Unit 1: Strategic Financial Management

Strategic Financial Management (SFM)

Strategic Financial Management refers to planning, organizing, directing, and controlling financial activities in a way that supports the long-term goals, competitive advantage, and financial stability of an organization.
It aligns financial decisions with the overall corporate strategy.

Objectives of Strategic Financial Management

Objective	Explanation
1. Wealth Maximization	Main goal is to maximize shareholder wealth by increasing the market value of the firm.
2. Ensuring Long-term Survival	Finance decisions ensure liquidity, solvency, and long-term sustainability.
3. Optimal Utilization of Resources	Efficient use of funds to achieve maximum returns at minimum cost.
4. Managing Risks	Identifying, analyzing, and reducing financial risks through hedging, diversification, and planning.
5. Maintaining Financial Flexibility	Ensuring availability of funds in both good and bad times.
6. Supporting Strategic Decisions	Finance supports mergers, acquisitions, expansion, new projects, cost reduction, and innovation.
7. Profit Maximization (Short-term)	Improving operational profitability and cash flows.

Functions of Strategic Financial Management

A. Investment Decisions (Capital Budgeting)

• Selecting profitable long-term projects.
• Using NPV, IRR, Payback, PI.
• Examples: new product launch, plant expansion, technology upgrade.

B. Financing Decisions

• Choosing best financing mix: equity, debt, preference share, retained earnings.
• Objective: minimize cost of capital and maximize returns.

C. Dividend Decisions

• Deciding how much profit should be distributed as dividends and how much to retain.
• Balance between shareholder expectations and future growth.

D. Working Capital Management

• Managing current assets and current liabilities for smooth operations.
• Examples: inventory, cash, receivables, payables.

E. Risk Management

• Managing interest rate risk, currency risk, credit risk, market risk, etc.

F. Financial Planning & Forecasting

• Budgeting, forecasting sales, profit planning.

G. Corporate Restructuring

• Mergers, acquisitions, divestitures, joint ventures.

VALUATION OF SECURITIES

Securities include equity shares, preference shares, and debentures/bonds.
Valuation helps in investment decisions, IPO pricing, M&A, and financial reporting.

1. Approaches to Corporate Valuation

A. Asset-Based Approach

• Value = Net Assets = (Total Assets – Total Liabilities)
• Useful in liquidation situations or asset-heavy companies.
• Example: Real estate firms, manufacturing units.

B. Income-Based Approach

• Based on present value of future earnings or cash flows.

Methods:

• Discounted Cash Flow (DCF)
• Capitalization of Earnings
• Used in most corporate valuations (M&A, investment analysis).

C. Market-Based Approach

• Value is compared with similar companies.

Methods:

• Price/Earnings (P/E) ratio
• Price/Book Value (P/BV)
• Enterprise Value/EBITDA
• Useful when market data is available (listed companies).

Valuation of Equity Shares

A. Dividend Discount Model (DDM)

i. Zero Growth DDM

If dividend is constant:

$$P_0=\frac{D}{\mathrm{k}}$$

ii. Constant Growth DDM (Gordon Model)

$$P_0=\frac{D_1}{k-\mathrm{g<span\; class="vlist-s"></span>}}$$

Where:

• D1​ = expected dividend next year
• $k$ = required rate of return
• $g$ = growth rate

iii. Multiple Growth Stages (Two-stage or H-model)

Used when company has high growth initially and stable growth later.

B. Earnings Capitalization Approach

If dividends are unstable but earnings are predictable:

$$P_0=\frac{E}{k}$$

C. Cash Flow Based Valuation (DCF)

Equity value = Present value of future Free Cash Flows to Equity (FCFE)

$$Equity\ Value = \sum \frac{FCFE_t}{(1+k)^t}$$

This is widely used in corporate finance.

Valuation of Debts (Bonds/Debentures)

Bonds give fixed interest (coupon) every year.

Bond Price Formula

$$P_0=\sum \frac{C}{(1+r{)}^t}+\frac{M}{(1+r{)}^{\mathrm{n}}}$$

Where:

• $C$ = annual coupon
• M = maturity value (face value)
• r = required rate of return
• n = number of years

If coupon rate > market rate, bond trades at premium.
If coupon rate < market rate, bond trades at discount.

4. Valuation of Preference Shares

A. Irredeemable Preference Shares (perpetual)

$$P_0 = \frac{D}{k}$$

Where $D$ = fixed preference dividend.

B. Redeemable Preference Shares

$$P_0=\frac{D}{(1+k)}+\frac{M}{(1+k{)}^{\mathrm{n}}}$$

(Multi-year versions include summation of dividends)

Summary Table

Security Type	Valuation Method	Formula / Basis
Equity Shares	DDM (dividends)	$P_0 = \frac{D_1}{k-g}$
	Earnings Approach	$P_0 = \frac{E}{k}$
	Cash Flow DCF	PV of FCFE
Bonds/Debts	Yield-based valuation	PV of coupons + PV of maturity value
Preference Shares	Perpetual	$P_0 = \frac{D}{k}$
	Redeemable	PV of dividends + PV of redemption amount