Title:

ROLE OF CORPORATE FINANCE IN BUSINESS

Course Title: Corporate Finance

Course Code: MF 702

Submitted By-

Nazim Nazmul, Roll – 573

EMBA, Session-2019-2020
Batch-23rd (Executive for Engineers)
Major: Finance

Date of Submission- 05th February 2021

Faculty of Business Administration

University of Science and Technology Chittagong

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 1. Concept of Corporate finance:
Corporate funds include sources of financing, the corporate capital structure, the steps taken by
management to maximize the profitability of the company to shareholders, as well as the instruments
and analysis used to assign financial resources. Corporate financing is mainly targeted at optimizing
or rising shareholder value. Since the principal principles of corporate finance analysis relate to the
financial concerns of all types of companies, although this is in theory separate from managerial
finance, which analyze the financial management of all organizations rather than only businesses.
Each decision a corporation takes has financial effects and often decisions that impact the finances
of a company are a decision on corporate finance

2. Two Fundamental Rules of Corporate Finance

Two basic rules underpin corporate finance. Both corporate finance methods and strategies are clearly
ways to apply these regulations. You will find these principles at the outset of each and every textbook
on corporate finance. One of these laws applies to the return principle, and the other to the risk
concept. In this article, we have defined these two laws.
They are as follows:
Rule # 1: Money today is worth more than money tomorrow
The fundamental rule of corporate finance is that the timing of cash flows is of paramount importance.
Also, we want the timing of the cash flows to be as soon as possible. The sooner we get the cash, the
better it is for our company. Every dollar that the company has in cash today is better than the same
dollar in cash tomorrow because of the following reasons:
• Inflation: Inflation eats into the purchasing power of the company’s funds constantly with
the passage of time. Thus if the company had the same nominal amount of money today or a
year from now, they would be able to purchase more goods and services with the money that
they have today as compared to the same amount of money a year later. Thus, to offset the

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 effect of inflation, companies must conduct their business in a manner that they ensure that
cash is received as soon as possible.

• Opportunity Cost: Also, every dollar that the company is not receiving has an opportunity
cost of capital. Let’s say the company’s debtors owe it $100 and they pay $100 the next year.
The nominal value of the money that they have paid is $100 however the real value is less.
This is because had the debtors paid immediately, the company would have cash immediately
on hand. They could then invest this cash in risk free securities and could have earned a year’s
interest on the same. By accepting the same $100 a year later, the company has in effect loaned
out $100 to its debtors and that too interest free!
Rule # 2: Risk free money is worth more than risky money
Corporate financial services require the sharing between existing and potential cash flows.
Companies will meet numerous ventures promising various cash flows in the future. It must be
understood, though, that not all cash flows are equal in the future. Any cash flows may be nearly
assured, such as investment in treasury notes, and others may be highly unsure, such as expected
stock market returns. The second rule then states that before making comparisons and choices, the
organization must change each cash flow at its own risk.
The following factors must be considered:
• Return of risky Capital: Some projects are extremely risky. Here, the company is concerned
about whether or not the money they are investing will be recovered. A higher rate of return
must be demanded from such projects to offset the likelihood of losing their entire capital that
the investors face.

• Return on less risky Capital: In other cases, the cash flow may be a little less uncertain. In
these cases, companies must consider the low risk before making their decision.
The bottom line is that before making a choice, all projects have to be made comparable. This is done
by adjusting for cash flow that will be received in different time periods as well as adjusting for the
different amounts of risks that are involved in different projects.

3. Sources/ patterns/major classes of capital

Debt capital
Corporations may rely on borrowed funds (debt capital or credit) as sources of investment to sustain
ongoing business operations or to fund future growth. Debt comes in several forms, such as through
bank loans, notes payable, or bonds issued to the public. Bonds require the corporations to make
regular interest payments (interest expenses) on the borrowed capital until the debt reaches its
maturity date, therein the firm must pay back the obligation in full. Debt payments can also be made
in the form of sinking fund provisions, whereby the corporation pays annual installments of the
borrowed debt above regular interest charges. Corporations that issue callable bonds are entitled to

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pay back the obligation in full whenever the company feels it is in their best interest to pay off the
debt payments. If interest expenses cannot be made by the corporation through cash payments, the
firm may also use collateral assets as a form of repaying their debt obligations (or through the process
of liquidation).
Equity capital
In order to collect the money, the companies will even sell their shares to buyers. Investors or lenders
seek an increase in the valuation (or appreciation in value) of the company over time to make a
successful transaction with their assets. Shareholder capital is improved as the equity and other assets
are spent in ventures (or investments) that receive a good return on their owners. Investors tend to
purchase equity shares in businesses that regularly receive a favorable capital gain, thereby increasing
the market value of the company's stock.

