decisions responsibility by top manager. Multidivisional structure is a set of separate functional structures reporting a central centre. Each functional structure is responsible for management of daily operation. The central staff is responsible for supervision and management of organization relation with environment and strategy. Matrix structure. Figure 2.5: CEO This structure is created with the aim of creating a type of structure composed of functional and multidivisional structures. The aim of matrix structure is combining the efficiency of functional structure with flexibility and sensitivity of multidivisional structure not only based on product logic, customer or geographical region, but also based on functional logic in multidivisional structure. In matrix organization, functional specialized employees work in one or some project teams. This delegation of activities to employees is done via negotiation 38 CU IDOL SELF LEARNING MATERIAL (SLM)

between functional and project managers and sometimes with the presence of people of teams or potential members. Hybrid structure: In hybrid structure, one part is dedicated to the type of structure and another part to another type of structure. The reason of formation of hybrid structures is combination of advantages of two structures by designers or the organization is changing. As in hybrid structure, by moving from one section of structure to another structure, the relations basis is changed and hybrid forms can be unclear. On the other hand, hybrid structure enables the organization in which the best and flexible structure is used. Network structure: The networks are formed when the organizations are faced with rapid changes of technology, short life cycles of product and dispersed and specialized markets. IN a network, required assets are distributed among some network partners as there is no unified organization in a network to generate the products or services and the network is producer or supplier. In a network structure, the partners are associated via customer supplier relations and a type of free market system is created. It means that the goods are traded among network partners as in a free market, they are traded. 2.7 SUMMARY  At each stage, an organization’s structural requirements may be different. For example, a small emerging NGO may not have a complex, multi-level structure with several specific units. On the other hand, a consolidating organization may propose several new units or an expansion plan in response to its past dynamic growth and its future strategic plans. Program managers should try to make sure that the structure is appropriate for the organization’s size, resources and program mix. Organizations may differ in other ways that affect structure. For example, some organizations have paying members or extremely active volunteers. Representatives of these groups may expect seats on the Board of Directors, special meetings, or other activities to address their concerns and sustain their support. Sometimes their powers or participation are governed by laws; sometimes the organization sets policies delineating the levels and kinds of participation and whether specific benefits or remuneration can be expected.  Most organizations are at different stages of growth, development, and capacity. The level of your organization may influence the organization’s structure. Every manager however, should work with the organization’s leaders to ensure that the structure can grow and expand along with its mission, mandates, staff, and programs. As Figure 4 illustrates, an organization should be able carry out more functions at each successive level of growth. Organizations’ structures evolve over time; the purpose of this Figure is to give you some benchmarks — or measures — by which you and your colleagues can evaluate your organization’s progress and increased capability.  With each successive stage, you may want to re-examine your structure to see if it is keeping pace with the new realities that you as a manager are facing. For example, most new organizations do not have adequate management systems or staff. They are 39 CU IDOL SELF LEARNING MATERIAL (SLM)

only beginning to get organized and so may have highly centralized management or control by just a few persons. The structure is designed so that staff can fill multiple roles. Resources may also not be adequate, and most data collection or reporting is designed to satisfy donors or national requirements. A glance at an organization in the consolidation stage demonstrates just how different things can be (see Figure 4). In the consolidation stage, a detailed structure —- with units and multiple levels of authority — is in place. The organization is guided by an agreed upon strategic plan and has begun to focus extensively on becoming more sustainable. Systems, and guidance in how to use them, are in place and staff are routinely trained and updated in their operation. Roles and responsibilities between directors, volunteers, and staff are clearly defined.  This chapter explains elements of organizational design that are vital for executing strategy. Leaders of firms, ranging from the smallest sole proprietorship to the largest global corporation, must make decisions about the delegation of authority and responsibility when organizing activities within their firms. Deciding how to best divide labour to increase efficiency and effectiveness is often the starting point for more complex decisions that lead to the creation of formal organizational charts.  Hile small businesses rarely create organization charts, firms that embrace functional, multidivisional, and matrix structures often have reporting relationships with considerable complexity. To execute strategy effectively, managers also depend on the skilful use of organizational control systems that involve output, behavioural, and clan controls. Although introducing more efficient business practices to improve organizational functioning is desirable, executives need to avoid letting their firms become “out of control” by being sceptical of management fads. Finally, the legal form a business takes is an important decision with implications for a firm’s organizational structure. 2.8 KEYWORDS  Ad Valorem Tax: A tax based on the value of taxable property. Ad valorem is a Latin term meaning “according to value.”  Advance Refunding Bonds: Bonds that are issued to refund an outstanding issue before its natural maturity date. Proceeds from the advance refunding bonds are invested in U.S. Treasury Bonds or other authorized securities, and are used to pay interest and principal on the bonds that were refunded until they are called or reach maturity.  Alternative Minimum Tax: The tax liability calculated by an alternative set of rules designed to force individuals with high levels of preference income to incur at least some tax liability. 40 CU IDOL SELF LEARNING MATERIAL (SLM)

