1 Introductiontocorporatefinance 130216005349 Phpapp02

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Introduction to CorporateFinance



Topics Covered

What is Corporate Finance

Key Concepts of Corporate Finance

Compounding & Discounting

Corporate Structure

The Finance Function

Role of The Financial Manager Separation of Onership and Management

!gency Theory and Corporate "o#ernance



Corporate Finance

is concerned ith the efficient and effectivemanagement of the finances of an organi$ation

in order to achieve the objectives of that

organization% This in#ol#es

lanning & Controlling the pro#ision of resources

'here funds are raised from(

!llocation of resources 'here funds are deployed to(

Control of resources 'hether funds are )eing used

effecti#ely or not(



Diff. b/w Corporate Finance &

Financial Accounting

Corporate Finance is inherently forard*loo+ing and )ased on

cash flos%

Financial !ccounting is historic in nature and focuses on profit rather than

cash%



Diff. b/w Corporate Finance &

anagement Accounting

Corporate Finance is concerned ith raising funds and pro#iding a

return to in#estors%

Management !ccounting is concerned ith pro#iding information to assist

managers in ma+ing decisions ithin the company%



Two !e" Concepts in Corporate Finance

The fundamental concepts in helping managers

to #alue alternati#e choices are

Relationship )eteen Ris+ and Return

Time ,alue of Money



#elationship between #is$ and #eturn

This concept states that an in#estor or a companyta+es on more ris+ only if higher return is offered in

compensation%

#eturn refers to

Financial reards gained as a result of ma+ing an

in#estment%

The nature of return depends on the form of the

in#estment% ! company that in#ests in fi-ed assets & )usiness

operations e-pects return in the form of profit

'measured on )efore*interest. )efore*ta- & an after*

ta- )asis(& in the form of increased cash flos%



#elationship between #is$ and #eturn

#is$ refers to ossi)ility that actual return may )e different from the

e-pected return%

When !ctual Return / 0-pected Return

This is a Welcome Occurrence% When !ctual Return 1 0-pected Return

This is a Ris+y In#estment%

In#estors. Companies & Financial Managers are more

li+ely to )e concerned ith• ossi)ility that !ctual Return 1 0-pected Return

In#estors & Companies demand higher e-pected return

• ossi)ility of actual return )eing different from e-pected

return increases%



Time %alue of one"

Time #alue of money is rele#ant to )oth Companies

In#estors

In ider conte-t. !nyone e-pecting to pay or recei#e money o#er a

period of time%

Time #alue of money refers to the facts that ,alue of money changes o#er time%



Time %alue of one"

Imagine that your friend offers you eitherRs%2333 today or Rs%2333 in one year4s time%

Faced ith this choice. you ill 'hopefully(

prefer to ta+e Rs%2333 today%

The uestion is to as$ that wh" do "ou prefer

#s.'((( toda")



Time %alue of one"

*olution+ There are three ma5or factors Time+ If you ha#e the money no. you can spend it no% It

is human nature to ant things no rather than ait for

them% !lternati#ely. if you do not ant to spend money

no. you can in#est it. so that in one year4s time you illha#e Rs%2333 plus any in#estment income earned%

,nflation+ Rs%2333 spent no ill )uy more goods &

ser#ices that Rs%2333 spent in one year4s time )ecause

inflation undermines the purchasing poer of your money% #is$+ If you ta+e Rs%2333 no you definitely ha#e the

money in your possession% The alternati#e of the promise of

Rs%2333 in a year4s time carries the ris+ that the payment

may )e less that Rs%2333 or may not )e paid at all%



Compounding is the ay to determine the future #alue of a sum of money

in#ested no%

F, 6 C3'27i(n

Where8 F, 6 Future ,alue

C3 6 Sum deposited no i 6 Interest Rate

n 6 num)er of years until the cash flo occurs

-ample+ Rs% 93 deposited for fi#e years at an annual

interest rate of :; ill ha#e future #alue of8

F, 6 93 - '27%3:(< 6 Rs%9:%=:

Compounding ta+es us forard from current #alue of an

in#estment to its future #alue%



Discounting is the ay to determine the present #alue of future cash flos%

, 6 F, > '27i(n

Where8 F, 6 Future ,alue

, 6 resent ,alue

i 6 Interest Rate

n 6 num)er of years until the cash flo occurs

-ample+ In#estor choice )eteen recei#ing Rs%2333 no &

Rs%2933 in one year4s time% !nnual Interest rate is 23;%

, 6 2933 > '2 7 3%2(2 6 Rs%23?2

!lternati#ely. , of Rs%2333 into a F,

F, 6 2333 - '2 7 3%2(2 6 Rs%2223

Discounting ta+es us )ac+ard from future #alue of a cash

flo to its present #alue%



Corporate bjectives

The o)5ecti#e should )e to ma+e decisions that

ma-imise the #alue of the company for its oners%

Financial O)5ecti#e of Corporate Finance is stated as 0aimisation of shareholder wealth1%

