THE OPEN UNIVERSITY OF TANZANIA FACULTY OF BUSINESS MANAGEMENT DEPARTMENT OF ACCOUNTING AND FINANCE OAF 212: FINANCE II MODULE OUTLINE

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1 THE OPEN UNIVERSITY OF TANZANIA FACULTY OF BUSINESS MANAGEMENT DEPARTMENT OF ACCOUNTING AND FINANCE OAF 212: FINANCE II MODULE OUTLINE 1.0 Module Aims: The module aims at building your competence in corporate finance further by extending the coverage in Finance I module to include three more of the finance functions financial planning and control, working capital management and financing sources. It continues to emphasize on strategic decision making techniques that best serve the interests of shareholders, which is to maximize the value of the company. Module Objectives: At the end on this module you will be able to: (i) Explain the role of financial planning and control and apply different planning tools financial forecasting and cash budgeting tools in planning for the firm s short term financial requirements (ii) Describe what working capital is and its components and apply different techniques that managers can use to manage various aspects of working capital cash and liquidity, credit and receivables, inventories, etc. (iii) Describe and discuss various sources of short term sources of financing (iv) Discuss and evaluate the different sources of long term financing venture capital, equity, debentures etc (v) Detail and evaluate the different theories of capital structure, their predictions about optimal capital structure and identify the limits of using debt in the firms capital structure. 2.0 Content The module will be covered through the following lectures 2.1 Lecture 1: Financial Planning Introduction The world of finance is full of examples of companies that grow at a phenomenal pace, run into cash flow problems and subsequently financial difficulties. These scenarios have been associated with the lack of proper financial planning that is consistent with the growth being experienced. Financial planning is thought of as a process of establishing guidelines for change and growth in a company. It is concerned with the major element of the firm s financial and investment policies without examining the individual components of those policies in details. It focuses on the big picture. This lecture is aimed at discussing financial 1

2 planning and show the interrelatedness of the various investment and financing decisions a firm makes. (i) Identify the role of management in fostering financial planning (ii) Describe what is usually meant by financial planning (iii) Describe what is long and short term planning (iv) Identify the stages and dimensions of financial planning (v) Describe the role of long term planning (vi) Identify the ingredients of a long term planning Content Management and financial planning Financial planning Stages of financial planning Dimensions of financial planning Roles of financial planning Ingredients of financial planning 2.2 Lecture 2: Financial forecasting Introduction In the preceding lecture you learned about financial planning in which you were introduced to among other things, the role of financial forecasting in the whole process of financial planning. This lecture will introduce you to financial forecasting process in greater details including the several techniques of forecasting. You will cover both the percentage of sales method (PSM) and the statistical methods. At the end of this lecture you will e able to: (i) Explain what financial forecasting is and describe its process and role in financial planning; (ii) Apply the percentage of sales methods to determine financial requirements; (iii)discuss the limitations of PSM as a financial forecasting technique; (iv) Apply the statistical techniques to determine financial requirements Content 2

3 Financial forecasting its process and roles The percentage of sales method of forecasting Determining the financial requirements Limitations of PSM Statistical Techniques 2.3 Lecture 3: Cash Budgeting Introduction In lecture 2 you learned about financial forecasting as a tool of financial planning in which you focussed at two forecasting techniques the PSM and the statistical techniques. You also looked at some of the limitations of PSM. In this lecture you will look at yet another financial planning tool the cash budget which will alleviate some of the limitations of percentage of sales methods. Lecture objectives: (i) Explain what a cash budget is and discuss its key functions in financial forecasting (ii) Prepares a cash receipts schedule (iii) Prepare a cash disbursements schedule (iv) Prepare a cash budget and analyse the financial requirements (v) Interpret the cash budget Content The meaning and functions of a cash budget Preparation of cash receipts Preparation of cash disbursements Preparation of cash budgets Interpretation of cash budget 2.4. Lecture 4: Working capital Management Introduction Working capital decisions are relatively small and short term financing decisions but equally important. Although many of these decisions may be handled by line managers, the overall responsibility still lies on the finance manager. Examples of questions that need to be addressed here include what should the organisation do with any temporary surplus cash should it deposit it in a ban account or be more adventurous and try to obtain a higher return by placing the fund in the money market? What about the increased risk and loss of liquidity resulting from the latter? While it is not profitable to have cash lying idle, what are the 3