 Amended Budget: A budget that includes changes to the adopted budget that have been approved by the county’s legislative body. Also referred to as a revised budget.  Amortization: The gradual reduction of bonded debt according to a specific schedule of payment times and amounts. 2.9 LEARNING ACTIVITY 1. Create a session on financing decision. ___________________________________________________________________________ ___________________________________________________________________________ 2. Create a survey on investment decision. ___________________________________________________________________________ ___________________________________________________________________________ 2.10 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is investment decision? 2. What is financing decision? 3. Define dividend decisions? 4. Define the finance decisions? 5. Write the main aim of investment decision? Long Questions 1. Explain the advantages of investment decision. 2. Elaborate the disadvantages of investment decision. 3. Illustrate the scope of dividend decisions. 4. Discuss on the scope of financing decisions. 5. Examine the concept of finance function. B. Multiple Choice Questions 41 1. Which type of security is known as variable income security? a. Debentures CU IDOL SELF LEARNING MATERIAL (SLM)

b. Preference shares. c. Equity shares d. None of these 2. Which among the following does quick asset does not include? a. Government bonds b. Book debts c. Advance for supply of raw materials d. Inventories 3. What does long term finance is required for? a. Current assets b. Fixed assets c. Intangible assets. d. None of these. 4. How does a financial leverage can be measured in? a. Stock term b. Flow term. c. Both (a) and (b). d. Return term 5. What will be net working capital if current ratio of a concern is 1? a. Positive b. Neutral c. Negative d. None of these Answers 1-a, 2-c, 3-d, 4-b, 5-c 2.11 REFERENCES References  Antoniou, A. Guney, Y & Paudyal, K. (2006). The determinants of debt maturity structure, evidence from France, Germany and UK. European Financial Management. 42 CU IDOL SELF LEARNING MATERIAL (SLM)

 Antoniou, A. Guney, Y & Paudyal, K. (2008). The determinants of capital structure: capital market-oriented versus bank-oriented institutions. Journal of Financial and Quantitative Analysis.  Arellano, M& Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies. Textbook references  Arellano, M. & Bover, O. 1995. Another look at the instrumental variable estimation of error-components models. Journal of Econometrics, 68(1): 29-51.  Atkin, M. & Glen, J. 1992. Comparing corporate capital structures around the globe. The International Executive, 34(5): 369-387.  Auerbach, P. & Siddiki, J.U. 2004. Financial liberalisation and economic development: an assessment. Journal of Economic Surveys. Website  https://www.srcc.edu/sites/default/files/Eco  http://www.pearsoncanada.ca/media/highered-showcase/multi-product- showcase/robbins-ch05.pdf  https://www.researchgate.net/publication/308736877_Organizational_Structure/link/5 7edb65808ae03fa0e829a88/download 43 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-3 TIME VALUE OF MONEY STRUCTURE 3.0 Learning objective 3.1 Introduction 3.2 Concept of Value of Money 3.3 Compoundingand Discounting 3.4 Summary 3.5 Keywords 3.6 Learning Activity 3.7 Unit End Questions 3.8 References 3.0 LEARNING OBJECTIVE After studying this unit, you will be able to  Describe the idea of money.  Illustrate the concept of value of money.  Explain the impression of discounting. 3.1 INTRODUCTION The most common and shortest definition of money, as it appears in dictionaries, such as The Concise Oxford Dictionary, is “a current medium of exchange, which is recognized and widely accepted in payments for goods and services and for the settlement of debts”. One could add to the above definition the following: “money is a current medium of exchange in the form of coins and banknotes; money represents coins and banknotes collectively”. When it comes as standard pieces of gold, silver, copper, nickel, etc., stamped by government authority and used as a medium of exchange and measure of value, it is called hard money; money may be any paper note issued by a government or an authorized bank and used in the same way; when appearing as bank notesmoney is also called paper money. Money is also used as a chosen means of value: when selling / buying a commodity of some kind, its price is conventionally expressed in a certain number of units of money; this is the recognized value of money, accepted both by the seller and the buyer, because the conventional value can be used furthermore to purchase other goods, merchandise or services. A monetary unit chosen as a value measure need not be always used extensively. In America, to take one 44 CU IDOL SELF LEARNING MATERIAL (SLM)

