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CORPORATE FINANCE
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Topic 1
Nature of Corporate
Finance
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To understand about meaning of Business
finance;
Importance of corporate finance;
Types of corporate firms;
To understand financial assets & financial
system;
Significance and areas of financial decisionmaking (Finance Functions);
To understand role of finance manager;
To study financial goals of an organization.
Objectives:
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Introduction: Finance
Financeis concerned with Valueand also
concerned with how to make best
decisions.
Finance is defined as the provision of
money at the time when it is required
Finance: Management of flows of money
through an organisation. Finance as to
providing of funds needed by a business.
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Business Finance
Business Finance as an activity or a processwhich is concerned with ;
- Acquisition of funds
- Use of funds- Distribution of profit by a
business
Business finance can be classified into;* Sole proprietary finance
* Partnership finance
* Company or Corporate finance
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Business Organization from Start-up
to a Major Corporation
Sole proprietorship
Partnership
Corporation
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Starting as a Proprietorship
Advantages: Ease of formation
Subject to few regulations
No corporate income taxes Disadvantages:
Limited life
Unlimited liability
Difficult to raise capital to support growth
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Starting as or Growing into a
Partnership
A partnership has roughly the sameadvantages and disadvantages as a soleproprietorship.
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Advantages and Disadvantages of a
Corporation
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation Cost of set-up and report filing
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Why is corporate finance
important to all managers?
Corporate finance provides the skillsmanagers need to:
Identify and select the corporate
strategies and individual projects that
add value to their firm.
Forecast the funding requirements of
their company, and devise strategies for
acquiring those funds.
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Real & Financial Assets
1) Real Assets:
(i) Tangible real assets
(ii) Intangible real assets
2) Financial Assets
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What are Real Assets & Financial assets?
Real Assets:
Tangible real assets
Intangible real assets
Financial Assets: A financial asset is a contract that entitles the
owner to some type of payoff or they are alsocalled as Securities
Debt Equity
Derivatives
In general, each financial asset involves two
parties, a provider of cash (i.e., capital) and a userof cash.
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Equity and Borrowed Funds
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Shares represent ownership rights oftheir holders. Shareholders are owners ofthe company. Shares can of two types:
Equity Shares Preference Shares
Loans, Bonds or Debts: representliability of the firm towards outsiders.
Lenders are not owners of the company.These provide interest tax shield.
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Equity and Preference Shares
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Equity Shares are also known asordinary shares.
Do not have fixed rate of dividend.
There is no legal obligation to pay dividends toequity shareholders.
Preference Shares have preference fordividend payment over ordinary
shareholders. They get fixed rate of dividends.
They also have preference of repayment atthe time of liquidation.
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FINANCIAL MARKETS
Money Market
Capital Market
FINANCIAL INSTITUTIOS
Commercial Banks
Insurance companies
Mutual funds
Provident funds
NBFC
Suppliers of funds
Individual
Business
Government
PrivatePlacements
Demanders offunds
Individuals
Business
Government
Funds
Deposits / Shares
Funds
Securities
Funds
Securities
Securities
Funds
Funds
Loans
FINANCIAL SYSTEM:
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Significance of Corporate Finance
Corporate Finance is broadly concerned with
acquisition and use of funds by a business firm.
It scope may be;
How large should the firm be and how fast
should it grow?
What should be the composition of the firms
assets?
What should be the mix of firmsfinancing?
How should the firm analyse, plan and control its
financial affairs?