4 consequences of tying it up unnecessarily in say inventories of finished goods or of debtors? While we recognise the fact that it is important to put money into these areas, optimality is important bearing in mind that money has opportunity cost. This and the next few lectures will concentrate on giving you an overview of the working capital management and policy. (i) Define working capital and describe its components (ii) Describe the working capital management policy options (iii) Describe the working capital cycle and other cash flows and its relation to cash conversion cycle. (iv) Discuss the working capital dynamics Content Working capital defined Working capital management policy options Working capital cycle and other cash flows Working capital dynamics 2.5 Lecture 5: Cash and liquidity management Introduction Investment in current assets in a typical manufacturing firm goes up to 40 percent of the firm s total assets. This means its management should occupy a large proportion of the finance managers time. The basic objective of current assets management is to keep the investment in them as low as possible while still operating the firm s activities efficiently and effectively. While it is a fact that the lower the investment in current assets the higher the return on assets (ROA) will be, too low investment in current assets may result in an increase in the firm s risk. This represents a significant balance that managers should strive to attain. In addition, the current assets may be divided into three categories along the liquidity line. The most liquid current assets are the cash and marketable securities; followed by accounts receivables and finally inventories. This lecture will introduce you to how managers manage cash and marketable securities. Receivables and inventory management will be dealt with in the next two lectures. At end of this lecture you will be able to: (i) Explain the reasons/motives/demand for holding cash and how idle cash might be invested (ii) Differentiate between cash and liquidity management (iii) Identify the costs associated with holding cash (iv) Discuss the link between float, cash collection and cash concentration 4

5 (v) Explain the characteristics of short term securities (vi) Apply cash management models Content Motives for holding cash Costs associated with holding cash Cash vs. liquidity management Investing idle cash Characteristics of short term securities Managing cash disbursements Cash management models (Baumol model, Miller-Orr model) 2.6 Lecture 6 Credit and receivables management Introduction Companies may sell their products and or offer their services cash or credit basis in their quest to improve annul sales. When the company sells on credit, it gives its customers time before they can settle their bills. It some times takes these customers some time even beyond the agreed time before they can settle the bills. This leads to the unpaid bills showing up on the company s balance sheet as Receivables or debtors. If this trend is left unchecked it may cause cash problems to the company. But how the company managers sets the terms of payment and decide which customer should be offered credit? How do they ensure that these customers pay promptly? These are related questions will be dealt with in this lecture. The lecture begins with a discussion on credit policy and management after which issues related to receivables management will be discussed. It is important to note the interconnectedness of credit policy and receivables here. The quality of the company s credit policy is connected to the receivables problem. (i) Assess the impact of interest rates on credit sales (ii) Assess and determine whether it pays granting credit to customers (iii) Evaluate receivables collection policy and procedures (iv) Recommend ways to monitor receivables and improve effectiveness of collection efforts Content Credit management and accounts receivables management defined Terms of sales and credit management agreements Credit analysis and credit decision Receivables collection policy and procedures o Monitoring receivables 5

6 o Collection efforts 2.7 Lecture 7: Inventory Management Introduction Inventory represents a significant investment for many firms. For example, inventory will often exceed 15 percent for typical manufacturing firm and 25 percent or more for a typical retail firm of the firm s assets. This is one of the good reasons that you as a manager should gain a good grip of how best you can manage your firm s inventories. This lecture is devoted to that end. (i) Develop an understanding of the importance of managing inventories (ii) Identify and describe inventory types as well as the goal of inventory management (iii) Identify costs associated with inventories (iv) Apply inventory management models ABC and EOQ - and their related extensions to manage various aspects of inventory management (v) Develop an understanding of the demand-dependent inventory management methods Content Importance of inventory management Inventory types Inventory costs Inventory management techniques The ABC model The economic order quantity (EOQ) model Extended EOQ model Demand-dependent models 2.8 Lecture 8 Short and medium term sources of finance Introduction Short term and medium finance is equally important to any firm. Larger firms have access to stock markets, bond markets and syndicated loan facilities. However, these facilities are not so accessible to small firms. So, small firms normally turn to their local banks, finance houses and their trade creditors (suppliers) for funding support in order to achieve their expansion programmes. This means that a combination of overdrafts and loans, trade credit, leasing, hire purchase, would make up the greater part of the funding needs. These sources however are not out of reach of the larger firms. Although they have access to dozens of 6