4. Principles/The Four Major Decisions in Corporate Finance

a. Investment Decision:
The decision on spending or capital budgeting shall require the decision to assign capital, or
the allocation of funds to long term investments that will yield potential benefits. Two
important factors are: (a) an estimation of the potential return on investment and (b) an
assessing of the cut-off rate against which a distinction may be made between the future return
on new investment. It is difficult to calculate the potential gains of investments and cannot be
estimated with accuracy. Investment decisions entail ambiguity because of the unpredictable
future

b. Financing Decision:
The second significant role of the financial planner is the funding judgment. She has to
determine basically when, how and where funds can be acquired to satisfy the investment
needs of the company. The primary question before him is assessing the equity and debt ratio.
The debt-to-equity mix is considered the financial structure of the company. The financial
planner must seek to protect his firm's best finance combination or the desired capital
structure. When the market value of shares is maximized, the financial structure of the
company is called optimal. The use of leverage impacts shareholder returns and risks; it may
increase equity fund returns, but it still raises risk. A right balance of return and danger must
be struck. The stock profit per share is to be maximised and the financial structure of the
company deemed to be optimal as the shareholders return is maximized at a minimum risk.
When the financial analyst will decide the right balance of debt and equity, the required sum
must be collected from the best available sources.

c. Dividend Decision: The third big financial decision is the dividend decision. The
financial officer must determine whether the company should transfer or hold all earnings or
distribute a share and preserve its balance. Like its debt strategy, its effect on shareholder

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 equity should be calculated by the dividend policy. The best dividend strategy maximizes the
market value of the shareholdings of the company. Therefore the financial officer must
calculate the optimal dividend – distribution ratio, provided the company's owners are not
oblivious to the dividend strategy. The distribution ratio is proportional to the owners'
percentage of dividends. Future problems of stability, incentive shares and cash returns can
also be considered in effect by the financial planner. Many profitable firms routinely pay cash
dividends.

d. Liquidity Decision:
In addition to controlling long-term investments, present asset management that affects the
liquidity of a business is yet another essential financial feature. In order to shield the company
from the risks of illiquidity and insolvency, existing assets should be handled effectively.
Present asset management impacts sustainability of the business. Responsibility and liquidity.
Profitability and liquidity in the handling of existing assets are in dispute. If the company does
not spend enough capital in current assets, it will become illiquid. Yet profitability would be
lost, as silent current assets would be unprofitable. A successful trade-off between
profitability and liquidity must therefore be accomplished. The financial planner must develop
sound wealth management strategies in order to ensure that neither inadequate nor excess
funds are invested in current assets. It should estimate the needs of the company in terms of
existing assets and ensuring that funding is made available if necessary.

5. What are the main focus of corporate finance based on

principles:

Maximize the value of a business Firm

The Investment The Financing The Dividend Decision

Decision Decision If you cannot find
Invest in assets that Find the right kind of investments that make
earn a return greater debt for your firm and your minimum
than the minimum the right mix of debt acceptable rate, return
acceptable hurdle and equity to the cash to owners of
Rate. fund your operations. your business.

The hurdle The return

The The right How much How you
rate should should
optimal kind cash you can choose
reflect the reflect the
mix of debt of debt return to return
riskiness of magnitude
and equity matches the depends cash to
the and the
maximizes tenor of your upon the owners
investment timing of the
firm assets current & will
and the mix cash flows as
value potential depend
of debt well
as all side investment whether
and equity opportunities they prefer
used to fund effects. dividends or
it. buybacks

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 5.1 The main Focus of Corporate finance On:

The Investment Decision

• Choose the right investment decision rules that maximize the firm’s value.
• Determine the best combination of hurdle rate and return that reflect the riskiness of
investment and magnitude timing of cash flows.

The Financing Decision:

• Determine the right mix of debt and equity for a specific business.
• Examine the sources of capital structure.

The Dividend Decision

• Examine the right amount of cash should be returned to the owner of the business and right
amount of hold back as a cash balance.
• Determine the investment opportunities of a business and investors prefer dividends or
buyback.

6. Importance and Scope of Corporate Finance

1. Research and Development:

Corporate Finance is needed for Research and Development. Today, a company cannot survive
without continuous research and development. The company has to go on making changes in its old
products. It must also invent new products. If not, it will be get automatically thrown out of the
market.

