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Chapter ± 1

1.1 Introduction
Corporate finance dealing with financial decisions business enterprises
make and the tools and analysis used to make these decisions. The primary
goal of corporate finance is to maximize corporate value while managing the
firm's financial risks. Although it is in principle different from managerial
finance which studies the financial decisions of all firms, rather than
corporations alone, the main concepts in the study of corporate finance are
applicable to the financial problems of all kinds of firms.
In July 1999, Carleton "Carly" Fiorina assumed the position of CEO of
Hewlett-Packard (HP). Investors were pleased with her view of HP's future:
She promised 15 percent annual growth in sales and earnings, quite a goal for a
company with five consecutive years of declining revenue. Ms. Fiorina also
changed the way HP was run. Rather than continuing to operate as separate
product groups, which essentially meant the company operated as dozens of
mini companies, Ms. Fiorina reorganized the company into just two divisions.

In 2002, HP announced that it would merge with Compaq Computers.
However, in one of the more acrimonious corporate battles in recent history, a
group led by Walter Hewlett, son of one of HP's cofounders, fought against the
merger. Ms. Fiorina ultimately prevailed, and the merger took place. With
Compaq in the fold, the company began a two-pronged strategy. It would
compete with Dell in the lower-cost, more commodity-like personal computer
segment and with IBM in the more specialized, high end computing market.
Unfortunately for HP's shareholders, Ms. Fiorina's strategy did not work out as
planned, and in February 2005, under pressure from HP's board of directors,
Ms. Fiorina resigned her position as CEO. Evidently, investors also felt a
change in direction was a good idea; HP's stock price jumped almost seven
percent the day the resignation was announced.

Understanding Ms. Fiorina's rise from corporate executive to chief
executive officer, and finally, ex-employee, takes us into issues involving the
corporate form of organization, corporate goals, and corporate control.
The discipline can be divided into long-term and short-term decisions
and techniques. Capital investment decisions are long-term choices about
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which projects receive investment, whether to finance that investment with
equity or debt, and when or whether to pay dividends to shareholders. On the
other hand, the short term decisions can be grouped ". This subject deals with
the short-term balance of current assets and current liabilities; the focus here is
on managing cash, inventories, and short-term borrowing and lending (such as
the terms on credit extended to customers).
The terms corporate finance and corporate financier are also associated
with investment banking. The typical role of an investment bank is to evaluate
the company's financial needs and raise the appropriate type of capital that best
fits those needs.























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2.2 Structure of Corporate Finance











MAXIMIZE THE
VALUE
OF THE BUSINESS
(FIRM)
The Investment Declslon
Invest ln ussets thut eurn
u return greuter thut the
mlnlmum ucceptuble
hurdle rute

The Flnunclng Declslon
Flnd the rlght klnd of debt
for your flrm und the rlght
mix of debt and equity to
fund your operations

The Flnunclng Declslon
Flnd the rlght klnd of debt
for your flrm und the rlght
mlx of debt und equlty to
fund your operutlons

The hurdle
rute should
reflect the
rlsklness of the
lnvestment
und the mlx of
debt und
equlty used to
fund lt

The return
should reflect
the mugnltude
und the tlmlng
of the cush
flows us well
us ull slde
effects

The optlmul
mlx of debt
und equlty
muxlmlzes
flrm vulue

The rlght
klnd of debt
mutches the
tenor of your
ussets

How much
cush you cun
return
depends on
current und
potentlul
lnvestment
opportunltles

How you
choose to
return cush to
the owners
wlll depend on
whether they
prefer
dlvldends or
buybucks

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1.3 WHAT IS CORPORATE FINANCE?

Suppose you decide to start a firm to make tennis balls. To do this, you
hire managers to buy raw materials, and you assemble a workforce that will
produce and sell finished tennis balls. In the language of finance, you make an
investment in assets such as inventory, machinery, land, and labor. The amount
of cash you invest in assets must be matched by an equal amount of cash raised
by financing. When you begin to sell tennis balls, your firm will generate cash.
This is the basis of value creation. The purpose of the firm is to create value for
you, the owner. The value is reflected in the framework of the simple balance
sheet model of the firm. Following Factor have to be consider before making
the Corporate Finance.

Capital investment decisions
Capital investment decisions are long-term corporate finance decisions
relating to fixed assets and capital structure. Decisions are based on several
inter-related criteria. (1) Corporate management seeks to maximize the value
of the firm by investing in projects which yield a positive net present value
when valued using an appropriate discount rate. (2) These projects must also
be financed appropriately. (3) If no such opportunities exist, maximizing
shareholder value dictates that management must return excess cash to
shareholders (i.e., distribution via dividends). Capital investment decisions
thus comprise an investment decision, a financing decision, and a dividend
decision.
Valuing flexibility
In many cases, for example R&D projects, a project may open or close) paths
of action to the company, but this reality will not typically be captured in a
strict NPV approach. Management will therefore (sometimes) employ tools
which place an explicit value on these options. So, whereas in a DCF valuation
the most likely or average or scenario specific cash flows are discounted, here
the ³flexible and staged nature´ of the investment is modeled, and hence "all"
potential payoffs are considered. The difference between the two valuations is
the "value of flexibility" inherent in the project. The two most common tools
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are Decision Tree Analysis (DTA) and Real options analysis (ROA); they may
often be used interchangeably:
DTA values flexibility by incorporating possible events (or states) and
consequent management decisions. (For example, a company would build a
factory given that demand for its product exceeded a certain level during the
pilot-phase, and outsource production otherwise. In turn, given further
demand, it would similarly expand the factory, and maintain it otherwise. In
a DCF model, by contrast, there is no "branching" - each scenario must be
modeled separately.) In the decision tree, each management decision in
response to an "event" generates a "branch" or "path" which the company
could follow; the probabilities of each event are determined or specified by
management. Once the tree is constructed: (1) "all" possible events and their
resultant paths are visible to management; (2) given this ³knowledge´ of the
events that could follow, and assuming rational decision making,
management chooses the actions corresponding to the highest value path
probability weighted; (3) this path is then taken as representative of project
value. See Decision theory: Choice under uncertainty.

ROA is usually used when the value of a project is contingent on the value
of some other asset or underlying variable. (For example, the viability of a
mining project is contingent on the price of gold; if the price is too low,
management will abandon the mining rights, if sufficiently high,
management will develop the ore body. Again, a DCF valuation would
capture only one of these outcomes.) Here: (1) using financial option theory
as a framework, the decision to be taken is identified as corresponding to
either a call option or a put option; (2) an appropriate valuation technique is
then employed - usually a variant on the Binomial options model or a
bespoke simulation model, while Black Sholes type formulae are used less
often; see Contingent claim valuation. (3) The "true" value of the project is
then the NPV of the "most likely" scenario plus the option value. (Real
options in corporate finance were first discussed by Stewart Myers in 1977;
viewing corporate strategy as a series of options was originally per Timothy
Luehrman, in the late 1990s.)

The Financing Decision
Achieving the goals of corporate finance requires that any corporate
investment be financed appropriately. As above, since both hurdle rate and
cash flows (and hence the riskiness of the firm) will be affected, the
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financing mix can impact the valuation. Management must therefore identify
the "optimal mix" of financing²the capital structures those results in
maximum value. (See Balance sheet, WACC, Fisher separation theorem;
but, see also the Modigliani-Miller theorem.).
The sources of financing will, generically, comprise some
combination of debt and equity financing. Financing a project through debt
results in a liability or obligation that must be serviced, thus entailing cash
flow implications independent of the project's degree of success. Equity
financing is less risky with respect to cash flow commitments, but results in
a dilution of ownership, control and earnings. The cost of equity is also
typically higher than the cost of debt (see CAPM and WACC), and so equity
financing may result in an increased hurdle rate which may offset any
reduction in cash flow risk. Management must also attempt to match the
financing mix to the asset being financed as closely as possible, in terms of
both timing and cash flows.
One of the main theories of how firms make their financing decisions
is the Pecking Order Theory, which suggests that firms avoid external
financing while they have internal financing available and avoid new equity
financing while they can engage in new debt financing at reasonably low
interest rates. Another major theory is the Trade-Off Theory in which firms
are assumed to trade-off the tax benefits of debt with the bankruptcy costs of
debt when making their decisions. An emerging area in finance theory is
right-financing whereby investment banks and corporations can enhance
investment return and company value over time by determining the right
investment objectives, policy framework, institutional structure, source of
financing (debt or equity) and expenditure framework within a given
economy and under given market conditions. One last theory about this
decision is the Market timing hypothesis which states that firms look for the
cheaper type of financing regardless of their current levels of internal
resources, debt and equity.
The Dividend Decision
Whether to issue dividends, and what amount, is calculated mainly on
the basis of the company's inappropriate profit and its earnings prospects for
the coming year. If there are no NPV positive opportunities, i.e. projects where
returns exceed the hurdle rate, then management must return excess cash to
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investors. These free cash flows comprise cash remaining after all business
expenses have been met.
This is the general case, however there are exceptions. For example,
investors in a "Growth stock", expect that the company will, almost by
definition, retain earnings so as to fund growth internally. In other cases, even
though an opportunity is currently NPV negative, management may consider
³investment flexibility´ / potential payoffs and decide to retain cash flows; see
above and Real options.
Management must also decide on the form of the dividend distribution,
generally as cash dividends or via a share buyback. Various factors may be
taken into consideration: where shareholders must pay tax on dividends, firms
may elect to retain earnings or to perform a stock buyback, in both cases
increasing the value of shares outstanding. Alternatively, some companies will
pay "dividends" from stock rather than in cash; see corporate action. Today, it
is generally accepted that dividend policy is value neutral (see Modigliani-
Miller theorem).
Working capital management
Decisions relating to working capital and short term financing are
referred to as working capital management. These involve managing the
relationship between a firm's short-term assets and its short-term liabilities.
As above, the goal of Corporate Finance is the maximization of firm
value. In the context of long term, capital investment decisions, firm value is
enhanced through appropriately selecting and funding NPV positive
investments. These investments, in turn, have implications in terms of cash
flow and cost of capital.
The goal of Working capital management is therefore to ensure that the
firm is able to operate, and that it has sufficient cash flow to service long term
debt, and to satisfy both maturing short-term debt and upcoming operational
expenses. In so doing, firm value is enhanced when, and if, the return on
capital exceeds the cost of capital.
Financial Risk Management
Risk management is the process of measuring risk and then developing
and implementing strategies to manage that risk. Financial risk management
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focuses on risks that can be managed ("hedged") using traded financial
instruments (typically changes in commodity prices, interest rates, foreign
exchange rates and stock prices). Financial risk management will also play an
important role in cash management.
This area is related to corporate finance in two ways. Firstly, firm
exposure to business risk is a direct result of previous Investment and
Financing decisions. Secondly, both disciplines share the goal of enhancing, or
preserving, firm value. All

large corporations have risk management teams, and
small firms practice informal, if not formal, risk management. There is a
fundamental debate on the value of "Risk Management" and shareholder value
that questions a shareholder's desire to optimize risk versus taking exposure to
pure risk. The debate links value of risk management in a market to the cost of
bankruptcy in that market.
Derivatives are the instruments most

commonly used in financial risk
management. Because unique derivative contracts tend to be costly to create
and monitor, the most cost-effective financial risk management methods
usually involve derivatives that trade on well-established financial markets or
exchanges. These standard derivative instruments include options, futures
contracts, forward contracts, and swaps. More customized and second
generation derivatives known as exotics trade over the counter (OTC).
Financial risk; Default (finance); Credit risk; Interest rate risk; Liquidity
risk; Market risk; Operational risk; Volatility risk; Settlement risk; Value at
Risk;.







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Chapter - 2
2.1 Relationship with Other Areas in Finance
Investment Banking
Use of the term ³corporate finance´ varies considerably across the
world. In the United States it is used, as above, to describe activities, decisions
and techniques that deal with many aspects of a company¶s finances and
capital. In the United Kingdom and Commonwealth countries, the terms
³corporate finance´ and ³corporate financier´ tend to be associated with
investment banking - i.e. with transactions in which capital is raised for the
corporation. These may include
Raising seed, start-up, development or expansion capital
Mergers, demergers, acquisitions or the sale of private companies
Mergers, demergers and takeovers of public companies, including public-to-
private deals.
Management buy-out, buy-in or similar of companies, divisions or
subsidiaries - typically backed by private equity.
Equity issues by companies, including the flotation of companies on a
recognised stock exchange in order to raise capital for development and/or to
restructure ownership.
Raising capital via the issue of other forms of equity, debt and related
securities for the refinancing and restructuring of businesses.
Financing joint ventures, project finance, infrastructure finance, public-
private partnerships and privatisations.
Secondary equity issues, whether by means of private placing or further
issues on a stock market, especially where linked to one of the transactions
listed above.
Raising debt and restructuring debt, especially when linked to the types of
transactions listed above.