Shareholder recei#e their ealth through increase in

#alue of their shares. in the form of Di#idends

Capital "ains

Shareholder ealth ill )e ma-imised )y ma-imising

the #alue of di#idends and capital gains that

shareholders recei#e o#er time%



Corporate *tructure

Sole roprietorships

artnerships



Corporate *tructure

Sole roprietorships

artnerships

@nlimited Aia)ility

ersonal ta- on profits



Corporate *tructure

Sole roprietorships

Corporations

artnerships

@nlimited Aia)ility




Corporate *tructure

Sole roprietorships

Corporations

artnerships

@nlimited Aia)ility


Aimited Aia)ility

Corporate ta- on profits 7

ersonal ta- on di#idends




Chief Financial Officer




Chief Financial Officer

Comptroller Treasurer



#ole of The Financial anager

Financial

manager

FirmBs

operations

Financial

mar+ets

'2( Cash raised from in#estors

2'3




Financial

manager

FirmBs

operations

Financial

mar+ets


'9( Cash in#ested in firm

2'3243




Financial

manager

FirmBs

operations

Financial

mar+ets



'( Cash generated )y operations

2'3243

253




Financial

manager

FirmBs

operations

Financial

mar+ets




'a( Cash rein#ested

2'3243

253

26a3




Financial

manager

FirmBs

operations

Financial

mar+ets




'a( Cash rein#ested

')( Cash returned to in#estors

2'3243

253

26a3

26b3



While accountancy plays an important roleithin corporate finance. the fundamental

pro)lem addressed )y corporate finance is

economic. i%e% ho )est to allocate the scarceresource of capital%

!im of Financial Manager is the optimalallocation of the scarce resources a#aila)le

to them%

Aim of Financial anager



Financial managers are responsi)le forma+ing decisions a)out raising funds 'the

financing decision(. allocating funds 'the

in#estment decision( and how much todistribute to shareholders 'the di#idend

decision(%




The high le#el of interdependence e-isting )eteen these decision areas should )e

appreciated )y financial managers hen

ma+ing decisions

Can you thin+ ho these decisions may )e

inter*relatedE


, t l ti hi b/ , t t



,nterrelationship b/w ,nvestment7

Financing & Dividend Decisions,nvestment+

Company decides tota+e on a large num)erof attracti#e nein#estment pro5ects

Finance+

Company ill need toraise finance in order tota+e up pro5ects

Dividends+

If finance is not a#aila)le frome-ternal sources. di#idends mayneed to )e cut in order toincrease internal financing%

Dividends+

Company decides to payhigher le#els of di#idendto its shareholders

Finance+

Aoer le#el of retainedearnings a#aila)le forin#estment meanscompany may ha#e tofind finance from

e-ternal sources%

,nvestment+

If finance is not a#aila)le frome-ternal sources than companymay ha#e to postpone futurein#estment pro5ects%

Finance+

Company finances itselfusing more e-pensi#esources. resulting in a

higher cost of capital%

,nvestment+

Due to a higher cost ofcapital the num)er of

pro5ects attracti#e to the

company decreases%

Dividends+

The company4s a)ility to paydi#idends in the future ill )ead#ersely affected%



Ma-imisation of a company4s ordinary share price isused as a surrogate o)5ecti#e to that of ma-imisation

of shareholder ealth%




wnership vs. anagement

Difference in Information

Stoc+ prices and returns

Issues of shares andother securities

Di#idends

Financing

Different O)5ecti#es

Managers #s%

stoc+holders Top mgmt #s% operating

mgmt

Stoc+holders #s% )an+s

and lenders



Agenc" & Corporate 8overnance

Managers do not alays act in the )estinterest of their shareholders. gi#ing rise to

hat is called the agency4 pro)lem%




Customers

Shareholders

including institutions and

private individuals Creditors

including banks, suppliers

and bond holders

Management

Employees

THECOMPANY

Diagram showing the agency relationships that exist between the

various stakeholders of a company




!gency is most li+ely to )e a pro)lem henthere is a di#ergence of onership and

control. hen the goals of management differ

from those of shareholders and henasymmetry of information e-ists%




!n e-ample of ho the agency pro)lem canmanifest itself ithin a company is here

managers di#ersify to reduce the o#erall ris+

of the company. there)y safeguarding their 5o) prospects%

Shareholders could achie#e this themsel#es )y di#ersification%




Monitoring and performance*related )enefitsare to potential ays to optimise managerial

)eha#ior and encourage goal congruence4%




Due to difficulties associated ithmonitoring. incenti#es such as performance*

related pay and e-ecuti#e share options can

)e a more practical ay of encouraging goalcongruence%




Institutional shareholders no onappro-imately :3 per cent of all @K ordinary

share capital% Recently. they ha#e )rought

pressure to )ear on companies ho do notcomply ith corporate go#ernance standards%




The pro)lem of corporate go#ernance hasrecei#ed a lot of attention folloing a num)er

of high profile corporate collapses and a

plethora of self*ser#ing e-ecuti#eremuneration pac+ages%

In the @K. e ha#e the e-ample of Transportand Gan+ing




@K corporate go#ernance systems ha#etraditionally stressed internal controls and

financial reporting rather than e-ternal

legislation%




Corporate go#ernance in the @K asaddressed )y the 2??9 Cad)ury Report and its

Code of Gest ractice. and the 2??<

"reen)ury Report%



! financial manager can ma-imise acompany4s mar+et #alue )y ma+ing good

in#estment. financing and di#idend decisions%


1 Introductiontocorporatefinance 130216005349 Phpapp02

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