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Financial Management
Theory and Practice
Tenth Edition
 About the Author

Dr Prasanna Chandra, Director of Centre for Financial

Management, is an MBA, PhD (Finance). He has nearly five
decades of teaching experience in postgraduate and executive
education programmes. He was a professor of finance at Indian
Institute of Management, Bangalore for nearly two decades. He was
a visiting professor of finance at Southern Illinois University, USA for
two years. He was appointed as a member of several committees
including the Capital Issues Advisory Committee, the High Powered
Committee on Insurance Sector Reforms, and the SEBI Committee
on Derivatives. He has served on the boards of a number of
organizations including Torrent Pharmaceuticals, Power Finance
Corporation, UTIIAS, ICFAI, SDMIMD, IFCI, IIM (B), Templeton
Mutual Fund, Bangalore Stock Exchange Limited, and Karnataka
Soaps and Detergents Limited. He has been a consultant to many
organizations.
Dr Chandra has conducted executive seminars for a number of
organizations like TCS, Infosys, Tata Motors, ITC, NIIT, Tata Steel,
Sasken Communications, BHEL, Bharat Shell, ANZ Grindlays, HMT,
Canara Bank, Vysya Bank, ONGC, Wipro, GAIL, Microsoft, Motorola,
and Tata Power.
He has published ten other books – Strategic Financial
Management: Managing for Value Creation; Projects: Planning,
Analysis, Financing, Implementation, and Review; Investment
Analysis and Portfolio Management; Investment Game; Corporate
Valuation; Finance Sense; Fundamentals of Financial Management;
Behavioural Finance and Valuation of Equity Shares and has
authored over 70 articles in professional journals and business
periodicals. He has been a Fulbright Scholar and a UNDP Fellow. He
has received several honours including the Best Teacher Award from
the Association of Indian Management Schools.
 Financial Management
Theory and Practice
Tenth Edition

Prasanna Chandra
Director
Centre for Financial Management (CFM)
Bangalore

McGraw Hill Education (India) Private Limited

Published by McGraw Hill Education (India) Private Limited
444/1, Sri Ekambara Naicker Industrial Estate, Alapakkam, Porur, Chennai
- 600 116

Financial Management: Theory and Practice, 10e

Copyright © 2019, 2015, 2011, 2008, 2004, 2001, 1997, 1993, 1989, 1984
by Prasanna Chandra
No part of this publication may be reproduced or distributed in any form or
by any means, electronic, mechanical, photocopying, recording, or
otherwise or stored in a database or retrieval system without the prior
written permission of the publishers. The program listings (if any) may be
entered, stored and executed in a computer system, but they may not be
reproduced for publication.
This edition can be exported from India only by the publishers,
McGraw Hill Education (India) Private Limited.
Print Edition
ISBN-13: 978-93-5316-652-6
ISBN-10: 93-5316-652-7
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ISBN-10: 93-5316-653-5
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McGraw Hill Education (India) nor its authors guarantee the accuracy or
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Hill Education (India) nor its authors shall be responsible for any errors,
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 To
My students and readers
for their inspiration
and
Padma, Pranav and Savita
for their support
 Contents

About the Author

Preface to the Tenth Edition
Preface to the First Edition
Acknowledgements
Finance in Action

PART–I INTRODUCTION
1. Financial Management: An Overview
1.1 Forms of Business Organisation
1.2 Financial Decisions in a Firm
1.3 Goal of Financial Management
1.4 The Fundamental Principle of Finance
1.5 Building Blocks of Modern Finance
1.6 Risk-Return Tradeoff
1.7 Agency Problem
1.8 Business Ethics and Social Responsibility
1.9 Organisation of the Finance Function
1.10 Relationship of Finance to Economics and Accounting
1.11 Emerging Role of the Financial Manager in India
1.12 Outline of the Book
Summary
Questions
Practical Assignment
2. The Financial System
2.1 Functions of the Financial System
2.2 Financial Assets
2.3 Financial Markets
2.4 Financial Market Returns
2.5 Financial Intermediaries
2.6 Regulatory Infrastructure
2.7 Growth and Trends in the Indian Financial System
Summary
Questions
Problems

PART–II FINANCIAL ANALYSIS AND PLANNING

3. Financial Statements, Taxes, and Cash Flow
3.1 Balance Sheet
3.2 Statement of Profit and Loss
3.3 Profits Versus Cash Flow
3.4 Statement of Cash Flow
3.5 Consolidated Financial Statements
3.6 Other Items in the Annual Report
3.7 Manipulation of the Bottom Line
3.8 Taxes
3.9 Modifying Accounting Data for Managerial Decisions
Summary
Questions
Solved Problems
Problems
Practical Assignment
4. Analysis of Financial Statements
4.1 Financial Ratios
4.2 Du Pont Analysis
4.3 Standardised Financial Statements
4.4 Applications of Financial Statement Analysis
4.5 Using Financial Statement Analysis
4.6 Going Beyond the Numbers
Summary
Questions
Solved Problems
Problems
Minicase - I
Minicase - II
Practical Assignment

