CORPORATE FINANCE

AN OVERVIEW
COURSE OUTLINE
 Overview of Financial Management
 Fundamental Valuation Concepts
 Capital Budgeting
 Cost of Capital
 Working Capital Management
 Capital Structure
 Dividend Policy
WHAT IS COPORATE FINANCE
 Every decision that a business makes has financial
implications, and any decision which affects the
finances of a business is a corporate finance decision.

 Defined broadly, everything that a business does fits

under the rubric of corporate finance.
COURSE OBJECTIVES
 Understand the theory and apply in the real world
 Immediate – mid term, end term and quizzes
 Later – career

 Decide if you want to take up advanced elective

finance courses

 Answer finance related questions in summer

placements
READINGS
 Main Reading
 “Financial Management - Theroy and Practice”, Prasanna Chandra (7e) ,
(Tata McGraw Hill)

 Additional Readings
 “Financial Management”, IM Pandey (Vikas Publishing House)
 “Corporate Finance and Investment” by Pike, Richard and Bill Neale,
(Prentice Hall)
 “Financial Management & Policy”, James C. Van Horne, (Prentice Hall, New
Delhi)
 “Fundamentals of Corporate Finance” by Ross, Waterfield Jordan, (Tata
McGraw Hill)
 “Corporate Finance – Theory & Practice” Aswath Damodaran, (John Wiley &
Sons)
 “Principles of Corporate Finance”, Richard A. Brealey and Stewart C. Myers,
(Tata McGraw Hill)
 Financial Management, MY Khan and PK Jain, (Tata McGraw Hill)
GRADING
 Mid Term
 End Term
 Quizzes – some announced
 Group Projects
 Form groups of 6 people, pick your own group
 Try and distribute work load equitably
 No duplication

 All exams and quizzes are open book and strictly individual
 Class participation is welcome
FORMS OF BUSINESS ORGANISATIONS
Sole Proprietorship
 One owner
 Very simple
 Unlimited liability
 The firm has no separate status from a legal and tax point of view
Partnership
 Two or more owners
 Fairly simple
 Unlimited liability
 The firm has a separate status
Private Limited Company
 Upto 50 owners
 Not too complex
 Limited liability
 A distinct legal person
FORMS OF BUSINESS ORGANISATIONS
Public Limited Company
 Many owners
 Somewhat complex
 Limited liability
 Distinct legal person
 Free transferability of shares

Public Limited Company’s Attraction

 The potential for growth is immense because of access to
substantial funds
 Investors enjoy liquidity because of free transferability of
securities
 The scope for employing talented managers is greater
ALL MANAGERS ARE FINANCIAL
MANAGERS
 The engineer, who proposes a new plant, shapes the
investment policy of the firm

 The marketing analyst provides inputs in the process of

forecasting and planning

 The purchase manager influences the level of investment in

inventories

 The sales manager has a say in the determination of the

receivables policy

 Departmental managers, in general, are important links in the

finance control system of the firm
ORGANISATION OF FINANCE FUNCTION
Chief Finance

Officer

Treasurer Controller

Financial Cost
Cash Credit Accounting Accounting
Manager Manager Manager Manager

Capital Fund Tax Data

Budgeting Raising Manager Processing
Manager Manager Manager

Portfolio Internal
Manager Auditor
ROLES OF FINANCE DEPARTMENT
 Treasury  Accounts & Control
 Financial Planning
Analysis
 Cash Management
 Fund Acquisition
 Investment Financing
 Investment Decisions
 Risk Management
 External Reporting
 Financial and
Management accounting
 Budget Planning Control
 Tax Planning and
Management
 MIS
 Accounts Receivable
RELATIONSHIP OF FINANCE TO
ACCOUNTING
 Accounting is concerned with score keeping, whereas finance is
aimed at value maximising.

 The accountant prepares the accounting reports based on the

accrual method. The focus of the financial manager is on cash
flows.