example, during the colonial period, the British pound represented the standard of value, while the then currently accepted medium of exchange was the Spanish currency. Money proved its efficiency; this is why it exists even in centrally planned economies. The existence of money and its functions as a medium of exchange and a measure of value facilitate the transactions of goods and services and the continuous specialisation of production. In a barter-based economy, where money was not used, trade would consist in the direct exchange of one commodity for another, just as primitive peoples used to do. It was a terribly intricate system, in which the main problem is posed by the so-called “double coincidence of wants”: for instance, a farmer selling tomatoes who needs a pair of new shoes would not only have to find a shoe-maker wishing to buy tomatoes, but also need to settle some kind of agreement as to what the tomatoes / shoes exchange rate should be, depending on the relative prices of these two products, of course. Barter is still practised in some areas worldwide, but nowadays money is regarded as a more practical means of exchange, facilitating a larger amount of economic transactions. In a money economy, a producer or the owner of a commodity may sell it for money that can be used in further payments for goods and products, thus avoiding the time and effort that are necessary to find someone who could accept a barter. 3.2 CONCEPT OF VALUE OF MONEY With the passage of time, all assets decrease in value and same is the case with money. But there is a lot difference between other assets and money. While other assets are used by themselves to achieve the end results, money is one aspect of any transaction. It can also be said that money is always one aspect of all transactions as the most peculiar attribute of money is its purchasing power. As the time passes, the purchasing power of money decreases. That means it would not be possible to purchase same quantity of any commodity at a future date which can be purchased today with a currency note of same denomination. To make up for this decrease, there can be two ways. First one is to decrease consumption as reduced quantity would be purchased with same amount of money and second one is to increase the amount of money to purchase same quantity of the commodity. This reduction in the purchasing power of money i.e. its value over the period of time is known as the time value of money. The value of money as on date is known as present value of money while the value of money on a future date is known as future value of money. To arrive at present value of a future sum, technique of discounting is used and while to reach at the future value of present sum, technique of compounding is used and for the same purpose a rate of required return is to be decided and used. Time value of money is the impact of time on the value of money. Basically, it is the change in purchasing power of money over a period of time. The concept of time value of money is utilized in making decisions regarding investment in different projects where multiple options for cash outlays and cash inflows are available. The concept of time value of money is also useful in selecting the highest paid investment option 45 CU IDOL SELF LEARNING MATERIAL (SLM)

amongst all available options of investment. The concept is also useful in finding out the rate of return if present value and future value of a cash stream is available. Time value of money is a very useful concept in financial management.  Time has its effect on almost everything. With the passage of time the value of any asset eradicates. As most of assets get depreciated over the period of time, so is the case with money. Money is a peculiar commodity because of its different attributes in comparison to other assets.  Firstly, the possessor is the owner of the money. There is as such no paper involved in to claim the ownership of money. Thus, it is riskier to carry money in physical form.  Second thing is that money is the only commodity which has got purchasing power. Thus, one part of every transaction is compulsorily money. Money is the medium of exchange in any economy. These two attributes of money make it risky but an important asset. The purchasing power of money is also known as the value of money. Any change in the purchasing power of money over the period of time is known as the time value of money.  Over the years the purchasing power of the currency decreases, especially in the country like ours where inflation is a persisting economic phenomenon. Inflation is an economic phenomenon in which the general price level of goods and services rise in the economy.  Because of the price rise, the consumer is able to purchase less quantity of the commodity in comparison to the quantity he was previously able to purchase with that amount. Inflation affects that money negatively which is held as cash. The purchasing power of such money is reduced over time. Inflation actually discourages savings.  As the inflation rate cannot be predicted too accurately, the investments are not made. Inflation also encourages storage of commodities as in anticipation of rise in price as the consumer may purchase larger quantities of various commodities in anticipation of future price rise.  The inflation and purchasing power are negatively correlated and if the inflation rate is high the purchasing power of money is reduced proportionately. If the inflation rate in the economy is not low or not steady or is unpredictable, there are more chances of awkward behaviour by consumers. Time has its impact on purchasing power of the money.  The concept of time value of money is simple to understand and interpret. The value of money affected with the passage of time is called as time value of money. In the period of deflation the value of money increases while it is reverse in case of inflationary period. 46 CU IDOL SELF LEARNING MATERIAL (SLM)