7 different types of finance they also value the characteristics cheapness and flexibility of the short and medium financing sources we shall discuss in this lecture. This lecture will introduce you to various sources of short and medium term finance. It will focus on the description of these sources giving the nature of each form of finance, explore the appropriate use of them in various circumstances and highlight the advantages and disadvantages of each. : (i) (ii) (iii) (iv) (v) Describe, compare and contrast the bank overdraft and the bank term loan Develop awareness of the central importance of trade credit and discuss the advantages of good debtors management practices. Outline the different services offered by factoring houses Describe what hire purchase and leasing are and discuss their relative merits Describe bills of exchange and bank bills and their uses in finance Content Bank overdrafts Bank term loans Trade credit and their terms Debtors management practices and their importance Factoring services Hire purchase and leasing Bills of exchange and bank bills 2.9 Lecture 9: Long term financing -Venture capital funding Introduction All firms must at varying times obtain long term capital. To do so, a firm must either borrow the money (debt financing), sell a portion of the firm (equity financing) or both. How the firm raises long term capital depends a great deal on the size of the firm, its life cycle stage and its growth prospects. A large segment of the Tanzania s corporate sector for example, is comprised of small and medium enterprises (SMEs) whose major problem, among others, is related to limited sources of long-term financing. This lecture, the first of a series of lectures in long term financing, will introduce you to one of the potential, but seldom talked about, source of long term finance for young, high risk, high growth small and medium enterprises venture capital. : 7

8 (i) (ii) (iii) (iv) (v) Develop an understanding of the venture capital as a source of long term finance and identify the key roles that venture capital funding play in corporate financing; Discuss the venture capital process and identify the key sources of funding for venture capital investments; Discuss the key issues in selecting a venture capitalist and some of the realities involved; Identify some of the key rules for successful venture capital investments and the circumstances under which venture capitalists cash out on their investments; and Develop an overview of venture capital financing market in Tanzania Content Venture capital described The role and realities of Venture capital funding Sources of funds for venture capital investments Attracting venture capital finance and choosing a venture capitalist Mechanics of venture capital funding Rules for successful venture capital investments When do venture capitalists cash out? Venture capital market in Tanzania Lecture 10: Long term financing: Initial public offerings Introduction When a company has grown either alone or with the help of the venture capital, it may continue to face more profitable opportunities beyond the ability of its internal sources, direct borrowing or venture capital funding can support. At this stage, the company may choose to raise equity capital from the wider public i.e. going public. This lecture will look at what initial public offering (IPO) or simply going public is, the process of going public, and the roles of investment banks acting as underwriters to the offering. It will then look at how the IPO price may be determined, the cost of the IPO to the issuing company, issues of underpricing as well as the benefits associated with going public (listing) as well as the benefits of listing across borders (cross listing) (i) (ii) (iii) Define and differentiate among different types of IPOs Describe the IPO process Outline the different issuing methods 8