2. Motivating Employees:

Manager and employees must be continuously motivated to improve their performance. They must
be given financial incentives, such as bonus, higher salaries, etc. They must also be given non-
financial incentives such as transport facilities, canteen facilities (eatery), etc. All this requires
finance.

3. Promoting a Company:

Finance is needed for promoting (starting) a company. It is needed for preparing Project Report,
Memorandum of Association, Articles of Association, Prospectus, etc. It is needed for purchasing
Land and Buildings, Plant and Machinery and other fixed assets. It is needed to purchase raw
materials. It is also needed to pay wages, salaries and other expenses. In short, we cannot start a
company without finance.

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4. Smooth conduct of Business:

Finance is needed for conducting the business smoothly. It is needed as working capital. It is
needed for paying day-to-day expenses. It is needed for advertising, sales promotion, distribution,
etc. A company cannot run smoothly without finance.

5. Expansion and Diversification:

Expansion means to increase the size of the company. Diversification means to produce and sell
new products. Modern machines and modern techniques are needed for expansion and
diversification. Finance is needed for purchasing modern machines and modem technology. So,
finance becomes mandatory for expansion and diversification of a company.

6. Meeting Contingencies:

The company has to meet many contingencies. For e.g. sudden fail in sales, loss due to natural
calamity, loss due to natural calamity, loss due to strikes, etc. The company needs finance to meet
these contingencies.
7. Dividend and Interest:

The company has to pay dividends to the shareholders. It has to pay interest to the debenture holders,
banks, etc. It also has to repay the loans. Finance is needed to pay dividend and interest.

8. Replacement of Assets:

Plant and Machinery are the main assets of the company. They are used for producing goods and
services. However, after some years, these assets become old and outdated. They have to be
replaced by new assets. Finance is needed for replacement of old assets. That is, finance is needed
to buy new assets.

CONCLUSION

Even if conceptually sound, these intricate financial techniques would be difficult to implement. At
some companies the discounted cash flow analysis errs by taking inflation into account in one part
of the formula, the calculation of the discount rate, but fails to do so in calculating the cash flows
that are to be discounted. At other companies, the system collapses, or at least bends, under the
weight of corporate politics. People simply produce the numbers that are needed to justify the
desired result.
Like some other aspects of corporate finance, the appeal of a discounted cash flow analysis is that it
seems to think broadly and reduce to a common denominator any type of proposal, large or small,
in any industry. A corporate staff sitting at headquarters can contemplate a new food product one

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day, a new electronics factory another, and a major business acquisition the next. All of them fit
neatly within the discounted cash flow “discipline.” Most business diversification decisions were
subjected to just this sort of analysis. Alas, as Michael Porter found in a 1987 study, the results have
been awful. Thirty-three large, prestigious companies had made over 2,000 acquisitions in new
fields (or industries) between 1950 and 1986, an average of 61 per company. Included were some of
the best managed companies such as General Electric, and some of the worst, such as Wickes. The
number of acquisitions retained (and divested) were used as a rough but reasonable measure of
success. Of the businesses acquired by 1980, 53.4 percent had been divested or shut down by
January 1987. And the results were conservatively calculated, because a good number of the
failures had been buried privately.

Quaker Oats, a profitable company, said that it is trying to maintain a return on equity of 20
percent, far above what American industry as a whole has been able to achieve. But neither
“scientific” financial tools nor any other off-the-shelf formula will get it there. In fiscal 1989, the
same year the company distributed the annual report that exulted in these tools, the company’s
Fisher-Price toy division stumbled badly, as did the pet food division. The following year, having
absorbed substantial losses at Fisher-Price, management decided to spin it off while it grappled with
declining sales elsewhere. The company may once again achieve those high overall returns, but
only rare ideas and rare good people, rather than scientific finance, will enable it to do so.

Admittedly there is a seductive aspect to finance: the possibility of making money in the purest
form, by dealing directly with money selling parts of the business, raising a war chest for hostile
acquisitions, and framing ingenious new capital structures. All the world becomes an oversized
chessboard, and people, factories, and products figure only as bit players in ambitious strategies.
Finance is a modestly useful discipline, and only that. It is a mistake to let it get out front, as we did
during the 1980s, in the process attracting to it much of the nation’s young talent who should
instead have gone to a no-nonsense city, such as Toledo, and gotten their hands dirty. One purpose
of this book is to reinforce that message.”