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Finance Functions / Objectives;
Long-Term Decision:
a) Investment or Long Term Asset MixDecision
b) Financing or Capital Mix Decision
c) Dividend or Profit Allocation Decision
Short-Term decision:
Liquidity or Short Term Asset MixDecision
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Areas of Financial Decision Making
Capital Budgeting Decision - Investment
- Identification of Investment
Opportunities
- Evaluation of capital projects
- Selection of capital projects
Capital Structure Decision - Finance
- Determining optimal debt-equity mix
- Measurement of cost of capital
- Mobilization of finance
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Dividend Decision
- Determination of Dividend policy
- Deciding interim dividends
- Deciding stock dividends- Tax considerations
Working Capital Management
- Cash Management- Receivables Management
- Inventory Management
- Financing of WC requirement
Areas of Financial Decision Making
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Finance Managers Role
Raising of Funds
Allocation of Funds
Profit Planning
Understanding Capital Markets
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Role of finance manager
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34(a)
4(b)Firms
FinancialOperation
Finance
Manager
Capital
Markets
1.Tapping financing sources2. Investment 3. CF generated4. (a) Reinvestments (b) Return of capital
St t d D ti f Fi E ti
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Status and Duties of Finance Executives
Board of Directors
Managing Director
Production
Manager
Personnel
Manager
Financial
Manager
Marketing
Manager
Retirement
Benefits
Cost
Control
Performance
Evaluation
Accounting
InventoryManagement
Planning andBudgeting
CreditManagement
Auditing
TRESURER CONTROLLER
S d D i f Fi
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Status and Duties of Finance
Executives
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The exact organisation structure forfinancial management will differ acrossfirms.
The financial officer may be known as thefinancial manager in some organisations,while in others as the vice-president offinance or the director of finance or the
financial controller.
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The Goal of Financial Management
Possible Goals:
Survive
Avoid financial distress & bankruptcyBeat the competition
Maximize sales or market share
Minimize costsMaximize profits
Maintain steady earning growth
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Financial Goals
(a) Profit maximization (profit after tax)
(b) Maximizing Earnings per Share
(c) Shareholders Wealth Maximization
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(a) Profit Maximization
Maximizing the Rupee Income of Firm
Resources are efficiently utilized Appropriate measure of firm
performance
Serves interest of society also
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Objections to Profit Maximization
It Ignores the Timing of Returns
It Ignores Risk
Assumes Perfect Competition In new business environment profit
maximization is regarded as
Unrealistic
Difficult
Inappropriate
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I. M. Pandey, Financial Management, 9thed., Vikas.
29
(b) Maximizing EPS
Market value is not a function of EPS. Hence
maximizing EPS will not result in highest price
for company's shares
Maximizing EPS implies that the firm should
make no dividend payment so long as funds
can be invested at positive rate of return
such a policy may not always work
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(c) Shareholders Wealth Maximization
Maximizes the net present value of a course of
action to shareholders.
Accounts for the timing and risk of the expected
benefits. Benefits are measured in terms of cash flows.
Fundamental objectivemaximize the market
value of the firms shares.
Value creation based on;
- Accounting profit vs cash flows
- Timing of cash flows
- Risk of cash flows (situation like pessimistic, optimistic)
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Profit maximization v/s Wealth
Maximization
Ex: Option 1 Option 2 Option 3
Year 1 200 500 333.33
Year 2 300 300 333.33
Year 3 500 200 333.33
Total 1000 1000 1000.00
Option-2 will maximize shareholders wealththoughit offers earlier returns.
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Comparison of Profit & Wealth objectives:
Profit Max. Wealth Max.
Returns Yes Yes
Time factor No Yes
Risk factor No Yes
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Need for a Valuation Approach
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SWM requires a valuation model.
The financial manager must know,
How much should a particular share be worth?
Upon what factor or factors should its valuedepend?
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Risk-return Trade-off
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Financial decisions of the firm are guidedby the risk-return trade-off.
The return and risk relationship:
Return = Risk-free rate + Riskpremium
Risk-free rate is a compensation for timeand risk premium for risk.
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Risk Return Trade-off
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Risk and expected return move in tandem; the greaterthe risk, the greater the expected return.
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What do firms do?
Business firms often persue several goals;
They seek to achieve high rate of growth
Enjoy substantial market share
Attain product and technological leadership
Promote employee welfare
Employees & Customers satisfaction
Support education and research
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Capital BudgetingDecision
Capital StructureDecision
Dividend Decision
Working capital
Decision
RETURN
RISK
Market ValueOf Firm
Finance Objectives
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