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2.2 CORPORATE FINANCE IN INDIA

This site provides comprehensive information on Corporate Finance
India. It also focuses on types of services offered by Corporate Financing
Community in India. The economic renaissance in the 1990s brought by
liberation of Indian economy had a stupendous effect on the financial health of
India. The Indian financial market which was previously insulated from
foreign investors were thrown open for foreign investments. And with modern
economic policies (at par with western countries) in operation large quantum
of foreign direct investments FDI started to flow into the Indian market. The
rise in business activities and its subsequent rise in financial activities led to
the need of proper and accurate financing for corporate in India. Corporate
Finance India provides businessman, investors and entrepreneurs with finance
and advice for proper and risk free investments with an eye for maximum
returns. Corporate Finance India community relies on ready-to-use data,
projections and in formations on India's economy. The projections future
movements of the financial market are based on information and data collected
from daily activities of the finance market. Corporate Financiers in India
advices their clients after taking into consideration financial environment of
the market along with important decisions taken by the Government which,
compliments the financial health of the country. Corporate Finance India
focuses on the provision of corporate advice and funding for Indian companies
who wish to take advantage of the liquidity of the Indian financial markets.
Corporate Finance India provides the following services to the Indian
Corporate Markets.

Corporate Finance.
"Debt and equity funding.
Start up and Growth capital.
Pre-IPO finance.
Real Estate Sales and Acquisition.
Company Sales and Acquisitions.

Corporate Finance India focus has been on entrepreneurial clients,
whether individuals or businesses, and on providing funding and investment in
entrepreneurial businesses. Corporate Finance India offers a complete solution
to its client¶s objectives through market research. Corporate Finance India
companies have an extensive network of investors and funding institutions and
group of corporate associates.

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2.3 INTERNATIONAL BUSINESS IN INDIA

The current scenario for 'International Business in India' is more than
heartening. With stupendous growth of more than 7% annually, improvement
and stabilization of relations with neighboring countries and record setting rise
of its stock indexes, India continues to grab international attention. It is
destination of opportunity with its high-potential workforce and burgeoning
middle class and as an increasingly dynamic competitor.

India being a multi-cultural, multi-lingual and multi-religion state, it is
not advisable to formulate a uniform business strategy. The eastern part of the
country is known as the 'land of the intellectuals' and is regarded as the cultural
hub of the country. The southern part is known for its technology acumen and
western part is the commercial-capital of the country. The north is where the
political power sits and operates the country. µInternational Business
Opportunity in India ' exists in areas like-

Information Technology and Electronics Hardware.
Telecommunication.
Pharmaceuticals and Biotechnology.
R&D.
Banking, Financial Institutions and Insurance & Pensions.
Capital Market.
Chemicals and Hydrocarbons.
Infrastructure.
Agriculture and Food Processing.
Retailing.
Logistics.
Manufacturing.
Power and Non-conventional Energy.

Sectors like Health, Education, Housing, Resource Conservation &
Management Group, Water Resources, Environment, Rural Development,
Small and Medium Enterprises (SME) and Urban Development are untapped
and offer huge scope. With highest numbers of technical, medical, business
management graduates and highest numbers of PhD¶s coupled with an
energetic English speaking mass India offers 'services' with 50-70% less cost
from their western counterparts. For 'International Business in India' bodies
like CII, FICCI and different Chambers of Commerce provides a variety of
business facilitation services by-
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Closely working with Government and business promotion organizations in
India and the respective partner countries.
Also hosts high-level Government dignitaries and help build close working
relationships between Governments and business organizations.
It also exchanges business delegations, joint task forces and identifies
bilateral business co-operation potential and makes suitable policy
recommendations to Governments.

With opportunities galore for' International Business in India' the trend is
mind boggling. India International Business' community along with Indian
Domestic Business community is steadily emerging as the Knowledge Capital
of the world. The World Bank and different rating organizations have forecast
that at 7-8% of Economic growth, she will be world¶s second largest economy
by 2050.





















2.4 Indian Businesses
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Indian Businesses are slowly shifting their base from agriculture major
industrialization. Numerous types of Businesses in India coming up. As India
is developing the Iron & Steel Businesses in India, IT Businesses in India,
Indian Businesses in Travel &I "tourism, Indian Businesses in Business
Process Outsourcing, Food Business market in India, Soft Drinks Businesses in
India and various other types of businesses are coming to the forefront and
taking the center stage.

The marketplace for Indian Businesses is quite varied including
industries in the field of Agriculture & Forestry, Automobiles, Business
Services, Chemicals, Computers, Construction, Education, Electrical,
Electronics, Engineering/ Machinery, Entertainment, Import & Export, Fashion
& Advertising, Food Processing, Government of India Websites, Immigration,
India Neighborhood, Intelligence, International, IT/ITes, Minerals & Metals,
Packaging & Paper, Real Estate in India, Regional Portals, Travel & Tourism
and many others. The scope of doing business in India has grown in its
magnitude.

Some of the major companies in the IT sector are Wipro, Tata
Consultancy Services, Infosys Technologies, HCL ltd, Satyam Computer
Services, Cognizant Technology Solutions, Patni Computers, BFL MphasiS,
Polaris, i-flex, IBM, Hewlett-Packard and Accenture. In general the major
Indian Businesses are the Tatas, Birlas, Ambanis and many more.

The Government has played a major role in the transformation of the
Indian Business scenario in India. The major changes initiated by the
Government for the betterment of the Indian Businesses are in the form of
macroeconomic reforms, tax reforms, finance reforms and freeing of capital
markets, reforms in the regulation of business firms, revitalization of the Indian
private sector, removal of exchange controls and convertibility, trade reforms,
and foreign direct investment. The Foreign companies are showing massive
interest in the Indian Businesses. The number of Businesses in India has
increased at an impressive rate. More and more foreign companies are having
their branches in India. They are either holding hands with the Indian
Businesses by entering into a partnership with them or they are building up
their own offices in India. The 'future of Indian Businesses looks bright and
assuring.

Chapter ± 3
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3.1 Sources of Raising Finance

When a company is growing rapidly, for example when contemplating
investment in capital equipment or an acquisition, its current financial
resources may be inadequate. Few growing companies are able to finance their
expansion plans from cash flow alone. They will therefore need to consider
raising finance from other external sources. In addition, managers who are
looking to buy-in to a business ("management buy-in" or "MBI") or buyout
(management buy-out" or "MBO")a business from its owners, may not have
the resources to acquire the company. They will need to raise finance to
achieve their objectives.

There are a number of potential sources of finance to meet the needs of a
growing business or to finance an MBI or MBO:

ձ Family and friends
ձ Business angels
ձ Clearing banks (overdrafts, short or medium term loans)
ձ Factoring and invoice discounting
ձ Hire purchase and leasing
ձ Merchant banks (medium to longer term loans)
ձ Venture capital
ձ Existing shareholders and directors funds

A key consideration in choosing the source of new business finance is to
strike a balance between equity and debt to ensure the funding structure suits
the business. The main differences between borrowed money (debt) and equity
are that bankers request interest payments and capital repayments, and the
borrowed money is usually secured on business assets or the personal assets of
shareholders and/or directors. A bank also has the power to place a business
into administration or bankruptcy if it defaults on debt interest or repayments
or its prospects decline.

In contrast, equity investors take the risk of failure like other
shareholders, whilst they will benefit through participation in increasing levels
of profits and on the eventual sale of their stake. However in most
circumstances venture capitalists will also require more complex investments
(such as preference shares or loan stock) in additional to their equity stake. The
overall objective in raising finance for a company is to avoid exposing the
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business to excessive high borrowings, but without unnecessarily diluting the
share capital. This will ensure that the financial risk of the company is kept at
an optimal level.

Business Plan

Once a need to raise finance has been identified it is then necessary to
prepare a business plan. If management intends to turn around a business or
start a new phase of growth, a business plan is an important tool to articulate
their ideas while convincing investors and other people to support it. The
business plan should be updated regularly to assist in forward planning. There
are many potential contents of a business plan. The European Venture

Capital Association suggests the following:

y Profiles of company founders directors and other key managers;
y Statistics relating to sales and markets;
y Names of potential customers and anticipated demand;
y Names of, information about and -assessment of competitors;
y Financial information required to support specific projects (for example,
major capital investment or new product development);
y Research and development information;
y Production process and sources of supply;
y Information on requirements for factory and plant;
y Regulations and laws that could affect the business product and process
protection (patents, copyrights, trademarks).

The challenge for management in preparing a business plan is to
communicate their ideas clearly and succinctly. The very process of researching
and writing the business plan should help clarify ideas and identify gaps in
management information about their business, competitors and the market.





3.2 TYPES OF FINANCE

A brief description of the key features of the main sources of business
finance is provided below.
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Venture Capital

Venture capital is a general term to describe a range of ordinary and
preference shares where the investing institution acquires a share in the
business. Venture capital is intended for higher risks such as start up situations
and development capital for more mature investments. Replacement capital
brings in an institution in place of one of the original shareholders of a
business who wishes to realise their personal equity before the other
shareholders.

There are over 100 different venture capital funds in the UK and some
have geographical or industry preferences. There are also certain large
industrial companies which have funds available to invest in growing
businesses and this 'corporate venturing' is an additional source of equity
finance.

Grants and Soft Loans

Government, local authorities, local development agencies and the
European Union are the major sources of grants and soft loans. Grants are
normally made to facilitate the purchase of assets and either the generation of
jobs or the training of employees. Soft loans are normally subsidised by a third
party so that the terms of interest and security levels are less than the market
rate. There are over 350 initiatives from the Department of Trade and Industry
alone so it is a matter of identifying. Which sources will be Appropriate in
each case.

Invoice Discounting and Invoice Factoring

Finance can be raised against debts due from customers via invoice
discounting or invoice factoring, thus improving cash flow. Debtors are used as
the prime security for the lender and the borrower may obtain up to about 80
per cent of approved debts. In addition, a number of these sources of finance
will now lend against stock and other assets and may be more suitable then
bank lending. Invoice discounting is normally confidential (the customer is not
aware that their payments are essentially insured) whereas factoring extends
the simple discounting principle by also dealing with the administration of the
sales ledger and debtor collection.

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Hire Purchase and Leasing

Hire purchase agreements and leasing provide finance for the acquisition
of specific assets such as cars, equipment and machinery involving a deposit
and repayments over, typically, three to ten years. Technically, ownership of
the asset remains with the lessor whereas title to the goods is eventually
transferred to the hirer in a hire purchase agreement.

Loans

Medium term loans (up to seven years) and long term loans (including
commercial mortgages) are provided for specific purposes such as acquiring an
asset, business or shares. The loan is normally secured on the asset or assets
and the interest rate may be variable or fixed. The Small Firms Loan Guarantee
Scheme can provide up to £250,000 of borrowing supported by a government
guarantee where all other sources of finance have been exhausted.

Bank Overdraft

An overdraft is an agreed sum by which a customer can overdraw their
current account. It is normally secured on current assets, repayable on demand
and used for short term working capital fluctuations. The interest cost is
normally variable and linked to bank base rate. Completing the Finance-raising
Raising finance is often a complex process. Business management need to
assess several alternatives and then negotiate terms which are acceptable to the
finance provider. The main negotiating points are often as follows:

y Whether equity investors take a seat on the board.
y Votes ascribed to equity investors.
y Level of warranties and indemnities provided by the directors.
y Financier's fees and costs.

During the finance-raising process, accountants are often called to
review the financial aspects of the plan. Their report may be formal or
informal, an overview or an extensive review of the company's management
information system, forecasting methods and their accuracy, review of latest
management accounts including working capital, pension funding and
employee contracts etc. This due diligence process is used to highlight any
fundamental problems that may exist
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3.3 Game Theory Application for Corporate Finance

Finance in general is concerned with how the savings of investors are
allocated through financial markets and intermediaries to firms, who use them
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to fund their activities. Finance can broadly be broken down into two fields.
The first is asset pricing, which is concerned with the decisions of investors.
The second is corporate finance, which is concerned with the decisions of
firms. This paper will focus on the latter field and how game theory can be
used to explain certain behaviors that are regularly witnessed. Traditional
financial thinking relies on assumptions of certainty, complete knowledge and
market efficiency and in this context, financial decisions should be relatively
straightforward. In the real world though, many times what is observed
deviates greatly from what would be expected using traditional financial
thinking. This paper will show how different game theory models can be used
to more accurately explain observed financial decisions dealing with capital
structure, corporate acquisitions and initial public offerings (IPOs).

Game theory has made great strides in explaining many of the observed
phenomena falling under corporate finance. One example is the capital
structure decided upon by a firm¶s management. Capital structure deals with
the firm¶s decision to raise funds through debt versus equity and what ratio of
debt to equity should the firm maintain. Modigliani and Miller in 1958 showed
that in perfect capital markets (i.e. no frictions and symmetric information) and
no taxes a firm could not change its total value by altering its debt/equity ratio;
thus capital structure is irrelevant. However in the real world, capital structure
is carefully thought about by every company, and it is in fact not irrelevant
because taxes do exist and capital markets are not perfect. In the United States,
interest paid by a company is a tax-deductible expense. This tax shield creates
an incentive to take on debt. Modigliani and Miller corrected their original
model to include corporate income taxes showing that a firm could increase its
equity, or shareholder value, by taking on debt and taking advantage of tax
shields. Their model then showed all firms stood to gain the most if they were
100% debt financed; however this is not observed in reality. In fact, some
companies and industries thrive with no debt at all. Different game theory
models have been used to explain the actions of managers in determining their
company¶s capital structure, the most influential deals with the signaling
effects attributed to debt vs. equity financing. In 1984 Myers and Majluf
developed a model based on asymmetric information that insists managers are
better informed of the prospects of the firm than the capital markets.

