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Corporate Finance – Notes

IIMBx – FC101x

Overview
1.1 Organizations

1. Proprietorship
 Single owner, full control
 Unlimited liability
 Less financial resources
2. Partnership
 Multiple owners
 Unlimited liability
 Moderate financial resources
3. Corporations
 Limited liability
 Financed through raising capital as risks are low
 Seen as separate entity
 Double taxation ( on corporation as well as dividends)
 Limited control

1.2 Role of Finance Manager

1. Manage the interface b/w firm and investors or shareholders


 Financial Markets(Equity/bonds) helps firms to raise capital
 Equities or Debt securities
 Loan from commercial banks
2. Manage the funds- internal and external
 Create value for investors
 Allocating to projects
3. Advising the top Management about cash flows
 Reinvesting
 Return funds (dividends, interests)
- Require understanding of financial markets and institutions as well as ability to evaluate projects

1.3 Assets and Sources of funds

o Firms need to invest in assets to enable them to make and sell products
1. Tangible assets : infrastructure
2. Intangible assets : Intellectual Property, Brand
3. Current assets : Short term, payment dues, cash in banks
o Assets = equity + liability

1.4 Ownership and Management

When separation of ownership and management happens


Adv: Managers are selected for their ability
Diasdv: The principal-agent problem arises when an “agent”(Manager) has to make decisions on behalf of
“principal”(Shareholders), and the incentives of agent don’t align with that of principal. Managers are given stock
options to overcome this.

o Information asymmetry : Shareholders not having the same level of information as the managers
o Principal-agent problem

1.5 Corporation and Stock Market

 IPO
 Investors : Short term, Long term
 Able to sell share without undue costs
 Stock Markets: Provide Liquidity, buy and sell shares, raise capital
 Market Cap : Market value of all shares = (Price of share)*(Total # of shares)
 Market Cap of Stock Exchange = sum of all stocks (NYSE- largest, $18T)
 Average Daily Turnover(ADT) = total annual turnover of shares bought and sold in an exchange / No. of
trading days in a year
o Measure of liquidity
o Shanghai SE , largest, $87.4B

Time Value of Money

1.1 Simple and Compound Interest


 SI : only on Principal = P (1 + rN)
 CI : also on interest earned during the period = P (1 + r)N

1.2 APR, EAR


 Annual Percentage Rate = (Periodic interest rate)*(No. of such periods in a year)
 Effective Annual Rate = (1 + Periodic interest rate)(No. of such periods) – 1
 EAR = (1 + APR/N)N – 1

1.3 Future Value and Present Value

 Cashflows
 Excel function: Formulas>Insert>financial>FV
 FV(rate , time period, payment, present value)
 Discount rate
 When comparing two investments : Opportunity Cost – Return on alternative investment of similar risk

1.4 Valuing a perpetuity


 A perpetuity is a security that pays constant amount of cash, at constant intervals, forever.
 Not loan as principal is not returned
 100 invested at 4% perpetual interest, we get 4 every year, forever.

 No arbitrage condition
 Law of one price
 Cash flow = principal * rate (C=P*r)

1.5 Annuity
 Annuity is constant cash flow occurring at regular intervals of time for fixed period of time
 Loans, EMIs, etc
 Future value of annuity(FVA)
 Formula for PV of annuity

(C/r) – (C/r)*[1/(1+r)^N]

Bonds and stocks

 Bond is a security issued by firm to raise funds


 Issuer and investor
 Bonds are on liability side on balance sheet
 Bonds are tradeable, loans are not
 Maturity date: last payment date
 Interest rate payment of bond is called coupon
 (Coupon rate=APR) expressed as a percentage of facevalue
 Coupon rate = annual coupon / facevalue = (coupon*#ofcouponsperyear)/facevalue