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PROJECT REPORT



On


Corporate finance






Submitted by: Submitted to:
Shobhna jain Mrs. Sandhya
(pgp sectoral) Prakash
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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
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
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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 flexible 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
are Decision Tree Analysis (DTA) and Real options analysis (ROA); they may
often be used interchangeably:
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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 knowledge 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
financing mix can impact the valuation. Management must therefore identify
the "optimal mix" of financingthe capital structures those results in
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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
investors. These free cash flows comprise cash remaining after all business
expenses have been met.
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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
investment 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
focuses on risks that can be managed ("hedged") using traded financial
instruments (typically changes in commodity prices, interest rates, foreign
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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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2.1 Relationship with Other Areas in Finance
Investment Banking
Use of the term corporate 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 companys finances and
capital. In the United Kingdom and Commonwealth countries, the terms
corporate finance and corporate 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 clients 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. International 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 PhDs 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 worlds 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.


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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:

Family and friends
Business angels
Clearing banks (overdrafts, 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. 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 firms management. Capital structure deals with
the firms 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
companys 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 firms
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 | 22

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 | 23

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 | 24

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 firms 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 diversification 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 | 25

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 | 26

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 control 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 permanent 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 sellers 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 | 27

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 markets 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.













Financial Statement of Cairns Ltd
4.1 In the Books of Cairns Ltd
Page | 28

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 | 29

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 | 30

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 | 31

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 | 32


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 companys 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 companys fund is 99.56 % which is
very good so this shows a strong backup for the company.


4. Stock turnover ratio =
Page | 33

[(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 | 34

1. Gross profit ratio =

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

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

Here the company is earning losses so thats 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 | 35

(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 | 36


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 | 37


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 | 38

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 | 39


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 | 40



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 | 41

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 | 42

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 | 43

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 | 44

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.



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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.







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Bibliography

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