If management feels that the market is currently undervaluing its firm¶s
equity then it will be unwilling to raise money through an equity issue because
it will be selling the stock at a discount. On the other hand, management might
be eager to issue equity if it feels its stock is overvalued, because it will be
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selling its stock at a premium. Investors are not dull and will predict that
managers are more likely to issue stock when they think it is overvalued while
optimistic managers may cancel or defer issues. Therefore, when an equity
issue is announced, investors will mark down the price of the stock
accordingly. Thus equity issues are considered a bad signal; even companies
with overvalued stock would prefer another option to raise money to avoid the
mark down in stock price. Firms prefer to use less information sensitive
sources of funds.

This leads to the pecking order of corporate financing: Retained earnings
are the most preferred, followed by debt, then hybrid securities such as
convertible bond and lastly equity. Some industries by their nature support
companies that finance most of their growth through retained earnings.
Airlines however are an example of an industry that is characterized by its high
debt level. In general, capital structure is similar within industries with
differences resulting from weighing the benefits of a higher tax shield versus
the benefits of the less information sensitive financial of retained earnings.

A second application of game theory to capital structure is concerned
with agency costs. In 1976 Jensen and Meckling described two kinds of agency
problems in corporations: One between equity holders and bondholders and the
other between managers and equity holders. The first arises because the
owners of a levered firm have an incentive to take risks at the expense of debt
holders. Stockholders of levered firms gain when business risk increases
because they receive the surplus when returns are high but the bondholders
bear the cost when default occurs. Bondholders¶ value does not increase with
the value of the firm, thus they would like the firm to take safe bets to
minimize the risk of default. Equity holders on the other hand, receive
whatever is leftover after paying back debt holders. They would like to see the
upside potential of the company maximized and this occurs through taking on
risky projects (higher returns are generated though greater risk taking.) It is
obvious that there is a conflict of interest between equity holders desire for
business risk and bondholders aversion to business risk. Financial managers
who act strictly in the interests of shareholders will favor risky projects over
safe ones. It is important to note that this agency cost does not occur in
financially sound companies. It mainly occurs when the odds of default or high
and equity holders feel they can make one last gamble to avoid bankruptcy and
get a big payoff at the same time.

Page | 21

An average payoff would not benefit the stockholders much when the
company is near default because most of the payoff will be paid out to the debt
holders. A financially sound company would not have this agency problem
because equity holders stand to lose more from risky projects when the
company is not in risk of going bankrupt, and thus want to avoid them along
with bondholders. The second conflict arises when equity holders cannot fully
control the actions of managers. This occurs when managers have an incentive
to pursue their own interests rather than those of the equity holders. Executive
compensation in the form of option contracts can create incentives for
managers to make risky decisions in an attempt to gain the highest payoff from
the call options. Higher risk increases the value of an option, but risk can also
cause a stock price to take a nosedive. A manager with options is not hurt
nearly as much as a worker with his/her retirement savings in a company
whose stock plummets because of risky bets. Option contracts were meant to
better align the interests of managers with stockholders, but it is obvious that
this is not so easily achieved. Game theory can also be used to explain what is
observed in the course of many corporate acquisitions. If markets are efficient
then one would expect a company to pay fair value when acquiring another
company; however in many instances the acquirer pays a large premium to buy
the other company. In 1986 Shleifer and Vishny provide one explanation of
this phenomenon, the free rider problem. One of the concepts behind efficient
markets is the market for corporate control. The market for corporate control
says that in order for resources to be used efficiently, companies need to be run
by the most able and competent managers. One way to achieve this is through
corporate acquisitions.

Initial Public Offerings (IPOs) have long been known to provide a
significant positive return in the initial days of trading. This occurrence
directly conflicts with the theory of market efficiency because the companies
should be fairly valued at their IPO and any return in the initial days should be
minimal. In 1986 Rock explained that this phenomenon was due to adverse
selection between informed buyers and uninformed buyers. The informed
buyers know the true value of the stock and will only purchase shares at or
below its true value. The implication of this is that the uninformed buyers will
receive a high allocation of overpriced shares since they will be the only
people in the market when the offering price is above the true value. Knowing
this, uninformed buyers would be unwilling to purchase the stock; forcing the
informed buyers to hold onto the stock because there is no one they can sell it
to. Therefore, to induce the uninformed to participate they must be
compensated for the overpriced stock they end up buying. One way to do this
Page | 22

is to under-price the stock on average. This means that on average the
uniformed will buy a stock that started out undervalued and thus they are still
able to buy the stock at or below its true value. Since all investors know that an
IPO will likely be under priced they all try to buy the stock as quick as possible
creating a demand for the stock that results in substantial price gain in the
initial days of trading.

Another interesting implication of IPOs pointed out by Ritter in 1991 is
the fact that while they experience high returns in the short run they typically
under-perform the market in the long run. One argument for this behavior is
that the market for IPOs is subject to fads and that investment banks under-
price IPOs to create the appearance of excess demand. This leads to a high
price initially but subsequently underperformance; therefore companies with
the highest initial returns should have the lowest subsequent returns. There
exists evidence of this in the long run.

Game theory has been extremely useful in explaining certain financial
decisions. This paper has only highlighted a few of the aspects where
behavioral analysis has helped explained observed behavior. Specifically,
game theory has helped explain the reasons companies might choose various
capital structures and the agency costs between managers, equity holders, and
debt holders. In addition, the existence of free rider problems and bidding wars
in corporate acquisitions has been made clear through game theory
applications. Lastly, IPOs exhibit behavior contrary to the efficient market
theory, and game theory can be utilized to help show why this behavior occurs.













3.4 Agency Costs of Free Cash Flow and Corporate Finance

Page | 23

Corporate managers are the agents of shareholders, a relationship
fraught with conflicting interests. Agency theory, the analysis of such conflicts,
is now a major part of the economics literature. The payout of cash to
shareholders creates major conflicts that have received little attention. Payouts
to shareholders reduce the resources under managers¶ control, thereby reducing
managers¶ power, and making it more likely they will incur the monitoring of
the capital markets which occurs when the firm must obtain new capital.
Financing projects internally avoids this monitoring and the possibility the
funds will be unavailable or available only at high explicit prices.

Managers have incentives to cause their firms to grow beyond the
optimal size. Growth increases managers¶ power by increasing the resources
under their control. It is also associated with increases in managers¶
compensation; because changes in compensation are positively related to the
growth in sales.

Competition in the product and factor markets tends to drive prices
towards minimum average cost in an activity. Managers must therefore
motivate their organizations to increase efficiency to enhance the problem of
survival. However, product and factor market disciplinary forces are often
weaker in new activities and activities that involve substantial economic rents
or quasi rents. In these cases, monitoring by the firm¶s internal control system
and the market for corporate control are more important. Activities generating
substantial economic rents or quasi rents are the types of activities that
generate substantial amounts of free cash flow.

Free cash flow is cash flow in excess of that required to fund all projects
that have positive net present values when discounted at the relevant cost of
capital. Conflicts of interest between shareholders and managers over payout
policies are especially severe when the organization generates substantial free
cash flow. The problem is how to motivate managers to disgorge the cash
rather than investing it at below the cost of capital or wasting it on organization
inefficiencies.

The theory developed here explains 1) the benefits of debt in reducing
agency costs of free cash flows, 2) how debt can substitute for dividends, 3)
why ³diversification´ programs are more likely to generate losses than
takeovers or expansion in the same line of business or liquidation-motivated
takeovers, 4) why the factors generating takeover activity in such diverse
Page | 24

activities as broadcasting and tobacco are similar to those in oil, and 5) why
bidders and some targets tend to perform abnormally well prior to takeover.

































3.5 The Role of Debt in Motivating Organisational Efficiency

Page | 25

The agency costs of debt have been widely discussed, but the benefits of
debt in motivating managers and their organizations to be efficient have been
ignored. I call these effects the ³control hypothesis´ for debt creation.
Managers with substantial free cash flow can increase dividends or repurchase
stock and thereby pay out current cash that would otherwise be invested in
low-return projects or wasted. This leaves managers with control over the use
of future free cash flows, but they can promise to pay out future cash flows by
announcing a ³permanent´ increase in the dividend. Such promises are weak
because dividends can be reduced in the future. The fact that capital markets
punish dividend cuts with large stock price reductions is consistent with the
agency costs of free cash flow.

Debt creation, without retention of the proceeds of the issue, enables
managers to effectively bond their promise to pay out future cash flows. Thus,
debt can be an effective substitute for dividends, something not generally
recognized in the corporate finance literature. By issuing debt in exchange for
stock, managers are bonding their promise to pay out future cash flows in a
way that cannot be accomplished by simple dividend increases. In doing so,
they give shareholder recipients of the debt the right to take the firm into
bankruptcy court if they do not maintain their promise to make the interest and
principal payments.

Thus debt reduces the agency costs of free cash flow by reducing the
cash flow available for spending at the discretion of managers. These control
effects of debt are a potential determinant of capital structure. Issuing large
amounts of debt to buy back stock also sets up the required organizational
incentives to motivate managers and to help them overcome normal
organizational resistance to retrenchment which the payout of free cash flow
often requires. The threat caused by failure to make debt service payments
serves as an effective motivating force to make such organizations more
efficient.

Stock repurchases for debt or cash also has tax advantages. (Interest
payments are tax deductible to the corporation, and that part of the repurchase
proceeds equal to the seller¶s tax basis in the stock is not taxed at all.)
Increased leverage also has costs. As leverage increases, the usual agency costs
of debt rise, including bankruptcy costs. The optimal debt-equity ratio is the
point at which firm value is maximized, the point where the marginal costs of
debt just offset the marginal benefits.

Page | 26

The control hypothesis does not imply that debt issues will always have
positive control effects. For example, these effects will not be as important for
rapidly growing organizations with large and highly profitable investment
projects but no free cash flow. Such organizations will have to go regularly to
the financial markets to obtain capital.

At these times the markets have an opportunity to evaluate the company,
its management, and its proposed projects. Investment bankers and analysts
play an important role in this monitoring, and the market¶s assessment is made
evident by the price investors pay for the financial claims. The control function
of debt is more important in organizations that generate large cash flows but
have low growth prospects, and even more important in organizations that
must shrink. In these organizations the pressures to waste cash flows by
investing them in uneconomic projects is most serious.













Chapter ± 4 Financial Statement of Cairns Ltd
4.1 In the Books of Cairns Ltd
Page | 27

Income Statement for year ended 31
st
march 2009
PARTICULARS AMOUNT AMOUNT
Net Sales 37,331
OPERATING EXPENSES
Administrative Expenses
Staff Cost 2,12,519
Data Acquisition 36,235
Other Administrative 7,20,544
Amortisation 365
Unsuccessful Exploration cost 8,13,568
Selling & Distribution
Advertisement 14,385
Publicity 42,959
Sponsorship 15,666
Financial Expenses
Bank Charges 3,058
Other Interest 388
18,59,687
PORFIT BEFORE INTEREST (18,22,356)
Less :- 0
PROFIT AFTER INTEREST (18,22,356)
Add :- Non Operating Income
Interest on Deposit 1,31,377
Dividend 2,00,225
Profit on Sale Of Investment 12,45,686
Special Gains 1,55,723
Other Income 61
29,43,072
PROFIT BEFORE TAX 11,20,716
Less : -
Current Tax 5,43,800
other tax 34,509
5,78,309

Profit After Tax 5,42,407


In the books of Cairns Ltd
Balance sheet as at 31
st
march 2009
Page | 28

PARTICULARS Amount Amount Amount
I) SORCES OF FUNDS
1) SHAREHOLDERS FUNDS
a) Share Capital
Equity Share Capital 1,89,66,678
Preference Share Capital 0
Stock Options Outstanding 3,88,978
19355656
b) Reserve & Surplus
Securities Premium A/C 30,10,90,274
(-) c) Miscellaneous Expenses
P/L Debit Expenses 5,38,000
300552274
2) Borrowed Funds
Capital Employed 31,99,07,930
II) APPLICATION OF FUNDS
1) FIXED ASSETS
Computers 609
Work in Progress 5,40,299
540908
2) INVESTMENT
Investment in Companies 29,22,53,966
29,27,94,478
3) Working Capital
Current Assets
Debtors 17 942
Cash & bank Balance 2,76,32,762
Other Current Assets 6,33,645
Loans & Advances 2,20,814
28505163
Less :- Current Liabilities
Creditors 8,75,666
Other Liabilities 2,01,068
Provisions 3,15,373
1392107
Sub-total (d) 2,71,13,056
Funds Used ( c+d) 31,99,07,930

In the Books of Cairns Ltd
Comparative Balance sheet as at 31
st
Dec 2007 &31
st
march 2009
Page | 29

