Financial Management: Definition, Objectives and Applications

This article explains the definition, objectives and applications of financial management in both corporate and personal finance. It also includes case studies on capital budgeting, variance and standard deviation, loan amortization, present value of lease payments and cost of capital computation.

Financial management as the name suggests, deals with managing the financing activities of the
companies, that involves, analysis of various ratios, determining the debt and equity mix for the
businesses and also deciding on the sources of financing, keeping in view the cost of each source of
funds and effective weighted average cost of capital for the business as a whole. The objective of
financial management is to maximize the shareholders’ wealth and the decisions taken by the financial
managers are taken, keeping in view this ultimate objective of shareholders’ wealth maximization.
Financial management can also be used in personal finances, involving identification of best avenues for
investing money and computation of amount that the individual will receive in future from each source,
or vice versa, I.e. in computing the amount that an individual needs to invest today, in order to get a
specific amount of money in the future.
(Ref: Eugene F. Brigham and Michael C. Ehrhardt, (2013))
For question -1:
The given case study deals with evaluation of a capital budgeting proposal for National Brewing Inc.,
who is considering the acquisition of a new still. It involves computation and analysis of the cash flows
from the new still over its useful life and a comparison of the present value of those cash flows based on
the cost of capital of the company, to determine, whether or not the project is financially viable, based
on the NPV of the project.
As per the computation given above, the NPV of the project is negative, hence, it is not advisable to
purchase the equipment.
For question: 2
It deals with computation of variance and standard deviation of returns of Euro flop’s stock over the
period of last 5 years. Variance refers to the expected deviation that the return might face from the
mean return of the security, i.e. Euro flop’s shares in this case.
Standard deviation is used to measure the amount of variation or dispersion of values from the mean. A
high standard deviation implies that values are spread out over a wider range, whereas on the other
hand, a low standard deviation implies that the values are closer to the mean value.
In the given problem, variance is 412.5 and the standard deviation is 20.31%
For question: 3
It involves computing the amount of each monthly payment for the loan of $ 15,999 and preparation of
the loan amortization schedule, showing the reducing interest component, after each installment being
repaid.
In the given problem, the interest amount that the client paid in the first installment was $199.99, which
reduced gradually, with each installment being repaid and the interest component on the last
installment was $ 6.85. This is majorly due to the diminishing loan balance, as each installment has a
portion of principle value being repaid along with interest.
Unrestricted

For Question: 4
This involves computation of present value of lease payments that the client expects to receive for the
next 10 years. The amount due in future, doesn’t have the same value as the amount due today and the
difference is due to the cost of capital of the client, since, it is assumed that the present value of the
amount due in future would be less than the actual amount due, based on the cost of capital of the
client.
In the given case, the cost of capital of the business is 14% and the computed present value is $ 149.184
For question 5:
This involves computation of the cost of capital for the entity as a whole, the entity has three sources of
funds, each source has different cost, hence, the cost of capital of the entity is the weighted average of
the cost for each source used by the entity.
It further involves selection of a project, based on the rate of return from the project and the cost of
capital of the entity.
List of References:
- Eugene F. Brigham and Michael C. Ehrhardt, (2013). Financial Management: Theory and Practice
(With Thomson ONE- Business school edition-1)
- Charles E. Menifield (2014), The Basics of Public Budgeting and Financial Management
Unrestricted