AMITY GLOBAL

BUSINESS SCHOOL Chandigarh

Introduction to
Corporate Finance
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh What is Corporate 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 parameters of corporate finance.

Regardless of whether you work for a corporation or
are an external party with an interest in a particular
corporation, understanding and being able to analyze
corporate decisions is important

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Introduction to Corporate
Finance
Corporate Finance addresses the following
three questions:
1. What long-term investments should the
firm engage in?
2. How can the firm raise money for the
required investments?
3. How much short-term cash flow does a
company need to pay its bills?

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
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Role of The Financial
Manager
(3) Cash generated by operations
(3)
(4a) Cash reinvested
(4a)
(4b) Cash returned to investors
(4b)
Financial
manager
Firm's
operations
Financial
markets
(1) Cash raised from investors
(1)
(2) Cash invested in firm
(2)
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
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Corporate Finance Functions
Financial Management
External Financing
Capital Budgeting
Risk Management
Corporate Governance
Corporate
Finance
Functions
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BUSINESS SCHOOL Chandigarh
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Dimensions of the External Financing
Function
6
Equity vs. debt
Funding via capital market vs. via financial
intermediary
Public vs. private capital markets
Going public
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
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The Capital Budgeting Function
Capital Budgeting the
process firms use to
choose the set of
investments that
generate the most
wealth for shareholders
Select investments for which the marginal benefits
exceed the marginal costs.
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BUSINESS SCHOOL Chandigarh
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The Financial Management Function
Managing daily cash inflows and outflows
Forecasting cash balances
Building long-term financial plans
Choosing the right mix of debt and equity
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BUSINESS SCHOOL Chandigarh
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The Risk Management Function
Managing the firms exposure to significant risks:
Interest rate risk
Exchange rate risk
Commodity price risk
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BUSINESS SCHOOL Chandigarh
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What Should Managers Maximize?
Profit maximization as goal:
Does not account for timing of returns
Profits - not necessarily cash flows
Ignores risk
Maximize shareholder wealth
Maximize stock price, not profits
Accounts for risk
As residual claimants, shareholders have better
incentives to force management to maximize firm
value than do other stakeholders.
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BUSINESS SCHOOL Chandigarh
11
Managerial Goals
Managerial goals may be different from
shareholder goals

Expensive perquisites
Survival
Independence

Increased growth and size are not
necessarily the same thing as increased
shareholder wealth.
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BUSINESS SCHOOL Chandigarh
12
Do Shareholders Control Management
?
Shareholders vote for the board of directors,
who in turn hire the management team.
Compensation Schemes can be carefully
constructed to be incentive compatible.
There is a market for managerial talentthis
may provide market discipline to the
managersthey can be replaced.
If the managers fail to maximize share price,
they may be replaced in a hostile takeover.
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh The Three Major Decisions in
Corporate Finance
The investment decision
Why are managers asked to make choices amongst
potential investments?




What makes for a good investment?


AMITY GLOBAL
BUSINESS SCHOOL Chandigarh The Three Major Decisions in
Corporate Finance
The financing decision
Where do firms raise/acquire the funds for value-
creating investments?


What mix of owners money (equity) or borrowed
money(debt) should the firm use?


AMITY GLOBAL
BUSINESS SCHOOL Chandigarh The Three Major Decisions in
Corporate Finance
The dividend decision
How much of a firms funds should be reinvested in
the business and how much should be returned to the
owners?
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh The Balance-Sheet Model of the
Firm

Current Assets

Fixed Assets
1 Tangible
2 Intangible

Total Value of Assets:

Shareholders
Equity

Current Liabilities
Long-Term Debt

Total Firm Value to Investors:
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh The Balance-Sheet Model of the
Firm

Current Assets

Fixed Assets
1 Tangible
2 Intangible


Shareholders
Equity

Current Liabilities
Long-Term Debt

What long-
term
investments
should the
firm engage
in?
The Capital Budgeting Decision
(Investment Decision)
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh The Balance-Sheet Model of the
Firm
How can the
firm raise the
money for the
required
investments?
The Capital Structure Decision
(Financing Decision)

Current Assets

Fixed Assets
1 Tangible
2 Intangible


Shareholders
Equity

Current Liabilities
Long-Term Debt

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh The Balance-Sheet Model of the
Firm
How much
short-term cash
flow does a
company need
to pay its bills?

The Net Working Capital Investment Decision
(Financial Decision)
Net
Working
Capital

Shareholders
Equity

Current Liabilities
Long-Term Debt


Current Assets

Fixed Assets
1 Tangible
2 Intangible

AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Cash flow
from firm (C)
The Firm and the Financial
Markets
T
a
x
e
s

(
D
)

Firm
Government
Firm issues securities (A)
Retained
cash flows (F)
Invests
in assets
(B)
Dividends and
debt payments (E)
Current assets
Fixed assets
Financial
markets
Short-term debt
Long-term debt
Equity shares
Ultimately, the firm must
be a cash generating
activity.
The cash flows from the
firm must exceed the cash
flows from the financial
markets.
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Financial Markets

Firms


Investors
Secondary Market
money
securities
Sue Bob
Stocks and
Bonds
Money
Primary Market
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BUSINESS SCHOOL Chandigarh
Investment Environment
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh

Investment

Activities that sacrifice present consumption for

future (uncertain) rewards.
Riskless Investment: (1) the asset is default-free.
(2) the maturity of the asset matches the
investment horizon of the investor.


represented by dollar returns represented by the rate of return
Riskless Investment deals with the time value of money
$100
$110
10%
Two Elements of Investment: Time and Risk
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Capital Structure :Debt and
Equity
The basic feature of a debt is that it is a
promise by the borrowing firm to repay a
fixed dollar amount of by a certain date.
The shareholders claim on firm value is
the residual amount that remains after
the debtholders are paid.
If the value of the firm is less than the
amount promised to the debtholders, the
shareholders get nothing.
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Financial Markets
Primary Market
When a corporation issues securities, cash
flows from investors to the firm.
Usually an underwriter is involved
Secondary Markets
Involve the sale of used securities from one
investor to another.
Securities may be exchange traded or trade
over-the-counter in a dealer market.
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh 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
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh Valuation
Some of the issues we will address:
How does a particular decision affect firm
value?
The link between these decisions and the
firm value can be made by recognizing that
the value of a firm is the present value of its
expected cash flows, discounted back at a
rate that reflects both the riskiness of the
projects of the firm and the financing mix used
to finance them.
What are the prominent valuation methods?


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BUSINESS SCHOOL Chandigarh
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The Corporate Governance
Function
Ensuring that managers pursue shareholders
objectives
Dimensions
of corporate
governance
Boards of directors
Ownership structures
Capital structures
Compensation plans
Takeover market disciplines firms that dont
govern themselves.
AMITY GLOBAL
BUSINESS SCHOOL Chandigarh
Corporate Governance and
Managerial Decisions
Managers making decisions that are
consistent with the firm objective of firm
value maximization is predicated on the
assumption that managers will act in the
best interest of shareholders

Corporate governance addresses the
relationships between the various
stakeholders in the firm