PARTICULARS 31-12-2007 31-03-2009 INCREASE /
DECREASE
% CHANGE
I) SORCES OF FUNDS
1) SHAREHOLDERS FUNDS
a) Share Capital
Equity Share Capital 1,77,83,994 1,89,66,678 11,82,684 6.65%
Preference Share Capital 0 0 0 0
Stock Options Outstanding 9,47,084 3,88,978 (5,58,106) -58.92%

b) Reserve & Surplus
Securities Premium A/C 27,60,84,115 30,10,90,274 2,50,06,159 9.05%

Sub Total (a) 29,48,15,193 32,04,45,930 2,56,30,737 8.69%

c) Miscellaneous Expenses
P/L Debit Expenses 10,80,407 5,38,000 (5,42,407) -50.20%

Sub Total (b) 29,37,34,786 31,99,07,930 2,61,73,144 8.91%

2) Borrowed Funds

Capital Employed 29,97,34,786 31,99,07,930 2,01,73,144 6.73%

II) APPLICATION OF FUNDS
1) FIXED ASSETS
Computers 0 609 609 100%
Work in Progress 0 5,40,299 5,40,299 100%
2) INVESTMENT
Investment in Companies 29,41,37,285 29,22,53,966 (18,83,319) -0.64%

Page | 30

Sub-Total © 29,41,37,285 29,27,94,478 (13,42,807) -0.45%

3) Working Capital
Current Assets
Debtors 12,708 17,942 5,234 41.18%
Cash & bank Balance 7,757 2,76,32,762 2,76,25,005 3,56,130 %
Closing Stock 0 6,33,645 6,33,645 100%
Bills Receivable 35,950 2,20,814 1,84,846 514.17%

Less :- Current Liabilities
Creditors 1,36,964 8,75,666 7,38,702 539.34%
Other Liabilities 1,446 2,01,068 1,99,622 13805%
Provisions 3,20,504 3,15,373 -5,131 -1.60%

Sub-total (d) (4,02,499) 2,71,13,056 2,67,10,557 66.36%

Funds Used ( c+d) 29,97,34,786 31,99,07,930 2,01,73,144 6.73%








4.2 Accounting Ratios
Balance Sheet Ratios
Page | 31


1. Current ratio =
(Current Asset) / (Current Liability)
28505163 / 1392107
= 20.47
The standard ratio is 2:1. It indicates the short term solvency of
the company here the company¶s current ratio is very excellent as to
every 1 liability they have 20.47 assets.
2. Quick ratio
(Current Asset ± Stock ± Prepaid Exp) / (Current liability ±
Bank Overdraft)

27237873 / 1392107
= 19.56
The standard ratio is 1:1. It indicates immediate solvency of the
company here the company has 19.56 assets as compare to 1 liability
each.
3. Proprietary ratio =

[(Proprietors fund) / (Total Assets) ] *100

[3199079 30/ 321300037] *100
= 99.56 %

The Share of proprietor in company¶s fund is 99.56 % which is
very good so this shows a strong backup for the company.


4. Stock turnover ratio =
Page | 32

[(Closing Stock) / (Working Capital)] *100
[633645 / 27113056] *100
= 2.33%

The standard ratio is 200 % here the ratio is only 2.33%. this
shows that the company will face certain problems in near future.
















Income Statement Ratio

Page | 33

1. Gross profit ratio =

[ (Gross profit) / (Net Sales) ] *100

[-1043076 / 37331] * 100
= -2794 %

Here the company is earning losses so that¶s why the gross profit
ratio is in minus.

2. Net Profit Ratio=

Net profit before tax / Net Sales *100

[40399 / 37331] *100
=108.21 %

It is very good but the business surviving only through non
operating income

3. Net Profit After tax ratio=

Net Profit After tax / Net Sales *100

[542407 / 37331] *100
=1452 %

This ratio is also good as it shows 1452 % ratio.









4. Operating Ratio =

Page | 34

(Cost of Goods sold + Operating Exp) / Net Sales *100

[1859687 / 37331] * 100
=4981 %

It is bad because the expenses are more than the sales.



















Mixed Ratios
Page | 35


1. Debtors Turnover Ratio=

Credit sales / Average ( Debtors +Bills Receivable)

[37331 / 238756 ]
= 0.15 times

It is not good because the sales is very less

2. Average Collection Period =

12 months / Debtors turnover ratio

[12 / 0.15]
= 80 months

It shows that the company will face shortage of funds in the
future because they will not be able to recover their money quickly as
they will recover only after 80 months.

3. Earnings Per Share=

(Net Profit after tax- Preference Dividend) / No. of Equity shares

[5,42,407 / 1876199069]
= 0.29

The earning per share ratio some what ok as it shows 0.29
return.









4. Price Earning Ratio =
Page | 36


Market Price per share / Earning per share

[10 / 0.29]
= 34.48

Assuming that the market price is 10. The price earning is
also good.

5. Return On Capital Employed =

(Profit Before Interest) / Capital Employed *100

[1822356) / 319907930] * 100
= -0.56 %

It is very bad as it shows negative balance of 0.56 %.













Page | 37

4.3 Case Study on General Mills

A. General Mills Consolidated Statements of Earnings:

1. The recorded sale amount of almost $8 billion is not the actual amount of
cash collected. The amount of $8 billion includes cash and credit sales.

2. Sales increased each year from 2000 to 2002. The difference between the
year 2000 and 2001 was a 5.35% increase (5,450-5,173/5,173 = .0535).
The difference between the year 2001 and 2002 was a 45.85% increase
(7,949-5,450/5,450 = .4585).

3. The largest expense for General Mills for the years 2000, 2001, and 2002
was the same; over 50% of the revenue each year went towards the cost
of sales. Sales in 2002 were the largest, about 7% more than the two
previous years. 2000: (2,698/5,173) = .522 = 52.2% 2001: (2,841/5,450
= .521 = 52.1% 2002: (4,767/7,949) = .599 = 59.9%

4. Net Income: 2000: $614 million 2001: $665 million 2002: $458 million
When comparing the net income figures for the past three years, it is seen
that between 2000 and 2001, the net income increased by $51 million,
but between 2001 and 2002, the net income decreased by $207 million.

5. A company's stock price is usually influenced by the amount of net
income because when finding the price of the stock, you must divide the
number of stocks by the net income. So, the higher the net income, the
lower the price of stocks, which is what buyers look for (means better
profit).

6. Even though General Mills paid dividends in 2000, 2001 and 2002, the
corresponding total dividend payments did not appear as an expense on
the income statement because dividends are not an expense; they are a
financing activity that is reported on the statement of stockholder's
equity. They are payments that are made to only the owners of the
company.




B. General Mills Consolidated Balance Sheets:
Page | 38


7. A company has assets so that they have a location and equipment to
operate/create a business. Assets are resources that are controlled by a
business. Without assets, one cannot produce and/or run a company. The
purpose of assets are to keep track of expenses, what a company owns,
like equipment, inventory, cash etc., and creates value for the company.

8. The total amount of assets at the end of 2002 was $16,540 million.

9. When comparing the assets from the beginning of 2002 to the end, we
found that the percentage increase in assets was 224.89% (16,540-
5,091/5,091 = 2.2489 = 224.89%). Goodwill is the type of asset that is
responsible for the increase.

10. The two groups that have contributed assets to General Mills and claims
on the assets are shareholders and lenders. Shareholders have about
$5,733 million in claims and the lenders have a claim of $5,591 million.


C. General Mills Consolidated Statement of Stockholder's Equity:


11. The General Mill's total stockholders increased significantly from May
27, 2001 to May 26, 2002 because they sold more stock.

12. Comprehensive income is the change in a company's owner's equity
during a period that is the result of all transactions and activities that are
not by the owner. These can include profits from operating activities,
foreign currency, and net income, events that change owner's equity
except those from the company's own stockholders and selling stock or
paying dividends.








D. General Mills Consolidated Statement of Cash Flows:
Page | 39



13. There are three categories of cash flows shown on the company's cash
flow statement. They are the following:
1. Operating activities 2. Investing activities 3. Financial
activities.

14. When comparing the net income figure to the amount of net cash
provided by operating activities for each of the three years, one observes
that the net income went up in the first two years and than decreased
between the second and the third year. The net cash from operating
activities increased each year, but its greatest growth was between the
second and the third year. So, when the net income was the lowest, the
net cash from operating activities was the greatest.

15. Net cash provided by Net cash used by operating activities investment
activities 2000: $722 million (564 million) 2001: $737 million (460
million) 2002: $913 million (3,271 million) It is clear to see that in the
year 2000 and 2001, operating activities was large enough to cover the
investing cash outflow, but in 2002, the investing cash outflow exceeded
far past the amount of net cash provided by operating activities. Loans
were used to make up the difference.

16. When comparing the dividend payments to the income amounts for the
current year, we found that the dividend payout ratio for 2002 was 78.2%
(358/458 = .7816 = 78.2) E. General Mills Report of Management
Responsibilities and Reports of Independent Public Accountants:

17. The management of General Mills, Inc. is responsible for the accounting
numbers in the annual report.

18. For safeguards, General Mills used internal controls to ensure the
accuracy of the reported numbers, including: an audit program, a
separation of duties and responsibilities, and instated policies that
demand ethical behavior from employees.

19. The independent accountant does not say that the reported amounts are
correct, but does state that they are reported fairly. "We believe these
consolidated financial statements do not misstate or omit any material
Page | 40

facts... In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects..." The CPA assures that the
statements are in accordance with the GAAP.

20. General Mills hired a CPA (Certified Public Accountant) to audit the
financial statements to ensure accuracy and to verify that the numbers on
the statements (disclosures made by the management in its reports) are
consistent with the company's actual financial position, cash flow, and
results from its operating activities.

21. General Mills hired KPMG LLP as their accountant to audit their
financial statements. The report of the independent accountants that
performed this was signed on June 24, 2002.


F. General Mills Financial Statements:


22. General Mills major operating activities during 2002 were net sales,
selling, general, and administrative, and cost of goods. The major
difference between accrual and the cash flow of these activities is that
accrual includes cash and credit, where these major operating activities
only include cash. Accrual accounts for all, while the cash flow doesn't
account for credit sales until the money is collected.

23. General Mills return on total assets for 2001 was 13.1% (665/5,091=
.1306) and in 2002, the return on total assets was 2.8% (458/16,540 =
.0276). The return on total assets deteriorated from 2001 by 10.3%
(.1306-.0276 = .103)

24. If you owned 10,000 of the company's common stock in 2002, your
claim on the company's earnings would be $13,800 (10,000 x 1.38 (EPS-
basic) = 13,800). If you were to own 10,000 of the company's common
stock in 2001, your claim would be greater than your claim if you would
to purchase them in 2002 by $9,600, making your claim in 2001 $23,400.
(10,000 x 2.34 (EPS-basic) = 23,400).



Page | 41

25. The major source of cash for General Mills in 2002 was the issuance of
long-term debt. With the cash they received, they were able to purchase
Pillsbury (acquired in a stock and cash transaction).

26. Major financing activities performed in 2002 were the change in long-
term debt. They increased their amount of debt while paying off some of
their notes payable. They also purchased some treasury stocks. In the
year 2002, their net cash increased incredibly, by about $3,500 million,
which was one of the biggest increases recorded over the previous years
for net cash.

27. A major investing activity that occurred in 2002 was when General Mills
purchased Pillsbury.

28. At the end of 2002, the company's most important assets were:
inventories, goodwill, receivables, and land, buildings, and equipment.
Other resources that might be important that aren't reported on the
balance sheet are the skills and level of intelligence of the management
and the employees, as well as the value of the brand name 29. If asked to
assess the company's financial performance of General Mills in 2002, I
would have to say that they were very successful. Their financial
activities show that they are a growing and prosperous company; their
operating and financing activities are increasing and the investing cash
flows decreasing, keeping the inflow larger than the outflow. Their
successfulness opens many new opportunities for them in the future.









