Introduction to Corporate

Finance

Welcome
Structure

 Corporate Finance as defined

 The Relationship of accounting and finance
 The Decisions and Principles
 Agency problems and Corporate Governance
 The Firm and Financial Markets
 The Investment Vehicle Model
Corporate Finance- Defined
 Any financial or monetary activity that deals with a
company and its money. This can include anything from
IPO's to acquisitions.
 Corporate finance is an area of finance dealing with the
financial decisions corporations make and the tools and
analysis used to make these decisions. The primary goal
of corporate finance is to maximize corporate value while
reducing the firm's financial risks.
 Stakeholders Vs Shareholders?
 The Relationship of accounting and
finance
• Financial management
• Acquiring and
allocation of the
capital

• Financial accounting • Managerial accounting

• Accounting of • planning, controlling
acquired and allocated and decision-making
capital based on calculations
• Financial analysis of costs
What is Finance- ?
 Finance can be thought of as the study of the following 5 questions:

 How much short-term or long-term cash flow does a company need to

pay its bills? (financial analysis, short-term and long-term financing,
dividend policies)- The Funds Requirement Decision
 How should short-term operating cash flows be managed?-Short Term
Investment Decision
 In what long-lived assets should the firm invest? (investing, capital
budgeting)- The Long Term Investment Decision
 How can the firm raise cash for required capital expenditure? (financing,
capital structure)- The Financing Decision
 How Much of the Profits Should be retained back in Business?- The
Dividend Decision
 The Decisions

CREATING
CORPORATE CORPORATE CORPORATE CORPORATE
INVESTMENT FINANCING DIVIDEND RISK
CORPORATE
DECISIONS CHOICES POLICIES MANAGEMENT ECONOMIC
VALUE
First Principles of Corporate
Finance
 Invest in projects that yield a return greater than
the minimum acceptable hurdle rate with
adjustments for project riskiness.
 Choose a financing mix that minimizes the hurdle
rate.
 If there are not enough investments that earn the
hurdle rate, return the cash to stockholders.
 These decision criteria will be consistent with
the objective of the firm: Maximize the Value
of the Firm
The Balance Sheet Model
Total Value of Assets: Total Firm Value to Investors:

Current
Liabilities
Current Assets
Long-Term
Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity
The Balance Sheet Model
The Capital Budgeting Decision
(Investment Decision) Current
Liabilities
Current Assets
Long-Term
Debt

What long-
Fixed Assets
term
1 Tangible investments
should the Shareholders’
2 Intangible firm engage Equity
in?
The Balance Sheet Model
The Capital Structure Decision
(Financing Decision) Current
Liabilities
Current Assets
Long-Term
How can the firm Debt
raise the money
for the required
Fixed Assets
investments?
1 Tangible
Shareholders’
2 Intangible Equity
The Balance Sheet Model
The Net Working Capital Investment Decision
(Financial Decision) Current
Liabilities
Current Assets
Net
Working Long-Term
Capital Debt

How much short-

Fixed Assets
term cash flow
1 Tangible does a company
Shareholders’
need to pay its
2 Intangible bills? Equity
Finance in the Corporation
Board of Directors

Chairman of the Board and

Chief Executive Officer (CEO)

President and Chief

Operations Officer (COO)

Vice President Vice President Vice President

Marketing Finance (CFO) Production

Treasurer Controller

Credit Manager Cost Accounting

Cash Manager Tax Manager Manager

Financial
Capital Financial Data Processing
Accounting
Expenditures Planning Manager
Manager
The Goal of Financial Management
 Van Horne: "In this book, we assume that the objective of the
firm is to maximize its value to its stockholders"
 Brealey & Myers: "Success is usually judged by value:
Shareholders are made better off by any decision which
increases the value of their stake in the firm... The secret of
success in financial management is to increase value."
 Copeland & Weston: The most important theme is that the
objective of the firm is to maximize the wealth of its
stockholders."
 Brigham and Gapenski: Throughout this book we operate on
the assumption that the management's primary goal is
stockholder wealth maximization which translates into
maximizing the price of the common stock.
 Profit Maximization Vs Wealth Maximization- Goals of Corporate
Finance
The Agency Problem
 The agency relationship
Shareholders
 Will managers work in the shareholders’ best
interests? Board of
 Agency costs Directors
 Corporate governance
 Incentive issues
 Control of the firm -- Managers

Allocation
of Resources
What Goes Wrong ?

 Divorce between ownership and

Management-Conflict in Interests
 Managers may give precedence to their own
personal interests over those of
Shareholders-Agency Costs
 Examples- High rewards, Insider Information
access, Managers Short –Sightedness, Risk
Profile etc.
How to Solve the Problem- ?

 Management Audit/Internal audit at behest of

shareholders
 Incentive arrangements for managers
 Legal Constraints- Companies act 2013
 Market Constraints- Threat of a Takeover
Corporate Governance
Separation of Ownership and Control

Board of Directors

Shareholders
Debt holders
Management

Debt
Assets
Equity
The Firm and the Financial Markets
Firm Firm issues securities (A) Financial
markets
Invests
Retained
in assets cash flows (F)
(B)
Short-term debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Taxes (D)

Ultimately, the firm The cash flows from

must be a cash the firm must exceed
Government
generating activity. the cash flows from
the financial markets.
The Fundamental Concepts

 Cash Flow Vs Profit

 Risk and Return
 Time Value of Money
 Opportunity Cost of Capital
 Value Creation
The Investment Vehicle Model-The Firm

Financial
The Firm Markets
Exchange of Money
and Real Assets

Investment
Decisions

Decisions
Financing
The Exchange of Money
and Financial Investors
World Assets

Financial
Intermediaries

1.Corporate 3. Financial Markets

Financial and Intermediaries 2. Investments
Management
“Let us run the risk of wearing out rather than rusting out.”
-Theodore Roosevelt