5. Financial Planning and Forecasting

5.1 What and Why of Financial Planning
5.2 Sales Forecast
5.3 Pro Forma Statement of Profit and Loss
5.4 Pro Forma Balance Sheet
5.5 Financial Modeling Using Spreadsheet
5.6 Growth and External Financing Requirement
5.7 Key Growth Rates
Summary
Questions
Solved Problems
Problems
Minicase
Appendix 5A Financial Planning and Forecasting at
General Electric
PART–III FUNDAMENTAL VALUATION CONCEPTS
6. The Time Value of Money
6.1 Time Lines and Notation
6.2 Future Value of a Single Amount
6.3 Present Value of a Single Amount
6.4 Future Value of an Annuity
6.5 Present Value of an Annuity
6.6 Present Value of a Perpetuity
6.7 Intra-year Compounding and Discounting
Summary
Questions
Solved Problems
Problems
Minicase - I
Minicase - II
Appendix 6A XNPV and XIRR

7. Valuation of Bonds and Stocks

7.1 Valuation Concepts
7.2 Bond Valuation
7.3 Bond Yields
7.4 Bond Market
7.5 Valuation of Preference Stock
7.6 Equity Valuation: Dividend Discount Model
7.7 Equity Valuation: the P/E Ratio Approach
7.8 The Relationship Between Earnings-Price Ratio,
Expected Return, and Growth
7.9 Stock Market
Summary
Questions
 Solved Problems
Problems
Minicase - I
Minicase - II
Practical Assignment

8. Risk and Return

8.1 Historical Returns and Risk
8.2 Expected Return and Risk of a Single Asset
8.3 Risk and Return of a Portfolio
8.4 Measurement of Market Risk
8.5 Determinants of Beta
8.6 Relationship Between Risk and Return
Summary
Questions
Solved Problems
Problems
Minicase - I
Minicase - II
Practical Assignment

9. Risk and Return: Portfolio Theory and Asset Pricing

Models
9.1 Portfolio Risk
9.2 Efficient Frontier and Optimal Portfolio
9.3 Capital Asset Pricing Model
9.4 Arbitrage Pricing Theory and Multifactor Models
Summary
Questions
Solved Problems
 Problems
Minicase

10. Options and their Valuation

10.1 How Options Work
10.2 Options and their Payoffs Just Before Expiration
10.3 Factors Determining Option Values
10.4 Binomial Model for Option Valuation
10.5 Black and Scholes Model
10.6 Applications of Option Pricing in Financial Management
Summary
Questions
Solved Problems
Problems
Minicase
Appendix 10A Exotic Options
Practical Assignment

PART–IV CAPITAL BUDGETING

11. Techniques of Capital Budgeting
11.1 Capital Budgeting Process
11.2 Project Classification
11.3 Investment Criteria
11.4 Net Present Value
11.5 Benefit-Cost Ratio
11.6 Internal Rate of Return
11.7 Modified Internal Rate of Returns (MIRR)
11.8 Payback Period
11.9 Accounting Rate of Return
11.10 Investment Appraisal in Practice
 Summary
Questions
Solved Problems
Problems
Minicase

12. Estimation of Project Cash Flows

12.1 Elements of the Cash Flow Stream
12.2 Basic Principles of Cash Flow Estimation
12.3 Cash Flow Illustrations
12.4 Cash Flows for a Replacement Project
12.5 Biases in Cash Flow Estimation
12.6 Adjustment for Inflation
Summary
Questions
Solved Problems
Problems
Minicase - I
Minicase - II

13. Risk Analysis in Capital Budgeting

13.1 Sources and Perspectives on Risk
13.2 Sensitivity Analysis
13.3 Scenario Analysis
13.4 Break-Even Analysis
13.5 Hillier Model
13.6 Simulation Analysis
13.7 Decision Tree Analysis
13.8 Corporate Risk Analysis
13.9 Managing Risk
13.10 Project Selection Under Risk
 13.11 Risk Analysis in Practice
Summary
Questions
Solved Problems
Problems
Minicase - I
Minicase - II

14. The Cost of Capital

14.1 Some Preliminaries
14.2 Cost of Debt and Preference
14.3 Cost of Equity
14.4 Determining the Proportions
14.5 Weighted Average Cost of Capital
14.6 Weighted Marginal Cost of Capital
14.7 Determining the Optimal Capital Budget
14.8 Divisional and Project Cost of Capital
14.9 Floatation Cost and the Cost of Capital
14.10 Factors Affecting the Weighed Average Cost of Capital
14.11 Misconceptions Surrounding Cost of Capital
Summary
Questions
Solved Problems
Problems
Minicase
Practical Assignment

15. Capital Budgeting: Extensions

15.1 Choice Between Projects of Unequal Life
15.2 Interrelationship Between Investment and Financing
Aspects
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