Page | 42

CONCLUSION
Arguably, the role of a corporation's management is to increase the value
of the firm to its shareholders while observing applicable laws and
responsibilities. Corporate finance deals with the strategic financial issues
associated with achieving this goal, such as how the corporation should raise
and manage its capital, what investments the firm should make, what portion
of profits should be returned to shareholders in the form of dividends, and
whether it makes sense to merge with or acquire another firm.
If the role of management is to increase the shareholder value, then
managers can make better decisions if they can predict the impact of those
decisions on the firm's value. By observing the difference in the firm's equity
value at different points in time, one can better evaluate the effectiveness of
financial decisions. A rudimentary way of valuing the equity of a company is
simply to take its balance sheet and subtract liabilities from assets to arrive at
the equity value. However, this book value has little resemblance to the real
value of the company. First, the assets are recorded at historical costs, which
may be much greater than or much less their present market values. Second,
assets such as patents, trademarks, loyal customers, and talented managers do
not appear on the balance sheet but may have a significant impact on the firm's
ability to generate future profits. So while the balance sheet method is simple,
it is not accurate; there are better ways of accomplishing the task of valuation.
Another way to value the firm is to consider the future flow of cash.
Since cash today is worth more than the same amount of cash tomorrow, a
valuation model based on cash flow can discount the value of cash received in
future years, thus providing a more accurate picture of the true impact of
financial decisions.
The primary goal of corporate finance is to maximize corporate value
while managing the firm's financial risks. Although it is in principle different
from managerial finance which studies the financial decisions of all firms,
rather than corporations alone, the main concepts in the study of corporate
finance are applicable to the financial problems of all kinds of firms.
Page | 43

The distinction between cash and equity shareholders' equity is the sum
of common stock at par value, additional paid-in capital, and retained earnings.
Some people have been known to picture retained earnings as money sitting in
a shoe box or bank account. But shareholders' equity is on the opposite side of
the balance sheet from cash. In fact, retained earnings represent shareholders'
claims on the assets of the firm, and do not represent cash that can be used if
the cash balance gets too low. In this regard, one can say that retained earnings
represent cash that already has been spent.
Shareholder equity changes due to three things:
y net income or losses
y payment of dividends
y share issuance or repurchase.
Changes in cash are reported by the cash flow statement, which
organizes the sources and uses of cash into three categories: operating
activities, investing activities, and financing activities.
The primary goal of corporate finance is to maximize corporate value
while managing the firm's financial risks. Although it is in principle different
from managerial finance which studies the financial decisions of all firms,
rather than corporations alone, the main concepts in the study of corporate
finance are applicable to the financial problems of all kinds of firms.
In the process of Corporate Finance the main factor plays an
important role that is Financial Risk Management. It is the process of
measuring risk and then developing and implementing strategies to manage
that risk. Financial risk management focuses on risks that can be managed
("hedged") using traded financial instruments (typically changes in
commodity prices, interest rates, foreign exchange rates and stock prices).
Financial risk management will also play an important role in cash
management.



Page | 44

Financial decisions, the analysis and tools that are required to reach
these conclusions is what corporation finance is all about. The objective of this
is to improve the value of the company while simultaneously reducing any
financial risks. In addition it oversees that the company gets maximum returns
on whatever ventures they have invested in. Corporate finance can be
categorized into short and long term decisions.
Short term decisions like capital management deal with current liabilities
and asset balance. This is basically management of cash, inventories and
lending on a short term basis. The long term category deals with investments
of capital in relation to projects and the techniques required to fund them.
Corporate finance is also associated with investment banking. The investment
banker is in charge of evaluating the different projects that are brought to the
bank and making appropriate investment decisions.
For the company to be able to achieve their objectives, they need to have
a proper financial structure in place. It has to be able to accommodate the
various financial options that are available. These sources could be a
combination of equity and also debt. When a business or project is funded
through equity, there is a lower risk in terms of the cash flow. The one done
through debt is more of a liability to the company which needs to be assessed.
This automatically affects the cash flow even if the project turns out to be a
success.
The company must try to equate the invest merge with the asset being
financed as much as possible. When a company is adequately financed, it has
enough in its reserves for any contingencies.







Page | 45

Bibliography

www.google.com
www.scribd.com
www.indiatimes.com
www.rediffmail.com
www.wikipedia.org





which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, the short term decisions can be grouped ". This subject deals with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers). The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs.

Page | 2

2.2 Structure of Corporate Finance

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Page | 3

a project may open or close) paths of action to the company. (3) If no such opportunities exist.. When you begin to sell tennis balls. and labor. the owner. The value is reflected in the framework of the simple balance sheet model of the firm. To do this. (1) Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate.1. In the language of finance. land.3 WHAT IS CORPORATE FINANCE? Suppose you decide to start a firm to make tennis balls. The amount of cash you invest in assets must be matched by an equal amount of cash raised by financing. machinery. (2) These projects must also be financed appropriately. distribution via dividends). you make an investment in assets such as inventory. Management will therefore (sometimes) employ tools which place an explicit value on these options. Capital investment decisions Capital investment decisions are long-term corporate finance decisions relating to fixed assets and capital structure. and a dividend decision. The purpose of the firm is to create value for you. whereas in a DCF valuation the most likely or average or scenario specific cash flows are discounted. So. here the ³flexible and staged nature´ of the investment is modeled. Following Factor have to be consider before making the Corporate Finance. your firm will generate cash. The difference between the two valuations is the "value of flexibility" inherent in the project. but this reality will not typically be captured in a strict NPV approach. for example R&D projects. Decisions are based on several inter-related criteria. maximizing shareholder value dictates that management must return excess cash to shareholders (i. you hire managers to buy raw materials.e. Valuing flexibility In many cases. This is the basis of value creation. a financing decision. Capital investment decisions thus comprise an investment decision. The two most common tools Page | 4 . and you assemble a workforce that will produce and sell finished tennis balls. and hence "all" potential payoffs are considered.

there is no "branching" . In a DCF model. the viability of a mining project is contingent on the price of gold. while Black Sholes type formulae are used less often. See Decision theory: Choice under uncertainty. management chooses the actions corresponding to the highest value path probability weighted. Again.  ROA is usually used when the value of a project is contingent on the value of some other asset or underlying variable. if the price is too low. in the late 1990s. it would similarly expand the factory. In turn.are Decision Tree Analysis (DTA) and Real options analysis (ROA). by contrast. As above. (Real options in corporate finance were first discussed by Stewart Myers in 1977. (3) this path is then taken as representative of project value.) The Financing Decision Achieving the goals of corporate finance requires that any corporate investment be financed appropriately.) In the decision tree.usually a variant on the Binomial options model or a bespoke simulation model. they may often be used interchangeably:  DTA values flexibility by incorporating possible events (or states) and consequent management decisions. and outsource production otherwise. (For example. a company would build a factory given that demand for its product exceeded a certain level during the pilot-phase. the probabilities of each event are determined or specified by management.each scenario must be modeled separately. viewing corporate strategy as a series of options was originally per Timothy Luehrman. each management decision in response to an "event" generates a "branch" or "path" which the company could follow. (For example. given further demand. (2) an appropriate valuation technique is then employed . see Contingent claim valuation. the decision to be taken is identified as corresponding to either a call option or a put option. and assuming rational decision making. management will abandon the mining rights. (3) The "true" value of the project is then the NPV of the "most likely" scenario plus the option value. and maintain it otherwise.) Here: (1) using financial option theory as a framework. since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected. (2) given this ³knowledge´ of the events that could follow. the Page | 5 . management will develop the ore body. if sufficiently high. a DCF valuation would capture only one of these outcomes. Once the tree is constructed: (1) "all" possible events and their resultant paths are visible to management.

i. One last theory about this decision is the Market timing hypothesis which states that firms look for the cheaper type of financing regardless of their current levels of internal resources. then management must return excess cash to Page | 6 . (See Balance sheet. The sources of financing will. generically. policy framework.). Another major theory is the Trade-Off Theory in which firms are assumed to trade-off the tax benefits of debt with the bankruptcy costs of debt when making their decisions. in terms of both timing and cash flows. is calculated mainly on the basis of the company's inappropriate profit and its earnings prospects for the coming year. thus entailing cash flow implications independent of the project's degree of success. The Dividend Decision Whether to issue dividends.e. see also the Modigliani-Miller theorem. An emerging area in finance theory is right-financing whereby investment banks and corporations can enhance investment return and company value over time by determining the right investment objectives. which suggests that firms avoid external financing while they have internal financing available and avoid new equity financing while they can engage in new debt financing at reasonably low interest rates. and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk. source of financing (debt or equity) and expenditure framework within a given economy and under given market conditions. control and earnings. comprise some combination of debt and equity financing. debt and equity. Management must therefore identify the "optimal mix" of financing²the capital structures those results in maximum value. institutional structure. but results in a dilution of ownership.financing mix can impact the valuation. The cost of equity is also typically higher than the cost of debt (see CAPM and WACC). If there are no NPV positive opportunities. but. Fisher separation theorem. Financing a project through debt results in a liability or obligation that must be serviced. projects where returns exceed the hurdle rate. Management must also attempt to match the financing mix to the asset being financed as closely as possible. WACC. Equity financing is less risky with respect to cash flow commitments. and what amount. One of the main theories of how firms make their financing decisions is the Pecking Order Theory.

The goal of Working capital management is therefore to ensure that the firm is able to operate. retain earnings so as to fund growth internally. see corporate action. In other cases. These investments. capital investment decisions. and if. firm value is enhanced when. the return on capital exceeds the cost of capital. As above. see above and Real options. the goal of Corporate Finance is the maximization of firm value. and to satisfy both maturing short-term debt and upcoming operational expenses. In so doing. investors in a "Growth stock". These free cash flows comprise cash remaining after all business expenses have been met. however there are exceptions. it is generally accepted that dividend policy is value neutral (see ModiglianiMiller theorem). firm value is enhanced through appropriately selecting and funding NPV positive investments. Today. Alternatively. Working capital management Decisions relating to working capital and short term financing are referred to as working capital management. firms may elect to retain earnings or to perform a stock buyback. and that it has sufficient cash flow to service long term debt. almost by definition. some companies will pay "dividends" from stock rather than in cash. Management must also decide on the form of the dividend distribution. Financial risk management Page | 7 . For example. generally as cash dividends or via a share buyback. This is the general case. even though an opportunity is currently NPV negative. These involve managing the relationship between a firm's short-term assets and its short-term liabilities. have implications in terms of cash flow and cost of capital. in turn. Financial Risk Management Risk management is the process of measuring risk and then developing and implementing strategies to manage that risk. In the context of long term. in both cases increasing the value of shares outstanding.investors. management may consider ³investment flexibility´ / potential payoffs and decide to retain cash flows. Various factors may be taken into consideration: where shareholders must pay tax on dividends. expect that the company will.

Market risk. More customized and second generation derivatives known as exotics trade over the counter (OTC). Credit risk. firm exposure to business risk is a direct result of previous Investment and Financing decisions. the most cost-effective financial risk management methods usually involve derivatives that trade on well-established financial markets or exchanges.focuses on risks that can be managed ("hedged") using traded financial instruments (typically changes in commodity prices. All large corporations have risk management teams. Secondly. if not formal. Interest rate risk. Operational risk. These standard derivative instruments include options. foreign exchange rates and stock prices). interest rates. and swaps. Settlement risk. forward contracts. or preserving. Default (finance). Derivatives are the instruments most commonly used in financial risk management. Firstly. and small firms practice informal. futures contracts.        Page | 8 . Financial risk. Value at Risk. This area is related to corporate finance in two ways. The debate links value of risk management in a market to the cost of bankruptcy in that market. both disciplines share the goal of enhancing. firm value. Liquidity risk. risk management. Financial risk management will also play an important role in cash management. There is a fundamental debate on the value of "Risk Management" and shareholder value that questions a shareholder's desire to optimize risk versus taking exposure to pure risk. Because unique derivative contracts tend to be costly to create and monitor. Volatility risk..

with transactions in which capital is raised for the corporation. In the United Kingdom and Commonwealth countries.  Raising debt and restructuring debt. including the flotation of companies on a recognised stock exchange in order to raise capital for development and/or to restructure ownership. including public-toprivate deals. debt and related securities for the refinancing and restructuring of businesses.  Secondary equity issues. demergers. buy-in or similar of companies. the terms ³corporate finance´ and ³corporate financier´ tend to be associated with investment banking . especially where linked to one of the transactions listed above.2 2. project finance. infrastructure finance.  Equity issues by companies.1 Relationship with Other Areas in Finance Investment Banking Use of the term ³corporate finance´ varies considerably across the world.  Management buy-out. These may include  Raising seed. especially when linked to the types of transactions listed above. acquisitions or the sale of private companies  Mergers. whether by means of private placing or further issues on a stock market.i.e.Chapter .       Page | 9 . decisions and techniques that deal with many aspects of a company¶s finances and capital. demergers and takeovers of public companies. publicprivate partnerships and privatisations.  Raising capital via the issue of other forms of equity. start-up. to describe activities. In the United States it is used. divisions or subsidiaries .typically backed by private equity.  Financing joint ventures. as above. development or expansion capital  Mergers.

Corporate Finance India focuses on the provision of corporate advice and funding for Indian companies who wish to take advantage of the liquidity of the Indian financial markets.2. Real Estate Sales and Acquisition. Corporate Finance India provides businessman. "Debt and equity funding. compliments the financial health of the country. Corporate Financiers in India advices their clients after taking into consideration financial environment of the market along with important decisions taken by the Government which. Corporate Finance India provides the following services to the Indian Corporate Markets. projections and in formations on India's economy. The Indian financial market which was previously insulated from foreign investors were thrown open for foreign investments. Start up and Growth capital. Corporate Finance India companies have an extensive network of investors and funding institutions and group of corporate associates.       Corporate Finance. And with modern economic policies (at par with western countries) in operation large quantum of foreign direct investments FDI started to flow into the Indian market. whether individuals or businesses. The economic renaissance in the 1990s brought by liberation of Indian economy had a stupendous effect on the financial health of India. Page | 10 . The rise in business activities and its subsequent rise in financial activities led to the need of proper and accurate financing for corporate in India. Company Sales and Acquisitions. The projections future movements of the financial market are based on information and data collected from daily activities of the finance market. It also focuses on types of services offered by Corporate Financing Community in India.2 CORPORATE FINANCE IN INDIA This site provides comprehensive information on Corporate Finance India. and on providing funding and investment in entrepreneurial businesses. Corporate Finance India offers a complete solution to its client¶s objectives through market research. investors and entrepreneurs with finance and advice for proper and risk free investments with an eye for maximum returns. Corporate Finance India focus has been on entrepreneurial clients. Corporate Finance India community relies on ready-to-use data. Pre-IPO finance.

