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What is Coprporate Finance

Every decision made in a business has financial implications, and


any decision that involves the use of money is a Corporate
Financial Decision.
Corporate Finance
The Financial Information Assessing and Assessing the Financial
Analysis of for making Enhancing the financial payoff to Consequences of
Pricing and better Financial Value creating and Operational and
Product Financial of Human augmenting barriers Production decisions
Strategy Decisions Capital to entry

(Marketing)
(Accounting) (OB-HR) (Corporate Strategy) (Operation)
Traditional Accounting Balance Sheet
Financial View of the Firm-Financial Balance Sheet
Corporate Finance or Business Finance?
Three fundamental principles that underlie corporate finance

-Investment Principle
(The investment principle determines where businesses invest their
resources)

-Financing Principle
(The financing principle governs the mix of funding used to fund these
investments)

-Dividend Principles
(The dividend principle answers the question of how much earnings
should be reinvested back into the business and how much returned to
the owners of the business.)

- & the Central Objective of Firm/Business being Value Maximization is


at the heart of corporate financial theory.
Theme 1: Corporate finance is common sense
Arguing that taking investments that make 9% with funds that cost 10% to raise
seems to be stating the obvious

Shrewd business people, notwithstanding their lack of exposure to corporate


finance theory, have always recognized these fundamentals and put them into
practice

Theme 2: Corporate finance is focused


It is the focus on maximizing the value of the business that gives corporate
finance its focus

Theme 3: The focus changes across the life cycle


Young Company and Established Company will have different practices

Theme 4: Corporate finance is universal


Every business, small or large, public or private, US or emerging market, has to
make investment, financing and dividend decisions.

The objective in corporate finance for all of these businesses remains the same:
maximizing value.

Theme 5: If you violate 1st principles, you will pay!


What is the 'Payback Period?

Payback period in capital budgeting refers to the period of


time required to recoup (recover-get back) the funds
expended in an investment, or to reach the break-even
point.

-length of time required to recover the cost of an


investment.
-longer payback periods are typically not desirable for
investment positions.
-
The payback period ignores the time value of money,
unlike other methods of capital budgeting, such as net
present value, internal rate of return or discounted cash
flow
Payback period
YEAR Company-A CUM Cash Flow-A Company-B CUM-Cash Flow B
1 1000 1000 4000 4000
2 3000 4000 4000 8000
3 4000 8000 2000 10000
4 5000 13000 2000 12000
Total 13000 12000

# Investment of 10000

Company- CUM Cash


YEAR A Flow-A Pay Back Period = 3 x [(10000-
1 1000 1000 8000)/(13000-8000)]
2 3000 4000
3 4000 8000
Pay Back Period = 3 x (2000/5000) =
4 5000 13000
3.40 years
Total 13000
'Accounting Rate of Return - ARR'
(Average Rate of Return or Simple Rate of Return)

Accounting Rate of Return is a percentage measuring average


annual operating profit against the average annual investments.
ARR does not consider the time value of money.
ARR does not consider cash flows, which can be an integral part of
maintaining a business.

Accounting Rate of Return Example


The total profit from a project over the past five years is 50,000.
During this span, a total investment of 250,000 has been made.
The average annual profit is 10,000 (50,000/5 years) and the
average annual investment is 50,000 (250,000/5 years). Therefore,
the accounting rate of return is 20% (10,000/50,000).
Calculate ARR (Accounting Rate of Return)

Table1 Year 0 Year 1 Year 2 Year 3


Initial Inv. -150000

Cash Flow Operating


Profit Before
Depreciation 65000 110000 175000
Residual value 25000
Average Annual Operating Profit
ARR = -------------------------------------------- x 100%
Average Investment

Average Annual Operating Profit= Average Annual Operating Profit


before depreciation (3 years in this case) Annual Average
Depreciation

1. Average Annual Operating Profit before depreciation (3yrs ) =


(65000+110000+165000)/3= 350000/3 = 116667
2. Annual Average Depreciation = (Initial Cost-Residual Value) / Time
period (3) = (150000-25000) / 3 = 41667
3. Average Annual Operating Profit = (1-2) = 116667-41667= 75000
4.Average Investment = (Initial Investment + Residual Value)/2 =
(150000+25000)/2= 87500
5.ARR = (75000/87500) x 100% = 85.71%
'Accounting Rate of Return - ARR'
(Average Rate of Return or Simple Rate of Return)

Accounting Rate of Return is a percentage measuring average annual


operating profit against the average annual investments.

-ARR does not consider the time value of money.

-ARR does not consider cash flows, which can be an integral part of
maintaining a business.

Accounting Rate of Return Example


The total profit from a project over the past five years is 50,000. During
this span, a total investment of 250,000 has been made.

The average annual profit is 10,000 (50,000/5 years) and the average
annual investment is 50,000 (250,000/5 years).

Therefore, the accounting rate of return is 20% (10,000/50,000).