Corporate Finance

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What Is Finance?
Virtually all individuals and organizations earn
or raise money and spend or invest money.
 A medium of exchange that is centralized,
generally accepted, recognized, and
facilitates transactions of goods and services,
is known as money.(ET)

Finance is the processes by which money is

transferred (financing and investing) among
businesses, individuals, and governments.
FINANCE-MEANING
Finance is a field that deals with the study
of investments. It includes the dynamics of
assets and liabilities over time under
conditions of different degrees of
uncertainty and risk.
Finance can also be defined as the science
of money management.
Contd....
A key point in finance is the time value of
money, which states that purchasing power
of one unit of currency can vary over time.
 Finance aims to price assets based on
their risk level and their expected rate of
return.
Finance can be broken into three different
sub-categories: public finance, corporate
finance and personal finance.
 Breaking down 'Finance’
The study of finance can also take many
forms, depending on the field or area of
finance which one wishes to study.
 For instance, Economics is considered a
pillar of financial science, where both
macro and microeconomic factors affect
virtually levels of financial decisions and
outcomes at all levels.
Forms of Business
Organisation
Sole Proprietorship
HUF
Partnership
Private Limited Company
Public Limited Company
Public Enterprises
Sole Proprietorship
One man Control
Top secrecy
Limited Capital
Limited sources
Unlimited liabilities
Small in size
Partnership
Partners (2 to 20 and in case of banking 2
to 10)
Partnership Deed
Unlimited Liabilities
Secrecy
 Active partners and sleeping partners
Private Limited Company
Members 2 to 50
Limited Liabilities
Special privileges
No offer to public (NO IPO)
Commencement of business
Documents for incorporation
Public Limited Company
Members 7 to unlimited
Limited Liabilities
No Special privileges
Offer to public
Commencement of business
Documents for incorporation
Large in size
Huge resources
Financial Market
 Introduction

 ‘FM’ may be defined as the art & science of

managing money. FM is concerned with the duties
of the financial managers in the business firm.
 Relationship of financial management and other
supportive disciplines
Financial Decision Areas is:
Primary Disciplines
Support 1. Accounting
1. Investment analysis 2. Macroeconomics
2. Working Capital Management 3. Microeconomics
3. Sources and cost of funds
4. Determination of capital structure
5. Dividend Policy
6. Analysis of risk and returns
Support
Other Related Disciplines
1. Marketing
2. Production
Resulting in 3. Quantitative methods

Shareholder wealth maximization

Functions of Finance under
Modern Approach
Financial Management in the modern
sense of the firm can be broken down into
three major decisions as functions of
finance. These are :
The investment decision
The financing decision
The dividend decision
 Organisation of Finance Function
Board of Directors

Managing Director /Chairman

Vice President /Director (Finance)/ Chief finance Officer

(CFO)

Treasurer Controller

Financial Cash Credit Foreign Tax

planning and Exchange Manager Cost
Manager Manager Accounting
fund-raising Manager
manager Manager

Financial
Capital
Pension Corporate Accounting
Expenditure Fund Accounting Manager
Manager Manager Manager
The Investment Decision
The investment decision relates to
the selection of assets in which funds
will be invested by a firm. The assets which
can be acquired fall into two broad
categories
Long term assets (which yield return over a period
over a time in future.) –Capital Budgeting.
Short term or current assets (convertible into cash
usually within one year.) –Working Capital
Management.
•Capital Budgeting
Capital budgeting is the most crucial
financial decision of the firm. It refers to selection of
an asset or investment proposal or course of action
whose benefits are likely to be available in future
over the lifetime of the project. The main elements
of capital budgeting are:
 Choice of the new assets out of the alternatives
available or relocation of the capital when an
existing asset fails to justify the funds committed.
 Capital budgeting decision is the analysis of risk
and uncertainty.
 The concept and measurement of cost of capital.
•Working Capital Management (wcm)
WCM is concerned with the management
of current assets. The key strategies and
considerations in ensuring a tradeoff between
profitability and liquidity is one of the major
dimensions of WCM. The management of
working capital has two basic ingredients:
 An overview of working capital
management as a whole
 Efficient management of the individual
current assets such as cash, receivables
and inventory.
The Financing Decision
The investment decision is broadly
concerned with the assets–mix or the
composition of the assets of the firm. A
capital structure with a reasonable
proportion of debt and equity capital is
called the Optimal Capital Structure.
The two aspects of financing decision
are :
The of capital structure theory
The capital structure decision
The Dividend Decision
The dividend should be analysed in
relation to the financing decision of the firm.
Two alternatives are available in dealing with
the profits of a firm:
 They can be distributed to the shareholders in the
form of the dividends
 They can be retained in the business itself.