India continues to grab international attention. Housing. Water Resources. Capital Market. improvement and stabilization of relations with neighboring countries and record setting rise of its stock indexes. Chemicals and Hydrocarbons. Sectors like Health. With stupendous growth of more than 7% annually. It is destination of opportunity with its high-potential workforce and burgeoning middle class and as an increasingly dynamic competitor. India being a multi-cultural. Pharmaceuticals and Biotechnology. Retailing. medical.3 INTERNATIONAL BUSINESS IN INDIA The current scenario for 'International Business in India' is more than heartening. µInternational Business Opportunity in India ' exists in areas like             Information Technology and Electronics Hardware. R&D. Agriculture and Food Processing. The eastern part of the country is known as the 'land of the intellectuals' and is regarded as the cultural hub of the country. The southern part is known for its technology acumen and western part is the commercial-capital of the country. multi-lingual and multi-religion state. FICCI and different Chambers of Commerce provides a variety of business facilitation services byPage | 11 . Telecommunication. Environment. Banking. The north is where the political power sits and operates the country. Logistics. business management graduates and highest numbers of PhD¶s coupled with an energetic English speaking mass India offers 'services' with 50-70% less cost from their western counterparts. Small and Medium Enterprises (SME) and Urban Development are untapped and offer huge scope. Resource Conservation & Management Group. Power and Non-conventional Energy. Rural Development. Education.2. With highest numbers of technical. For 'International Business in India' bodies like CII. Manufacturing. Infrastructure. Financial Institutions and Insurance & Pensions. it is not advisable to formulate a uniform business strategy.

joint task forces and identifies bilateral business co-operation potential and makes suitable policy recommendations to Governments.4 Indian Businesses Page | 12 . With opportunities galore for' International Business in India' the trend is mind boggling.  It also exchanges business delegations.    2.  Also hosts high-level Government dignitaries and help build close working relationships between Governments and business organizations. India International Business' community along with Indian Domestic Business community is steadily emerging as the Knowledge Capital of the world. The World Bank and different rating organizations have forecast that at 7-8% of Economic growth. Closely working with Government and business promotion organizations in India and the respective partner countries. she will be world¶s second largest economy by 2050.

Immigration. The Government has played a major role in the transformation of the Indian Business scenario in India. Indian Businesses in Business Process Outsourcing. Birlas. Ambanis and many more. Hewlett-Packard and Accenture. The scope of doing business in India has grown in its magnitude. HCL ltd. More and more foreign companies are having their branches in India. Intelligence. finance reforms and freeing of capital markets. Travel & Tourism and many others. IBM. Soft Drinks Businesses in India and various other types of businesses are coming to the forefront and taking the center stage. Numerous types of Businesses in India coming up. and foreign direct investment. The Foreign companies are showing massive interest in the Indian Businesses. Satyam Computer Services. trade reforms. Electronics. Chemicals. tax reforms. revitalization of the Indian private sector. BFL MphasiS. removal of exchange controls and convertibility. Cognizant Technology Solutions. As India is developing the Iron & Steel Businesses in India. Infosys Technologies. They are either holding hands with the Indian Businesses by entering into a partnership with them or they are building up their own offices in India. IT/ITes. IT Businesses in India. Indian Businesses in Travel &I "tourism. Minerals & Metals. Food Business market in India. In general the major Indian Businesses are the Tatas. Business Services. reforms in the regulation of business firms. Engineering/ Machinery. Construction. Chapter ± 3 Page | 13 . Entertainment. Some of the major companies in the IT sector are Wipro. Patni Computers. Electrical. Real Estate in India. Automobiles.Indian Businesses are slowly shifting their base from agriculture major industrialization. The 'future of Indian Businesses looks bright and assuring. i-flex. India Neighborhood. Education. Computers. Tata Consultancy Services. Regional Portals. Packaging & Paper. The number of Businesses in India has increased at an impressive rate. Government of India Websites. International. Food Processing. Fashion & Advertising. Import & Export. Polaris. The major changes initiated by the Government for the betterment of the Indian Businesses are in the form of macroeconomic reforms. The marketplace for Indian Businesses is quite varied including industries in the field of Agriculture & Forestry.

However in most circumstances venture capitalists will also require more complex investments (such as preference shares or loan stock) in additional to their equity stake.1 Sources of Raising Finance When a company is growing rapidly. A bank also has the power to place a business into administration or bankruptcy if it defaults on debt interest or repayments or its prospects decline. Few growing companies are able to finance their expansion plans from cash flow alone. They will therefore need to consider raising finance from other external sources. In contrast. The main differences between borrowed money (debt) and equity are that bankers request interest payments and capital repayments. The overall objective in raising finance for a company is to avoid exposing the Page | 14 . equity investors take the risk of failure like other shareholders. may not have the resources to acquire the company. whilst they will benefit through participation in increasing levels of profits and on the eventual sale of their stake. They will need to raise finance to achieve their objectives. In addition. short or medium term loans) Factoring and invoice discounting Hire purchase and leasing Merchant banks (medium to longer term loans) Venture capital Existing shareholders and directors funds A key consideration in choosing the source of new business finance is to strike a balance between equity and debt to ensure the funding structure suits the business. managers who are looking to buy-in to a business ("management buy-in" or "MBI") or buyout (management buy-out" or "MBO")a business from its owners. for example when contemplating investment in capital equipment or an acquisition. its current financial resources may be inadequate.3. There are a number of potential sources of finance to meet the needs of a growing business or to finance an MBI or MBO: Family and friends Business angels Clearing banks (overdrafts. and the borrowed money is usually secured on business assets or the personal assets of shareholders and/or directors.

2 TYPES OF FINANCE A brief description of the key features of the main sources of business finance is provided below. Statistics relating to sales and markets. information about and -assessment of competitors. but without unnecessarily diluting the share capital. The business plan should be updated regularly to assist in forward planning. There are many potential contents of a business plan.business to excessive high borrowings. The very process of researching and writing the business plan should help clarify ideas and identify gaps in management information about their business. 3. The challenge for management in preparing a business plan is to communicate their ideas clearly and succinctly. copyrights. major capital investment or new product development). Names of. Page | 15 . Regulations and laws that could affect the business product and process protection (patents. Names of potential customers and anticipated demand. If management intends to turn around a business or start a new phase of growth. Financial information required to support specific projects (for example.  Business Plan Once a need to raise finance has been identified it is then necessary to prepare a business plan. trademarks). This will ensure that the financial risk of the company is kept at an optimal level. Research and development information. Production process and sources of supply. competitors and the market. Information on requirements for factory and plant. a business plan is an important tool to articulate their ideas while convincing investors and other people to support it. The European Venture Capital Association suggests the following: y y y y y y y y y Profiles of company founders directors and other key managers.

There are also certain large industrial companies which have funds available to invest in growing businesses and this 'corporate venturing' is an additional source of equity finance. Invoice Discounting and Invoice Factoring Finance can be raised against debts due from customers via invoice discounting or invoice factoring. Replacement capital brings in an institution in place of one of the original shareholders of a business who wishes to realise their personal equity before the other shareholders. There are over 350 initiatives from the Department of Trade and Industry alone so it is a matter of identifying. Debtors are used as the prime security for the lender and the borrower may obtain up to about 80 per cent of approved debts. a number of these sources of finance will now lend against stock and other assets and may be more suitable then bank lending. Grants are normally made to facilitate the purchase of assets and either the generation of jobs or the training of employees. In addition. Which sources will be Appropriate in each case. Venture capital is intended for higher risks such as start up situations and development capital for more mature investments. There are over 100 different venture capital funds in the UK and some have geographical or industry preferences. Grants and Soft Loans Government.Venture Capital Venture capital is a general term to describe a range of ordinary and preference shares where the investing institution acquires a share in the business. Invoice discounting is normally confidential (the customer is not aware that their payments are essentially insured) whereas factoring extends the simple discounting principle by also dealing with the administration of the sales ledger and debtor collection. local development agencies and the European Union are the major sources of grants and soft loans. Page | 16 . local authorities. thus improving cash flow. Soft loans are normally subsidised by a third party so that the terms of interest and security levels are less than the market rate.

During the finance-raising process.Hire Purchase and Leasing Hire purchase agreements and leasing provide finance for the acquisition of specific assets such as cars. Loans Medium term loans (up to seven years) and long term loans (including commercial mortgages) are provided for specific purposes such as acquiring an asset. accountants are often called to review the financial aspects of the plan. an overview or an extensive review of the company's management information system. pension funding and employee contracts etc. Their report may be formal or informal. y Level of warranties and indemnities provided by the directors. equipment and machinery involving a deposit and repayments over. Completing the Finance-raising Raising finance is often a complex process. The interest cost is normally variable and linked to bank base rate. ownership of the asset remains with the lessor whereas title to the goods is eventually transferred to the hirer in a hire purchase agreement. Business management need to assess several alternatives and then negotiate terms which are acceptable to the finance provider. y Votes ascribed to equity investors. typically. repayable on demand and used for short term working capital fluctuations. The main negotiating points are often as follows: y Whether equity investors take a seat on the board.000 of borrowing supported by a government guarantee where all other sources of finance have been exhausted. The loan is normally secured on the asset or assets and the interest rate may be variable or fixed. Technically. Bank Overdraft An overdraft is an agreed sum by which a customer can overdraw their current account. The Small Firms Loan Guarantee Scheme can provide up to £250. business or shares. y Financier's fees and costs. forecasting methods and their accuracy. It is normally secured on current assets. three to ten years. review of latest management accounts including working capital. This due diligence process is used to highlight any fundamental problems that may exist Page | 17 .

who use them Page | 18 .3 Game Theory Application for Corporate Finance Finance in general is concerned with how the savings of investors are allocated through financial markets and intermediaries to firms.3.

no frictions and symmetric information) and no taxes a firm could not change its total value by altering its debt/equity ratio. capital structure is carefully thought about by every company.e. some companies and industries thrive with no debt at all. which is concerned with the decisions of firms. the most influential deals with the signaling effects attributed to debt vs. interest paid by a company is a tax-deductible expense. which is concerned with the decisions of investors. by taking on debt and taking advantage of tax shields. The second is corporate finance. Game theory has made great strides in explaining many of the observed phenomena falling under corporate finance. The first is asset pricing. and it is in fact not irrelevant because taxes do exist and capital markets are not perfect. This tax shield creates an incentive to take on debt. This paper will show how different game theory models can be used to more accurately explain observed financial decisions dealing with capital structure. Traditional financial thinking relies on assumptions of certainty. Finance can broadly be broken down into two fields. or shareholder value. However in the real world. This paper will focus on the latter field and how game theory can be used to explain certain behaviors that are regularly witnessed. Different game theory models have been used to explain the actions of managers in determining their company¶s capital structure. In the United States. Modigliani and Miller corrected their original model to include corporate income taxes showing that a firm could increase its equity. thus capital structure is irrelevant. In the real world though. Modigliani and Miller in 1958 showed that in perfect capital markets (i. however this is not observed in reality. many times what is observed deviates greatly from what would be expected using traditional financial thinking. management might be eager to issue equity if it feels its stock is overvalued. In fact. because it will be Page | 19 . On the other hand. One example is the capital structure decided upon by a firm¶s management. Capital structure deals with the firm¶s decision to raise funds through debt versus equity and what ratio of debt to equity should the firm maintain.to fund their activities. financial decisions should be relatively straightforward. Their model then showed all firms stood to gain the most if they were 100% debt financed. In 1984 Myers and Majluf developed a model based on asymmetric information that insists managers are better informed of the prospects of the firm than the capital markets. complete knowledge and market efficiency and in this context. equity financing. corporate acquisitions and initial public offerings (IPOs). If management feels that the market is currently undervaluing its firm¶s equity then it will be unwilling to raise money through an equity issue because it will be selling the stock at a discount.