 Money is the only commodity having purchasing power. It is the means of transaction. It is the medium of exchange. Money serves the purpose of exchange as it is the measure of value. The value is the purchasing power of money which makes it powerful commodity.  Moreover, if any comparison is to be made in the values of money, few rules need to be followed. Firstly the unit should be same, like all values should be in same currency. Secondly, the values should be at same point of time. That means, Rs 100 today cannot be treated as equal to Rs 100 at a future date. The value of money at different points of time is different like today it is having a specific value and after one year it will have different value then after two years, it will have different value. Usually, with passage of time, the value of money decreases.  The reasons for the same are described in the following paragraph. It would be worthy to note here that the difference between the value of money today and the value of same money on a future date is called time value of money. There is impact of time on the value of money due to four reasons.  First one is the inflation rate. Inflation is a universal economic phenomenon. In general, inflation is an economic condition where prices of commodities rise with the passage of time. This would result in either purchasing less quantity with the same amount of money or paying more money for the same quantity of the commodity. Thus, it is said that during inflationary period, the purchasing power of money decreases. The effect of inflation is the eradication in the purchasing power of money and the value of money is more today, in comparison to what it would be on a future date.  Second reason for the impact of time on money is the risk involved in holding the money. Money held idly is more vulnerable to such risk.  Third reason is the consumption preference of the consumer. An individual consumer has the preference to consume today over future consumption as future is unknown. The consumer consumption preference also has its impact on future flow of money and hence on the value of money. All consumers try find out a trade-off between present and future consumption. Everyone has desire of fulfilling his needs today itself and not in future. Present consumption is postponed only in the expectation of having increased amount on a future date. If money is not consumed today, it can even be employed to earn some return. That means money can be invested today, in an appropriate investment avenue.  And thus, the fourth reason is the availability and attractiveness of investment opportunities in the economy. If there will be no lucrative investment opportunities available in the economy, the consumer would prefer to consume the money and if 47 CU IDOL SELF LEARNING MATERIAL (SLM)

yielding investment opportunities are there in the economy, the money will be invested in the want of increased amount on a future date.  In this case, the consumer will postpone present consumption and depart from his money for some time, to invest it in a suitable investment avenue yearning for appropriate return. Investment means deferring of present consumption. All these reasons have their effect on the time value of money. Once the concept of time value of money is understood, next step would be to understand the meaning of present value and future value.  From Exhibit 1, it can be understood that if one has to find out the future value of any present sum of money, the technique of compounding is to be used and if the present value of any future sum is to be calculated, then technique of discounting is used. In the following example, Rs 1100 is the future value of Rs 1000 today and Rs 1000 is the present value of Rs 1100 to be received after one year @ 10%. Similarly Rs 1210 is the future value of Rs 1000 invested for two years @ 10% and Rs 1000 is the present value of Rs 1210 to be received after two years, invested @ 10%..  As it is observed that traditionally the value of money was considered same at all points of time. A hundred rupee note was considered a hundred rupee note forever. No impact of time on money was considered.  With the development of knowledge, it was understood that time has its effect on the value of money. This led to the development of the concept of time value of money.  Consideration of present value of money and future value of money gave fruitful insight into the impact of time on the value of money.  Whenever one has to receive money in future, it is beneficial to calculate its present value and analyse it in the context of present cash outflow and required rate of return.  This makes the comparison at of cash outflows and cash inflows at same point of time, which is otherwise not comparable, at least on time basis. 3.3 COMPOUNDINGAND DISCOUNTING Most of us are familiar with the parable of the blind men and the elephant, each of whom developed a theory of ‘elephant hood’ on the basis of a limited perception: one fellow’s elephant was like a rope, another’s like a broad leaf, a thirds like a tree trunk, and so on. We conceived of this volume in the fear that our current picture of ‘compoundhood’ might be like the blind men’s elephant, and in the hope that by putting together the disparate pieces of what we know, something like the whole elephant might appear. Each of us might have a limited perception, illuminating and interesting in its own way, but no one perspective gives the whole story. What we endeavour to do in this Handbook is to give a variety of pictures of compounding that both complicate and deepen our understanding of this important means of 48 CU IDOL SELF LEARNING MATERIAL (SLM)