 Accounting deals primarily with the past. Finance is concerned

mainly with the future.
EMERGING ROLE OF THE
FINANCIAL MANAGER IN INDIA
The job of the financial manager in India has become
more important, complex and demanding due to the
following factors:
 Liberalisation
 Globalisation
 Technological developments
 Volatile financial prices
 Economic uncertainty
 Tax law changes
 Ethical concerns over financial dealings
 Shareholder activism
EMERGING ROLE OF THE
FINANCIAL MANAGER IN
INDIA
The key challenges for the financial manager appear to
be in the following areas:
 Investment planning and resource allocation
 Financial structure
 Mergers, acquisitions, and restructuring
 Working capital management
 Performance management
 Risk management
 Corporate governance
 Investor relations
KEY FINANCIAL INTERMEDIARIES
 Commercial Banks
 PSU / foreign / Private sector / Cc-operative

 Financial Institutions
 Set up for specialised needs
 Some have transformed into banks

 Insurance Companies
 Earlier only two (LIC, GIC)

 Mutual Funds
 Non Banking Financial Companies
 Non-banking Financial Services Companies
 Merchant banks
 Credit Rating Agencies
 Depositories
REGULATORY INFRASTRUCTURE
 RBI
 functions

 SEBI
 Functions

Mini assignment
RECENT TRENDS IN INDIAN FINANCIAL
SYSTEM
 Large number of financial institutions for a variety of services
 Expanding network of commercial banks
 Increasing number and complexity of products on offer
 Growth in primary and secondary capital markets
 High level of competition
 Market determined rates – greater volatility
 More self – regulation
 Integrating with global financial system
 Innovation
KEY PRINCIPLES
 Invest in projects that yield a return greater than the minimum
acceptable hurdle rate.
 The hurdle rate should be higher for riskier projects and reflect the
financing mix used – owners’ funds (equity) or borrowed money (debt)

 Returns on projects should be measured based on cash flows and the

timing of these cash flows; they should also consider both positive and
negative side effects of these projects.
 Choose a financing mix that minimises the hurdle rate and
matches the assets being financed.
 If these are not enough investments that earn the hurdle rate,
return the cash to shareholders.
 The forms of returns – dividends and share buybacks – will depend upon
the shareholders’ characteristics.

Objective – Maximise the Value of the Firm

KEY PRINCIPLES
Objective – Maximise the Value of the Firm

 Investment Principle

 Financing Principle

 Dividend Principle
OBJECTIVE OF FINANCIAL MANAGEMENT

 FINANCE THEORY RESTS ON THE PREMISE THAT MANAGERS

SHOULD MANAGE THEIR FIRM’s RESOURCES WITH THE
OBJECTIVE OF ENHANCING THE FIRM’s MARKET VALUE.

“The quest for value drives scarce resources to their most

productive uses and their most efficient users. The more
effectively resources are deployed, the more robust will be the
economic growth and the rate of improvement in our standard
of living. Adam Smith’s ‘invisible hand’ is at work when
investors’ private gain is a public value.”
CRITIQUE AND DEFENCE OF SHAREHOLDER
WEALTH MAXIMISATION GOAL
Critique
• The capital market sceptics argue
that stock prices fail to reflect
true values
• The balancers argue that a firm
should seek to ‘balance’ the
interests of various stakeholders
• Advocates of social responsibility
argue that a business firm must
assume wider social
responsibilities
Defence
• Financial economists argue that
stock prices are the least biased
estimates of intrinsic values in
developed markets
• Balancing the interests of various
stakeholders is not a practical
governing objective
• The only social responsibility of
business is to create value and
do so legally and with integrity
SHAREHOLDER ORIENTATION IN INDIA
In the wake of liberalisation, globalisation, and institutionalisation
of the capital market, there is a greater incentive to focus on
creating value for shareholders. The following observations are
clear indications.

Dhirubai Ambani : In everything that we do, we have only one

supreme goal, that is to maximise your wealth as India's largest
investor family.

Anand Mahindra : All of us are beginning to look at companies as

owned by shareholders. The key is to raise shareholder returns.

Mini assignment
ALTERNATIVE GOALS
Maximisation of Profit
This goal is not as inclusive a goal as maximisation of shareholders’
wealth. Its limitations are:
 Profit in absolute terms is not a proper guide to decision
making. It should be expressed either on a per share basis or
in relation to investment.
 It leaves considerations of timing and duration undefined.
 It glosses over the factor of risk
Maximisation of EPS or ROE
While these goals do not suffer from the first limitation mentioned
above, they suffer from the other two limitations
NEXT SESSION
 The Investment Principle

 Fundamental Valuation Concepts

 Time Value of Money