Therefore. In general. then hybrid securities such as convertible bond and lastly equity. receive whatever is leftover after paying back debt holders. Stockholders of levered firms gain when business risk increases because they receive the surplus when returns are high but the bondholders bear the cost when default occurs. Financial managers who act strictly in the interests of shareholders will favor risky projects over safe ones. Firms prefer to use less information sensitive sources of funds. Some industries by their nature support companies that finance most of their growth through retained earnings. It mainly occurs when the odds of default or high and equity holders feel they can make one last gamble to avoid bankruptcy and get a big payoff at the same time. when an equity issue is announced. The first arises because the owners of a levered firm have an incentive to take risks at the expense of debt holders. Thus equity issues are considered a bad signal. Bondholders¶ value does not increase with the value of the firm. In 1976 Jensen and Meckling described two kinds of agency problems in corporations: One between equity holders and bondholders and the other between managers and equity holders.selling its stock at a premium. investors will mark down the price of the stock accordingly. Page | 20 . capital structure is similar within industries with differences resulting from weighing the benefits of a higher tax shield versus the benefits of the less information sensitive financial of retained earnings. It is important to note that this agency cost does not occur in financially sound companies. This leads to the pecking order of corporate financing: Retained earnings are the most preferred. They would like to see the upside potential of the company maximized and this occurs through taking on risky projects (higher returns are generated though greater risk taking. even companies with overvalued stock would prefer another option to raise money to avoid the mark down in stock price.) It is obvious that there is a conflict of interest between equity holders desire for business risk and bondholders aversion to business risk. Investors are not dull and will predict that managers are more likely to issue stock when they think it is overvalued while optimistic managers may cancel or defer issues. followed by debt. A second application of game theory to capital structure is concerned with agency costs. Airlines however are an example of an industry that is characterized by its high debt level. thus they would like the firm to take safe bets to minimize the risk of default. Equity holders on the other hand.

This occurs when managers have an incentive to pursue their own interests rather than those of the equity holders. to induce the uninformed to participate they must be compensated for the overpriced stock they end up buying. A financially sound company would not have this agency problem because equity holders stand to lose more from risky projects when the company is not in risk of going bankrupt. The market for corporate control says that in order for resources to be used efficiently. One way to do this Page | 21 .An average payoff would not benefit the stockholders much when the company is near default because most of the payoff will be paid out to the debt holders. the free rider problem. but risk can also cause a stock price to take a nosedive. companies need to be run by the most able and competent managers. A manager with options is not hurt nearly as much as a worker with his/her retirement savings in a company whose stock plummets because of risky bets. Initial Public Offerings (IPOs) have long been known to provide a significant positive return in the initial days of trading. but it is obvious that this is not so easily achieved. however in many instances the acquirer pays a large premium to buy the other company. The informed buyers know the true value of the stock and will only purchase shares at or below its true value. This occurrence directly conflicts with the theory of market efficiency because the companies should be fairly valued at their IPO and any return in the initial days should be minimal. Higher risk increases the value of an option. One of the concepts behind efficient markets is the market for corporate control. Therefore. Game theory can also be used to explain what is observed in the course of many corporate acquisitions. Option contracts were meant to better align the interests of managers with stockholders. Knowing this. The second conflict arises when equity holders cannot fully control the actions of managers. In 1986 Rock explained that this phenomenon was due to adverse selection between informed buyers and uninformed buyers. If markets are efficient then one would expect a company to pay fair value when acquiring another company. One way to achieve this is through corporate acquisitions. In 1986 Shleifer and Vishny provide one explanation of this phenomenon. The implication of this is that the uninformed buyers will receive a high allocation of overpriced shares since they will be the only people in the market when the offering price is above the true value. uninformed buyers would be unwilling to purchase the stock. forcing the informed buyers to hold onto the stock because there is no one they can sell it to. and thus want to avoid them along with bondholders. Executive compensation in the form of option contracts can create incentives for managers to make risky decisions in an attempt to gain the highest payoff from the call options.

and debt holders. the existence of free rider problems and bidding wars in corporate acquisitions has been made clear through game theory applications. equity holders. Since all investors know that an IPO will likely be under priced they all try to buy the stock as quick as possible creating a demand for the stock that results in substantial price gain in the initial days of trading. One argument for this behavior is that the market for IPOs is subject to fads and that investment banks underprice IPOs to create the appearance of excess demand. There exists evidence of this in the long run. This leads to a high price initially but subsequently underperformance. game theory has helped explain the reasons companies might choose various capital structures and the agency costs between managers.4 Agency Costs of Free Cash Flow and Corporate Finance Page | 22 .is to under-price the stock on average. 3. Lastly. IPOs exhibit behavior contrary to the efficient market theory. This paper has only highlighted a few of the aspects where behavioral analysis has helped explained observed behavior. Specifically. therefore companies with the highest initial returns should have the lowest subsequent returns. Another interesting implication of IPOs pointed out by Ritter in 1991 is the fact that while they experience high returns in the short run they typically under-perform the market in the long run. In addition. Game theory has been extremely useful in explaining certain financial decisions. This means that on average the uniformed will buy a stock that started out undervalued and thus they are still able to buy the stock at or below its true value. and game theory can be utilized to help show why this behavior occurs.

However. because changes in compensation are positively related to the growth in sales. and making it more likely they will incur the monitoring of the capital markets which occurs when the firm must obtain new capital. Growth increases managers¶ power by increasing the resources under their control. The payout of cash to shareholders creates major conflicts that have received little attention. The theory developed here explains 1) the benefits of debt in reducing agency costs of free cash flows. is now a major part of the economics literature. The problem is how to motivate managers to disgorge the cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies. 4) why the factors generating takeover activity in such diverse Page | 23 . monitoring by the firm¶s internal control system and the market for corporate control are more important. It is also associated with increases in managers¶ compensation. 3) why ³diversification´ programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidation-motivated takeovers. In these cases.Corporate managers are the agents of shareholders. a relationship fraught with conflicting interests. product and factor market disciplinary forces are often weaker in new activities and activities that involve substantial economic rents or quasi rents. 2) how debt can substitute for dividends. Competition in the product and factor markets tends to drive prices towards minimum average cost in an activity. Activities generating substantial economic rents or quasi rents are the types of activities that generate substantial amounts of free cash flow. the analysis of such conflicts. Financing projects internally avoids this monitoring and the possibility the funds will be unavailable or available only at high explicit prices. Managers have incentives to cause their firms to grow beyond the optimal size. Free cash flow is cash flow in excess of that required to fund all projects that have positive net present values when discounted at the relevant cost of capital. Agency theory. Payouts to shareholders reduce the resources under managers¶ control. Conflicts of interest between shareholders and managers over payout policies are especially severe when the organization generates substantial free cash flow. Managers must therefore motivate their organizations to increase efficiency to enhance the problem of survival. thereby reducing managers¶ power.

activities as broadcasting and tobacco are similar to those in oil.                 3. and 5) why bidders and some targets tend to perform abnormally well prior to takeover.5 The Role of Debt in Motivating Organisational Efficiency Page | 24 .

including bankruptcy costs. the usual agency costs of debt rise. debt can be an effective substitute for dividends. In doing so. and that part of the repurchase proceeds equal to the seller¶s tax basis in the stock is not taxed at all. (Interest payments are tax deductible to the corporation. they give shareholder recipients of the debt the right to take the firm into bankruptcy court if they do not maintain their promise to make the interest and principal payments. The fact that capital markets punish dividend cuts with large stock price reductions is consistent with the agency costs of free cash flow. enables managers to effectively bond their promise to pay out future cash flows. The optimal debt-equity ratio is the point at which firm value is maximized. Thus debt reduces the agency costs of free cash flow by reducing the cash flow available for spending at the discretion of managers. As leverage increases. Thus. but they can promise to pay out future cash flows by announcing a ³permanent´ increase in the dividend. I call these effects the ³control hypothesis´ for debt creation. Such promises are weak because dividends can be reduced in the future.The agency costs of debt have been widely discussed. These control effects of debt are a potential determinant of capital structure. the point where the marginal costs of debt just offset the marginal benefits. The threat caused by failure to make debt service payments serves as an effective motivating force to make such organizations more efficient. something not generally recognized in the corporate finance literature. Managers with substantial free cash flow can increase dividends or repurchase stock and thereby pay out current cash that would otherwise be invested in low-return projects or wasted. This leaves managers with control over the use of future free cash flows. without retention of the proceeds of the issue. Page | 25 . but the benefits of debt in motivating managers and their organizations to be efficient have been ignored. Debt creation. By issuing debt in exchange for stock. managers are bonding their promise to pay out future cash flows in a way that cannot be accomplished by simple dividend increases. Issuing large amounts of debt to buy back stock also sets up the required organizational incentives to motivate managers and to help them overcome normal organizational resistance to retrenchment which the payout of free cash flow often requires. Stock repurchases for debt or cash also has tax advantages.) Increased leverage also has costs.

The control function of debt is more important in organizations that generate large cash flows but have low growth prospects. these effects will not be as important for rapidly growing organizations with large and highly profitable investment projects but no free cash flow. At these times the markets have an opportunity to evaluate the company. and the market¶s assessment is made evident by the price investors pay for the financial claims. Such organizations will have to go regularly to the financial markets to obtain capital. and its proposed projects.1 In the Books of Cairns Ltd Page | 26 .The control hypothesis does not imply that debt issues will always have positive control effects. In these organizations the pressures to waste cash flows by investing them in uneconomic projects is most serious. Investment bankers and analysts play an important role in this monitoring.        Chapter ± 4 Financial Statement of Cairns Ltd 4. its management. and even more important in organizations that must shrink. For example.

Income Statement for year ended 31st march 2009 PARTICULARS Net Sales OPERATING EXPENSES Administrative Expenses Staff Cost Data Acquisition Other Administrative Amortisation Unsuccessful Exploration cost Selling & Distribution Advertisement Publicity Sponsorship Financial Expenses Bank Charges Other Interest PORFIT BEFORE INTEREST Less :PROFIT AFTER INTEREST Add :.072 11.309 Profit After Tax 5.356) 0 (18.385 42.666 3.407  In the books of Cairns Ltd Balance sheet as at 31st march 2009 Page | 27 .22.20.959 15.377 2.058 388 18.55.43.31.800 34.00.687 (18.509 5.Non Operating Income Interest on Deposit Dividend Profit on Sale Of Investment Special Gains Other Income PROFIT BEFORE TAX Less : Current Tax other tax AMOUNT AMOUNT 37.12.331 2.356) 1.519 36.686 1.59.235 7.22.78.42.43.13.723 61 29.20.544 365 8.716 5.568 14.45.225 12.

38.27.645 2.666 2.53.75.89.13.66.373 1392107 2.056 31.10.978 19355656 30.01.15.33.299 540908 29.99.762 6.274 5.478 17 942 2.000 300552274 31.PARTICULARS I) SORCES OF FUNDS 1) SHAREHOLDERS FUNDS a) Share Capital Equity Share Capital Preference Share Capital Stock Options Outstanding b) Reserve & Surplus Securities Premium A/C (-) c) Miscellaneous Expenses P/L Debit Expenses 2) Borrowed Funds Capital Employed II) APPLICATION OF FUNDS 1) FIXED ASSETS Computers Work in Progress 2) INVESTMENT Investment in Companies 3) Working Capital Current Assets Debtors Cash & bank Balance Other Current Assets Loans & Advances Less :.930 In the Books of Cairns Ltd Comparative Balance sheet as at 31stDec 2007 &31st march 2009 Page | 28 .76.88.90.Current Liabilities Creditors Other Liabilities Provisions Sub-total (d) Funds Used ( c+d) Amount Amount Amount 1.40.20.94.068 3.07.930 609 5.814 28505163 8.07.966 29.71.32.99.22.678 0 3.

50.82.34.47.84.285 29.144 6.05% Sub Total (a) 29.10.144 8.01.37.41.115 30.38.000 (5.299 609 5.42.684 0 (5.58.83.48.73.64% 0 0 609 5.PARTICULARS I) SORCES OF FUNDS 1) SHAREHOLDERS FUNDS a) Share Capital Equity Share Capital Preference Share Capital Stock Options Outstanding 31-12-2007 31-03-2009 INCREASE / % CHANGE DECREASE 1.084 1.99.407 5.34.07.66.678 0 3.60.40.966 (18.37.92% b) Reserve & Surplus Securities Premium A/C 27.159 9.73% II) APPLICATION OF FUNDS 1) FIXED ASSETS Computers Work in Progress 2) INVESTMENT Investment in Companies 29.56.407) -50.07.40.786 31.69% c) Miscellaneous Expenses P/L Debit Expenses 10.106) 6.65% 0 -58.97.930 2.45.06.89.22.299 100% 100% Page | 29 .930 2.319) -0.274 2.20% Sub Total (b) 29.80.77.90.73.91% 2) Borrowed Funds Capital Employed 29.30.53.83.61.930 2.994 0 9.15.88.193 32.04.99.737 8.978 11.786 31.

02.068 3.71.94.666 2.36.Sub-Total © 29.33.2 Accounting Ratios Balance Sheet Ratios Page | 30 .504 8.20.32.478 (13.15.25.807) -0.56.37.13.708 7.60% Sub-total (d) (4.130 % 100% 514.950 17.762 6.056 2.702 1.27.34% 13805% -1.75.33.73%      4.99.73.930 2.42.786 31.01.373 7.84.131 539.20.99.41.45% 3) Working Capital Current Assets Debtors Cash & bank Balance Closing Stock Bills Receivable 12.10.Current Liabilities Creditors Other Liabilities Provisions 1.36% Funds Used ( c+d) 29.964 1.38.01.18% 3.499) 2.34.76.285 29.17% Less :.622 -5.97.005 6.67.645 2.757 0 35.234 2.144 6.645 1.446 3.942 2.76.07.814 5.557 66.846 41.