9 (iv) Discuss the different considerations when choosing an underwriter (v) Outline the roles played by the underwriter in the IPO process (vi) Define underpricing and outline the reasons for underpricing (vii) Identify the various costs associated with IPOS (viii) Identify the benefits associated with listing and cross listing Content IPOS defined and classified The IPO process Issuing methods Choosing an underwriter Role of the underwriter Determining the IPO price Underpricing of IPOs Cost of IPOs Benefits of listing and cross-listing 2.11 Lecture 11: Long term Financing: Seasoned equity offerings (SEOs) Introduction In the preceding lecture you were introduced to the mechanics of initial public offerings. As the company continue to grow and face more growth opportunities. Under this condition, the company may choose to sell more shares to the public in order to raise the capital it needs to take up these growth opportunities. This lecture will look at the mechanics of offering such shares after having it shares listed on the stock exchange, how to determine the offer terms, and analyse the effect that such offerings have on the shareholders wealth. The lecture will end with a discussion on how the markets react to public announcements of such offers (i) (ii) (iii) (iv) (v) (vi) Define SEOs and describe the process Identify and differentiate between offer methods Determine the terms of offer in rights issues Analyse the effects of a rights issues on the wealth of a shareholder Describe the dilution effect of SEOs Explain how the market react to equity offering announcements Content SEOs defined The SEO process 9

10 Alternative offering methods Rights issues Mechanics of rights issues o No of rights need to purchase a share o Ex-rights price o Value of a right Effects of rights issues on shareholders Dilution effects Market s reaction to equity offer announcements 2.12 Lecture 12: Long term financing: Long term Debt Introduction You may have entered into a long term loan arrangement already; e.g. student loan, salaried staff loan, car financing loan, etc. Borrowing money is something individuals normally do and so do firms. Although you have dealt with capital structure decisions earlier in which you learned how firms determine how much to borrow, this lecture will take you through the different forms and features of borrowings. For example, when a firm decides to issue debt securities it must do a number of decisions e.g. should the debt have fixed or variable interest rate? When should it mature, should it include a sinking fund which will retire it in instalments, should the firm retain a call option so that it can call in the debt and refund it if interest rates drop? These are, but a few, features you will learn in this lecture. (i) Describe the four main types of long term corporate debt instruments (ii) Explain clearly the terms maturity; interest rate, sinking fund, call option, and covenants of a long term debt instrument (iii) Develop an overview of the debt market in Tanzania (iv) Perform a bond refunding decision Content Types of long term debt Main features of long term debt Designing a long term debt issue An overview of the debt market in Tanzania International debt financing Bond refunding analysis 2.13 Lecture 13: Capital structure Introduction 10

11 In the preceding few lectures, you were introduced to a number of sources of long term financing creating an impression that firms are at liberty to use any of them. In reality however, the decision to use one or a combination of such sources is not a clear cut one. Assuming that these sources can be classified into two categories only that is into debt like and equity like sources, the question that follows is how much debt should the firm use relative to equity. This is the question that this lecture will try to address. It will discuss the basic ideas underlying optimal debt policies and how firms should establish them. Lecture objectives (i) Define capital structure and identify corporate decisions which alters the firm s capital structure position (ii) Identify the key capital structure question(s) (iii) Describe the link between capital structure decision and both the firm s value and cost of capital (iv) Describe the income and the tradition views on capital structure and their prediction of optimal capital structure (v) Describe the different views of Modigliani and Miller on capital structure and their predictions of optimal capital structure Content The Capital structure basics The capital structure questions The Income and traditional views of capital structure The Modigliani and Miller s views under no taxes assumptions The Modigliani and Miller s views under corporate taxes assumption 2.14 Lecture 14 The limits of using debt in capital structure Introduction In the preceding lecture you saw various debates about capital structure and its effect on the firm s value and overall cost of capital. The traditional view for example argued that capital structure and firm value are related and that the firm s value is maximized at the point where the firm s cost of capital is at a minimum. The Modigliani and Miller in the world of no taxes argue that capital structure is irrelevant as far as the firm s value and cost of capital are concerned. But when corporate taxes were incorporated in the analysis, Modigliani and Miller s view was modified to show that the firm s value for the geared firm would be higher than that of the ungreared firm by an amount equal to the present value of debt tax shield. This latter view suggests that value maximizing managers should choose capital structures with as high proportion of debt as 100 percent. However, it is virtually impossible to find companies whose managers behave as such. The question that follows is what limits firm managers from using high proportions of debt in their financing as suggested by Modigliani and miller? This lecture will look at alternatives views such as the presence of bankruptcy 11