extending the lexicon of a language. Our intention is to complicate our view both theoretically and descriptively. In terms of theory, we consider compounding from disparate frameworks, both generative and non-generative, and from different perspectives: synchronic, diachronic, psycholinguistic, and developmental. Descriptively, we hope to sharpen our understanding of what constitutes a compound by looking not only at familiar languages, but also at a range of typologically and areally diverse languages. The two views are complementary.We will offer a brief overview of the volume in section 2, but first we try to take our own first pass at this distinctive species of word formation: do we really know what a compound is? Compounding is a linguistic phenomenon that might at first glance seem straightforward: in his introductory text Bauer (2003:40) defines a compound as “the formation of a new lexeme by adjoining two or more lexemes.” But Marchand, in ‘Expansion, Transposition, and Derivation’presents another view, in effect saying that compounds don’t exist as a separate sort of word formation: indeed, he distinguishes only two basic categories of word-formation, expansion and derivation. Whether a complex word belongs to one or the other category depends on whether what he calls the ‘determinate’ – in effect, the head of the complex word -- is an independent morpheme or not. For Marchand, an expansion is a complex word in which the determinate is an independent morpheme. Expansions might have either a bound or a free morpheme as their ‘determinant’ – in current terms, their modifier or non-head element. This allows Marchand to class prefixed items like reheat or outrun as the same animal as compounds like steamboat or colourblind. Words in which the determinate/head is bound are derivations; in effect, suffixed words constitute one category of word formation, compounds and prefixed words another. The reader might ask why a handbook on compounding should begin by contrasting an apparently straightforward definition of compound with such a non-canonical view of compounds. The answer is precisely that there has always been much discussion of exactly what a compound is, and even of whether compounds exist as a distinct species of word formation. We can identify two main reasons why it is difficult to come up with a satisfying and universally applicable definition of ‘compound’. On the one hand, the elements that make up compounds in some languages are not free-standing words, but rather stems or roots. On the other, we cannot always make a clean distinction between compound words on the one hand and derived words or phrases on the other. We might term these the ‘micro question’ and the ‘macro question’.Let us look at the ‘micro question’ first. In the 1960 edition of his magnum opus, Marchand, for example, assumes that “when two or more words are combined into a morphological unit, we speak of a compound’. But this definition of compound is rooted in the analytical features of English, in particular, its lack of inflectional morphemes. In inflectional languages like Czech, Slovak, or Russian, the individual constituents of syntactic phrases are inflected. Compounds result from the combination not of words, but stems -- uninflected parts of independent words that do not themselves constitute 49 CU IDOL SELF LEARNING MATERIAL (SLM)

independent words. It is the compound as a whole that is inflected. In Slovak, for example, we know that‘express train’ is a compound because the left-hand constituentis devoid of an inflectional morpheme and displays a linking element. On the other hand, we know that fast train (any train that goes fast) is a syntactic phraseand not a compound because the adjectiveis inflected to agree with the noun. It is only the lack of inflectional morphemes in English that makes surface forms of English compounds and free syntactic groups identical in terms of their morphological forms (compare, for example, blackboard and black board). In light of this issue, it would seem that defining a compound as a combination of two or more lexemes, as Bauer does, is the safer way to go: the term lexeme would seem specific enough to exclude affixes but broad enough to encompass the roots, stems, and free words that can make up compounds in typologically diverse languages. But with Bauer’s definition we have to be clear about what we mean by ‘lexeme’.One problem hinges on how we distinguish bound roots from derivational affixes. One criterion that we might use is semantic: roots in some sense have more semantic substance than affixes. But there are languages in which items that have been formally identified as affixes have as much, or nearly as much, semantic substance as items that might be identified as roots in other languages. Mithunargues, for example, for what she calls ‘lexical affixes’ in many Native American languages.Bearing meanings like ‘clothes’, ‘floor’, ‘nape’, ‘knob’ (in Spokane) or ‘eat’, ‘say’, ‘fetch’, ‘hit’ (in Yup’ik), they might look semantically like roots, but their distribution is different from that of roots, and they serve a discourse function rather different from that of roots (they serve to background information that has already been introduced in a discourse). So distinguishing lexemes from non-lexemes might not be possible in semantic terms.Another criterion must therefore be formal: we might say that bound roots can be distinguished from affixes only by virtue of also occurring as free forms (inflected, of course, in languages that require inflection). But that means that words like overfly and outrun in English must be considered compounds, rather than prefixed forms. There are two problems with this conclusion. First, the status of verbal compounds in English is highly disputed, and these items are clearly verbal. Second, even though over and out also occur as free morphemes in English, the form that attaches to the verbs fly and run behaves rather differently than the first element of a compound. Specifically, the first element of a compound in English is typically syntactically inertia does not affect the syntactic distribution of the complex word. 3.4 SUMMARY  The cash inflows from the bond are discounted and compared with the present purchase price of the bond and decision is made. Similarly, the concept of time value of money is used in valuation of other financial securities, having longer maturity period. An individual if has to know about his retirement corpus, the concept of time value of money is to be utilized for the purpose. The concept of time value of money 50 CU IDOL SELF LEARNING MATERIAL (SLM)