The decision as to which course should

be followed depends largely on the significant
dividend decision, the dividend –pay –out
ratio, i.e. what proportion of net profits should
be paid out to the shareholders.
OBJECTIVES OF FINANCIAL
MANAGEMENT
The objective provide a framework for
optimum financial decision making. They
are concerned with designing a method of
operating the internal investment and
financing of a firm.there are two widely
discussed approaches under this, these
are:
Profit Maximisation
Wealth Maximisation
Profit Maximisation
Profit /EPS maximisation should be undertaken
and those that decrease profits or EPS are to be
avoided. Profit is the test of economic efficiency.
It leads to efficient allocation of resources, as
resources tend to be directed to uses which in
terms of profitability are the most desirable.
Financial management is mainly concerned with
the efficient economic resources namely capital.
The main technical flaws of this criteria are :
 Ambiguity
 Timing of benefits
 Uncertaininity or Quality of Benefits
Ambiguity
The term 'profit maximization' as a
criterion for financial decision is vague
and ambiguous concept.
The term 'profit' is amenable to different
interpretations by different people.
For example, profit may be long-term or
short-term. It may be total profit or rate of
profit. It may be net profit before tax or
net profit after tax. It may be return on
total capital employed or total assets or
shareholders equity and so on.
Timing of Benefits
Another technical objection to the profit
maximization criterion is that “It Ignores
the differences in the time pattern of the
benefits received from Investment
proposals or courses of action.
When the profitability is worked out the
bigger the better principle is adopted
as the decision is based on the total
benefits received over the working life of
the asset, Irrespective of when they were
received.
Quality of Benefits
Another Important technical limitation of profit
maximization criterion is that it ignores the
quality aspects of benefits which are
associated with the financial course of action.
The term 'quality' means the degree of
certainty associated with which benefits can
be expected. Therefore, the more certain the
expected return, the higher the quality of
benefits.
As against this, the more uncertain or
fluctuating the expected benefits, the lower
the quality of benefits.
Profit Maximization is not
Operationally Feasible
The profit maximization criterion is not
appropriate and suitable as an operational
objective.
It is unsuitable and inappropriate as an
operational objective of Investment
financing and dividend decisions of a firm.
It is vague and ambiguous. It ignores
important dimensions of financial analysis
viz. risk and time value of money.
Contd....
An appropriate operational decision
criterion for financial management should
possess the following quality.
a) It should be precise and exact.
b) It should be based on bigger the better
principle.
c) It should consider both quantity and
quality dimensions of benefits.
d) It should recognize time value of money.
 Wealth Maximisation

Wealth maximisation is also known as Value

or Net present worth maximisation. Its
operational features satisfy all the three
requirements of the operational of the financial
course of action namely, exactness, quality of
benefits, and the time value of money. Two
important issues related to the value/share price
maximisation are:
 Focus on stakeholders ,stakeholders include groups
such as employees, customers, suppliers, creditors,
owners and others who have a direct link to the firm.
 EVA (Economic Value Added) –EVA is equal to the
after-tax operating profits of a firm less the cost of the
firm to finance investments.
Advantages of Wealth
Maximization
Cash Flow Approach :Firstly, the wealth
maximization is based on cash flows and
not on profits.
Unlike the profits, cash flows are exact
and definite and therefore avoid any
ambiguity associated
with accounting profits.
Profit can easily be manipulative, if there
is a change in accounting
assumption/policy, there is a change in
profit.
Longer Period Concept
Secondly, profit maximization presents
a shorter term view as compared to
wealth maximization. Short-term profit
maximization can be achieved by the
managers at the cost of long-term
sustainability of the business.
Time Value of Money
Thirdly, wealth maximization considers
the time value of money. It is
important as we all know that a dollar
today and a dollar one-year latter do not
have the same value. In wealth
maximization, the future cash flows are
discounted at an appropriate discounted
rate to represent their present value.
Contd....
Suppose there are two projects A and B,
project A is more profitable however it is
going to generate profit over a long
period of time, while project B is less
profitable however it is able to generate
return in a shorter period.
In a situation of an uncertainty, project B
may be preferable. So, timing of returns
is ignored by profit maximization, it is
considered in wealth maximization.
Risk and Uncertainty
Factor
Fourthly, the wealth-maximization criterion
considers the risk and uncertainty
factor while considering the discounting
rate. The discounting rate reflects both
time and risk. Higher the uncertainty, the
discounting rate is higher and vice-versa.