56 % which is very good so this shows a strong backup for the company. It indicates the short term solvency of the company here the company¶s current ratio is very excellent as to every 1 liability they have 20. Proprietary ratio = [(Proprietors fund) / (Total Assets) ] *100 [3199079 30/ 321300037] *100 = 99.56 % The Share of proprietor in company¶s fund is 99.47 The standard ratio is 2:1. Stock turnover ratio = Page | 31 .56 The standard ratio is 1:1.1. 4.56 assets as compare to 1 liability each. 2. It indicates immediate solvency of the company here the company has 19. Quick ratio (Current Asset ± Stock ± Prepaid Exp) / (Current liability ± Bank Overdraft) 27237873 / 1392107 = 19. 3. Current ratio = (Current Asset) / (Current Liability) 28505163 / 1392107 = 20.47 assets.

[(Closing Stock) / (Working Capital)] *100 [633645 / 27113056] *100 = 2.33% The standard ratio is 200 % here the ratio is only 2.33%. this shows that the company will face certain problems in near future. Income Statement Ratio Page | 32 .

4.21 % It is very good but the business surviving only through non operating income 3. Operating Ratio = Page | 33 . Net Profit After tax ratio= Net Profit After tax / Net Sales *100 [542407 / 37331] *100 =1452 % This ratio is also good as it shows 1452 % ratio. Gross profit ratio = [ (Gross profit) / (Net Sales) ] *100 [-1043076 / 37331] * 100 = -2794 % Here the company is earning losses so that¶s why the gross profit ratio is in minus. 2.1. Net Profit Ratio= Net profit before tax / Net Sales *100 [40399 / 37331] *100 =108.

(Cost of Goods sold + Operating Exp) / Net Sales *100 [1859687 / 37331] * 100 =4981 % It is bad because the expenses are more than the sales. Mixed Ratios Page | 34 .

29 return. 4.42. of Equity shares [5. Debtors Turnover Ratio= Credit sales / Average ( Debtors +Bills Receivable) [37331 / 238756 ] = 0.1. 3.15] = 80 months It shows that the company will face shortage of funds in the future because they will not be able to recover their money quickly as they will recover only after 80 months.15 times It is not good because the sales is very less 2.407 / 1876199069] = 0.29 The earning per share ratio some what ok as it shows 0. Earnings Per Share= (Net Profit after tax. Price Earning Ratio = Page | 35 . Average Collection Period = 12 months / Debtors turnover ratio [12 / 0.Preference Dividend) / No.

56 % It is very bad as it shows negative balance of 0. The price earning is also good. Page | 36 .Market Price per share / Earning per share [10 / 0.56 %.48 Assuming that the market price is 10.29] = 34. Return On Capital Employed = (Profit Before Interest) / Capital Employed *100 [1822356) / 319907930] * 100 = -0. 5.

and 2002 was the same.767/7. A company's stock price is usually influenced by the amount of net income because when finding the price of the stock. the net income decreased by $207 million. the corresponding total dividend payments did not appear as an expense on the income statement because dividends are not an expense.2% 2001: (2. Even though General Mills paid dividends in 2000. but between 2001 and 2002. 5.949-5.521 = 52.450/5.450 = . 3. 2000: (2. they are a financing activity that is reported on the statement of stockholder's equity.522 = 52. the higher the net income. The amount of $8 billion includes cash and credit sales. B. General Mills Consolidated Balance Sheets: Page | 37 . which is what buyers look for (means better profit). Net Income: 2000: $614 million 2001: $665 million 2002: $458 million When comparing the net income figures for the past three years.1% 2002: (4. The recorded sale amount of almost $8 billion is not the actual amount of cash collected. it is seen that between 2000 and 2001.698/5.173 = .841/5. The difference between the year 2001 and 2002 was a 45.450-5. The largest expense for General Mills for the years 2000. you must divide the number of stocks by the net income. So. about 7% more than the two previous years. 6. the lower the price of stocks.0535). Sales increased each year from 2000 to 2002. over 50% of the revenue each year went towards the cost of sales. They are payments that are made to only the owners of the company. General Mills Consolidated Statements of Earnings: 1.4585).4. Sales in 2002 were the largest. 2. 2001 and 2002. 2001.9% 4.35% increase (5.599 = 59.949) = .173/5. The difference between the year 2000 and 2001 was a 5. the net income increased by $51 million.3 Case Study on General Mills A.450 = .173) = .85% increase (7.

one cannot produce and/or run a company. what a company owns. 2001 to May 26. Without assets. Goodwill is the type of asset that is responsible for the increase. 12.. we found that the percentage increase in assets was 224. D. Comprehensive income is the change in a company's owner's equity during a period that is the result of all transactions and activities that are not by the owner. like equipment. foreign currency. C. These can include profits from operating activities. General Mills Consolidated Statement of Cash Flows: Page | 38 .091 = 2.7. Shareholders have about $5. and creates value for the company.5405. A company has assets so that they have a location and equipment to operate/create a business. The General Mill's total stockholders increased significantly from May 27.540 million.2489 = 224. When comparing the assets from the beginning of 2002 to the end.091/5. cash etc.591 million. Assets are resources that are controlled by a business. events that change owner's equity except those from the company's own stockholders and selling stock or paying dividends. 2002 because they sold more stock.733 million in claims and the lenders have a claim of $5. 8. The total amount of assets at the end of 2002 was $16. General Mills Consolidated Statement of Stockholder's Equity: 11. 10. The two groups that have contributed assets to General Mills and claims on the assets are shareholders and lenders. inventory.89% (16. 9.89%). and net income. The purpose of assets are to keep track of expenses.

but its greatest growth was between the second and the third year. the investing cash outflow exceeded far past the amount of net cash provided by operating activities. 18. but does state that they are reported fairly.2) E.13. 19.2% (358/458 = . 14. Operating activities 2. is responsible for the accounting numbers in the annual report. Financial activities. including: an audit program.7816 = 78. Inc. when the net income was the lowest. and instated policies that demand ethical behavior from employees. The management of General Mills. General Mills Report of Management Responsibilities and Reports of Independent Public Accountants: 17. a separation of duties and responsibilities. but in 2002. The independent accountant does not say that the reported amounts are correct. General Mills used internal controls to ensure the accuracy of the reported numbers. Net cash provided by Net cash used by operating activities investment activities 2000: $722 million (564 million) 2001: $737 million (460 million) 2002: $913 million (3. The net cash from operating activities increased each year. we found that the dividend payout ratio for 2002 was 78. So. There are three categories of cash flows shown on the company's cash flow statement. operating activities was large enough to cover the investing cash outflow. For safeguards. 16. When comparing the net income figure to the amount of net cash provided by operating activities for each of the three years. When comparing the dividend payments to the income amounts for the current year. Loans were used to make up the difference. the net cash from operating activities was the greatest. "We believe these consolidated financial statements do not misstate or omit any material Page | 39 .271 million) It is clear to see that in the year 2000 and 2001. They are the following: 1. Investing activities 3. 15. one observes that the net income went up in the first two years and than decreased between the second and the third year.

The major difference between accrual and the cash flow of these activities is that accrual includes cash and credit.0276 = . and results from its operating activities.8% (458/16. Page | 40 . General Mills hired a CPA (Certified Public Accountant) to audit the financial statements to ensure accuracy and to verify that the numbers on the statements (disclosures made by the management in its reports) are consistent with the company's actual financial position.103) 24. your claim on the company's earnings would be $13..3% (." The CPA assures that the statements are in accordance with the GAAP.1306) and in 2002.400). general.600.. 2002.000 of the company's common stock in 2002. the consolidated financial statements referred to above present fairly.. General Mills major operating activities during 2002 were net sales. in all material respects.800 (10.540 = . selling.091= .38 (EPSbasic) = 13. General Mills hired KPMG LLP as their accountant to audit their financial statements. (10. General Mills return on total assets for 2001 was 13. the return on total assets was 2. and administrative.400. where these major operating activities only include cash. F. If you were to own 10.0276). In our opinion. cash flow. your claim would be greater than your claim if you would to purchase them in 2002 by $9. The return on total assets deteriorated from 2001 by 10.000 of the company's common stock in 2001. making your claim in 2001 $23. 20. General Mills Financial Statements: 22. Accrual accounts for all. If you owned 10.facts.000 x 2. and cost of goods.800).1306-.1% (665/5. while the cash flow doesn't account for credit sales until the money is collected.34 (EPS-basic) = 23.. The report of the independent accountants that performed this was signed on June 24. 23. 21.000 x 1.

27. and land.  Page | 41 . The major source of cash for General Mills in 2002 was the issuance of long-term debt. 28. keeping the inflow larger than the outflow. They also purchased some treasury stocks. their operating and financing activities are increasing and the investing cash flows decreasing. the company's most important assets were: inventories. Other resources that might be important that aren't reported on the balance sheet are the skills and level of intelligence of the management and the employees.25. If asked to assess the company's financial performance of General Mills in 2002. they were able to purchase Pillsbury (acquired in a stock and cash transaction). which was one of the biggest increases recorded over the previous years for net cash. goodwill. and equipment. as well as the value of the brand name 29. A major investing activity that occurred in 2002 was when General Mills purchased Pillsbury. buildings. Major financing activities performed in 2002 were the change in longterm debt. their net cash increased incredibly. At the end of 2002. Their successfulness opens many new opportunities for them in the future. They increased their amount of debt while paying off some of their notes payable. 26. With the cash they received. receivables. by about $3. I would have to say that they were very successful.500 million. In the year 2002. Their financial activities show that they are a growing and prosperous company.

rather than corporations alone. Page | 42 . the role of a corporation's management is to increase the value of the firm to its shareholders while observing applicable laws and responsibilities. assets such as patents. So while the balance sheet method is simple. thus providing a more accurate picture of the true impact of financial decisions. Corporate finance deals with the strategic financial issues associated with achieving this goal. what portion of profits should be returned to shareholders in the form of dividends. what investments the firm should make. trademarks. the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. the assets are recorded at historical costs. First. it is not accurate. which may be much greater than or much less their present market values. If the role of management is to increase the shareholder value. Since cash today is worth more than the same amount of cash tomorrow. such as how the corporation should raise and manage its capital. a valuation model based on cash flow can discount the value of cash received in future years. one can better evaluate the effectiveness of financial decisions. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks. Another way to value the firm is to consider the future flow of cash. Although it is in principle different from managerial finance which studies the financial decisions of all firms. then managers can make better decisions if they can predict the impact of those decisions on the firm's value. Second. However. loyal customers. By observing the difference in the firm's equity value at different points in time. this book value has little resemblance to the real value of the company. A rudimentary way of valuing the equity of a company is simply to take its balance sheet and subtract liabilities from assets to arrive at the equity value. and talented managers do not appear on the balance sheet but may have a significant impact on the firm's ability to generate future profits. and whether it makes sense to merge with or acquire another firm.CONCLUSION Arguably. there are better ways of accomplishing the task of valuation.

foreign exchange rates and stock prices). investing activities. retained earnings represent shareholders' claims on the assets of the firm. In fact. Some people have been known to picture retained earnings as money sitting in a shoe box or bank account. In the process of Corporate Finance the main factor plays an important role that is Financial Risk Management. Changes in cash are reported by the cash flow statement. Although it is in principle different from managerial finance which studies the financial decisions of all firms. the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. one can say that retained earnings represent cash that already has been spent. additional paid-in capital.The distinction between cash and equity shareholders' equity is the sum of common stock at par value. Financial risk management focuses on risks that can be managed ("hedged") using traded financial instruments (typically changes in commodity prices. It is the process of measuring risk and then developing and implementing strategies to manage that risk. In this regard. and retained earnings. which organizes the sources and uses of cash into three categories: operating activities. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks. Page | 43 . rather than corporations alone. Shareholder equity changes due to three things: y net income or losses y payment of dividends y share issuance or repurchase. But shareholders' equity is on the opposite side of the balance sheet from cash. interest rates. and do not represent cash that can be used if the cash balance gets too low. Financial risk management will also play an important role in cash management. and financing activities.

they need to have a proper financial structure in place. These sources could be a combination of equity and also debt. The investment banker is in charge of evaluating the different projects that are brought to the bank and making appropriate investment decisions. The one done through debt is more of a liability to the company which needs to be assessed. It has to be able to accommodate the various financial options that are available. Page | 44 . Corporate finance can be categorized into short and long term decisions. inventories and lending on a short term basis. it has enough in its reserves for any contingencies. Corporate finance is also associated with investment banking. The objective of this is to improve the value of the company while simultaneously reducing any financial risks. there is a lower risk in terms of the cash flow. When a business or project is funded through equity. Short term decisions like capital management deal with current liabilities and asset balance. In addition it oversees that the company gets maximum returns on whatever ventures they have invested in. For the company to be able to achieve their objectives. When a company is adequately financed. This is basically management of cash. the analysis and tools that are required to reach these conclusions is what corporation finance is all about.Financial decisions. The long term category deals with investments of capital in relation to projects and the techniques required to fund them. The company must try to equate the invest merge with the asset being financed as much as possible. This automatically affects the cash flow even if the project turns out to be a success.

scribd.com www.com www.Bibliography www.indiatimes.google.com www.wikipedia.com www.org Page | 45 .rediffmail.

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