12 costs, agency costs as well as personal taxes, to show how they may deter managers from using higher proportions of debt in their firm capital structures. Lecture objectives (i) Define bankruptcy and the associated costs (ii) Define agency and the associates costs (iii) Describe how bankruptcy and agency cost limits managers desire to use high proportions of debt in their companies capital structure (iv) Outline personal taxes and evaluate how these also limits the desire of managers to use debt in their capital structures Content Bankruptcy and the associated costs Agency problem in debt financing and their associated costs The impact of bankruptcy and agency costs on the present value of the debt tax shield Personal taxes Millers argument of optimal capital structure and personal taxes 3.0 Module assessment: Compulsory student progressive portfolio (ungraded) 1 Timed test 30% Final Exam 70% Requirements: A very good Knowledge and understanding of Finance I, accessing up to dated corporate finance case studies and information from news papers (Financial Times), finance journal and financial reports, intensive group discussion for case studies analysis, possessing basic ICT knowledge, computational facilities such as calculators and financial table. 5.0 Recommended readings: Arnold, G. (2008) Corporate financial management. 4th edition. Essex: FT Pearson Education/Prentice Hall. Brealey, R. A. & Myers, S. C. (2003) Principles of corporate finance. 7 th edition. Boston: McGraw-Hill, Irwin. Brealey, R. A., Myers, S. C. & Allen, F.. (2011) Principles of corporate finance. 10 th edition. McGraw Hill Higher EducationBrealey, R. A., Myers, S. C. & Marcus, A.J. (2006) Fundamentals of corporate finance. 6 th edition. Boston: McGraw-Hill, Irwin. Damodaran, A. (2001) Corporate finance: Theory and practice. 2nd edition. New York: John Wiley & Sons Inc. 12

13 Emery, D. R., Finnerty, J. D. & Stowe, J. D. (2007) Corporate financial management. 3rd edition. Prentice Hall Firer, C.; Ross, S. A.; Westerfield, R. W. & Jordan B. D. (2005) Fundamentals of Corporate Finance. 3rd South African edition. Berkshire UK: McGraw-Hill Companies. Gitman, L. J. (2009) Principles of managerial finance. 12 th edition. Addison-Wesley/Prentice Hall Joseph, G. C. (2002) Analysis of factors affecting accessibility of small and medium enterprises to venture capital in Tanzania, Unpublished MBA Dissertation, University of Dar es Salaam, Dar es Salaam. McMenamin, J. (1999) Financial management: An introduction. New York: Routledge, Moyer, R. C., McGuigan, J. R., & Kretlow, W. J. (2008) Contemporary financial management. 11 th edition. Cingage Learning. Pandey, I. M. (2006) Financial management. 9 th edition. New Delhi: Vikas Publishing House Pvt Ltd. Ross, S. A., Westerfield, R. W. & Jaffe, J. F. (2008) Corporate finance. International 8 th edition. Boston: McGraw-Hill/Irwin. Ross, S.A., Westerfield, R. W. & Jordan, B. D. (2006) Fundamentals of corporate finance. 7 th edition. New York: McGraw Hill Van-Horne, J. (2002) Financial management and policy. 12 th edition. Upper Saddle River, New Jersey: Prentice-Hall Many of these books are available at OUT HQ library, its regional centres, or appropriate sections in the Tanzania Library Services (TLS) branches. Some of them are available at bargain prices in bookshops, bookstalls in the city and other towns (shop around). Other institutional libraries should have some of them (take the initiative). The list above is also not exhaustive. Many other books in finance cover the intended materials. Be curious but guided by this outline and explore them wherever you find them. You may also try your luck by visiting the following websites where you may find and download some of these or other equally relevant text books, including those of other subjects: and Other Web resources Biz/ed: business and economics subject launch pad available at Herriot-Watt University, UK at or simply go to You can also search for learning resources such as podcast and video lecture clips on The following local websites are also extremely useful for this module: etc. 13