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S1 Intro

This document provides an introduction to corporate finance concepts. It discusses key financial decisions companies face, such as capital budgeting, capital structure, working capital management, and dividend policy. It also covers the balance sheet model of the firm and how investment and financing decisions are related. The goal of corporate finance managers is to maximize shareholder value over the long run while balancing the interests of other stakeholders. Agency conflicts and conflicts among different types of capital providers are also discussed.

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Mayank Singh
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17 views20 pages

S1 Intro

This document provides an introduction to corporate finance concepts. It discusses key financial decisions companies face, such as capital budgeting, capital structure, working capital management, and dividend policy. It also covers the balance sheet model of the firm and how investment and financing decisions are related. The goal of corporate finance managers is to maximize shareholder value over the long run while balancing the interests of other stakeholders. Agency conflicts and conflicts among different types of capital providers are also discussed.

Uploaded by

Mayank Singh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Introduction to Corporate Finance

Prof. Arnab Bhattacharya


MBA (Term III) Corporate Finance
Balance Sheet Model of Firm

Net Assets Debt & Equity

Net Working
Debt
Capital (NWC)
Real Financial
Assets Assets
Net Fixed
Equity
Assets (NFA)

Uses of Funds Sources of Funds


Balance Sheet Model of Firm

Investment Decisions Financing Decisions

1. How to invest? 1. How to finance?


- Working capital - Borrow
- Capital expenditure - Reinvest
- Sell ownership
2. How much to invest?
- Project finance 2. How much to finance?
- Financial or strategic - Financing Gap
- Financing Flexibility
3. When / where to invest? 3. When / where to finance?
- Tangible / intangible assets - Financial markets
Uses of Funds Sources of Funds
Basic Financial Decisions in a Firm

 Capital budgeting decision


 Capital structure decision
 Working capital management
 Dividend policy decisions
Basic Financial Decisions in a Firm

 Capital budgeting decision


 Long-term investment decisions in land, buildings,
machines and equipment
 In what long-lived assets should the firm invest?
 Process of making and managing expenditures on long-
lived assets
Basic Financial Decisions in a Firm

 Capital structure decision


 Capital for financing long-term investments and short-
term net working capital
 How can firm raise funding for capex?
 Process of deciding on the proportions of firm’s
financing from current and long-term debt, and equity
Basic Financial Decisions in a Firm

 Working capital management


 Short-term capital (cash, inventories, receivables) for
uninterrupted daily operations
 How should short-term operating cash flows be
managed?
 Managing mismatch between timing of cash inflows
and cash outflows during operating activities
Basic Financial Decisions in a Firm

 Dividend policy
 Form of distributing cash back to shareholders
 Dividends and share buybacks

 How should firm distribute its profits back to


shareholders?
 Process of deciding when to pay, how to pay and how
much to pay regarding dividend distributions
Firm Life Cycle and Corporate Finance

 Firm Life Cycle and Corporate Finance Decisions

Mature Mature
Life Cycle Start-up Early Growth High Growth Decline
Growth Stable

New products, Maintain Reduce


Investing New product Increase
Market testing capacity capacity, capacity, asset
Policy development capacity
increase acquisitions divestures

Mainly equity,
Financing Equity Equity, public High debt High debt Debt reduces
low debt
Policy financing market option capacity capacity with firm value
capacity
High cash burn,
High cash Positive cash Cash build up, Cash return
Dividend equity
burn, zero flows, low moderate High payout from asset
Policy infusion, zero
payout payout payout divestures
payout
Product Revenue
Key Focus Business Idea Profitability Profitability Cash flows
Development Growth
Goal of Corporate Finance Manager

10

 Primary objective of corporate finance manager


 Maximize market value of shareholder equity

 What about other stakeholders?


 Employees, customers, suppliers, government, society
 ESG ~ Environmental, Social and Governance
 Why not set goal to maximize market value of entire firm?

 Horizon of goal setting?


 Short term, medium term or long term?

 Important assumption
 Well functioning financial markets and institutions
Agency Conflicts in a Firm

11

 Principal - Agent relationship


 Principals (owners) hire agents (managers)

 Agency problems ~ conflict of interests


 Managers may have personal interests which are in
conflict with those of owners (Jensen-Meckling, 1976)
 Agency costs
 Direct costs ~ monitoring costs (audit fees)
 Indirect costs ~ opportunity costs (forgone projects)
Conflicts Among Capital Providers

12

 Principal – Principal relationship


 Debt contracts different from equity contracts

 Conflicts between debt and equity holders


 Equity holders have residual claims
 Debt holders have downside risk, but limited upside

 ‘Selfish strategies’ by shareholders in the presence


of financial distress
 Incentive to take large risks; Incentive towards
underinvestment; ‘Milking the property’
Financial Market and Firm Cash Flows

13

 Cash flows between firm and financial market

Total value of Total value of


firm’s assets firm to investors
Financial Market and Firm Cash Flows

14

 Cash flows between firm and financial market


 Issuances of securities (bonds and equities) by firm to
raise cash from financial markets ~ financing activity
 Capital structure decisions

 Investments of capital raised from market in long-term


assets ~ investing activity
 Capital budgeting decisions

 Cash flow generation from operating assets (project


cash flows) ~ operating activity
 Capital budgeting, working capital decisions
Financial Market and Firm Cash Flows

15

 Cash flows between firm and financial market


 Cash paid to government as taxes ~ operating activities
 Capital budgeting, working capital decisions

 Cash paid out to investors in the form of interest,


principal repayment and dividends ~ financing activities
 Capital structure, dividend policy decisions

 Remaining cash flows reinvested in business ~


operating activities
 Capital structure, dividend policy decisions
Financial System

16

 Financial institutions
 Banks, NBFCs, mutual funds, insurance companies

 Financial markets
 Money markets, capital markets

 Financial instruments
 Different types of securities with varying maturities

 Financial services
 I-banks, AMCs, CRAs, depositories, auditors
Type of Financial Markets

17

 Capital market
 Primary market ~ firms sell securities to raise long-term
funds for financing their investments
 Secondary market ~ individual and institutional traders
trade financial securities such as equities, bonds,
currencies, derivatives and commodities
 Money market
 Market for short-term financial instruments
 Maturity < 1 year, highly liquid securities
 Commercial papers, T-bills, repos, corporate debentures
Type of Financial Markets

18

 Types of financial markets


 Derivatives ~ options, futures, forwards, swaps
 Hedging, speculation, arbitrage

 Foreign exchange
 International trade, import exports

 Commercial banking
 Term loans, working capital loans
Type of Financial Instruments

19

 Capital market instruments


 Equity shares (IPOs, FPOs, QIPs, DRs)
 Preference equity shares
 Debt securities (Corporate bonds, debentures)
 Hybrid securities (convertible bonds)

 Money market instruments


 Treasury bills, repos
 Commercial papers, Certificate of deposits
Thank you 

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