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INTRODUCTION TO CORPORATE FINANCE

INTRODUCTION TO CORPORATE FINANCE. What is Corporate Finance?. Corporate Finance addresses the following three questions: What long-term investments should the firm choose? How should the firm raise funds for the selected investments? How should short-term assets be managed and financed?.

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INTRODUCTION TO CORPORATE FINANCE

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  1. INTRODUCTION TO CORPORATE FINANCE

  2. What is Corporate Finance? Corporate Finance addresses the following three questions: • What long-term investments should the firm choose? • How should the firm raise funds for the selected investments? • How should short-term assets be managed and financed?

  3. Total Value of Assets: Total Firm Value to Investors: Current Liabilities Current Assets Long-Term Debt Fixed Assets 1 Tangible 2 Intangible Shareholders’ Equity Balance Sheet Model of the Firm

  4. The Capital Budgeting Decision Current Liabilities Current Assets Long-Term Debt Fixed Assets 1 Tangible 2 Intangible Shareholders’ Equity What long-term investments should the firm choose?

  5. Long Term Decision • Relates to Capital Budgeting Decisions • Techniques: (i) Traditional- Payback Period, Accounting Rate of Return (ii) Modern- Net Present value Method, Internal Rate of Return, Profitability Index, etc.

  6. 25% Debt 70% Debt 30% Equity 75% Equity Capital Structure The value of the firm can be thought of as a pie. 50% Debt The goal of the manager is to increase the size of the pie. 50% Equity The Capital Structure decision can be viewed as how best to slice the pie. If how you slice the pie affects the size of the pie, then the capital structure decision matters.

  7. The Capital Structure Decision Current Liabilities Current Assets Long-Term Debt How should the firm raise funds for the selected investments? Fixed Assets 1 Tangible 2 Intangible Shareholders’ Equity

  8. Capital Structure Decision • Decision relation to Funding of the Projects • Sources -Short Term (trade credit, bank overdraft,etc.) -Long Term (i) Owners Funds ( Equity/Preference Share Capital, Retained Earnings) (ii) External Funds(Debentures, Long Term Loans, etc.)

  9. Short-Term Asset Management Current Liabilities Current Assets Net Working Capital Long-Term Debt How should short-term assets be managed and financed? Fixed Assets 1 Tangible 2 Intangible Shareholders’ Equity

  10. The Financial Manager The Financial Manager’s primary goal is to increase the value of the firm by: • Selecting value creating projects • Making smart financing decisions

  11. EMERGING ROLE OF THE FINANCIAL MANAGER IN INDIA The key challenges for the financial manager appear to be in the following areas: • Investment planning and resource allocation • Financial structure • Mergers, acquisitions, and restructuring • Working capital management • Risk management • Corporate governance • Investor relations

  12. RELATIONSHIP OF FINANCE TO ACCOUNTING • • Accounting is concerned with score keeping, whereas • finance is aimed at value maximising. • • The accountant prepares the accounting reports based • on the accrual method. The focus of the financial • manager is on cash flows. • • Accounting deals primarily with the past. Finance is • concerned mainly with the future.

  13. Financial Accounting Capital Expenditures Financial Planning Cost Accounting Data Processing Credit Manager Cash Manager Tax Manager Board of Directors Controller Treasurer Chairman of the Board and Chief Executive Officer (CEO) Vice President and Chief Financial Officer (CFO) President and Chief Operating Officer (COO) Hypothetical Organization Chart

  14. Invests in assets (B) Current and Fixed Assets Short tem debt Long term debt Equity shares Firm Financialmarkets Government The Firm and the Financial Markets Firm issues securities (A) Retained cash flows (F) Investsin assets(B) Cash flowfrom firm (C) Dividends anddebt payments (E) Short-term debt Long-term debt Equity shares Current assetsFixed assets Taxes (D) The cash flows from the firm must exceed the cash flows from the financial markets. Ultimately, the firm must be a cash generating activity.

  15. The Corporate Firm • The corporate form of business is the standard method for solving the problems encountered in raising large amounts of cash. • However, businesses can take other forms.

  16. Forms of Business Organization • The Sole Proprietorship • The Partnership • The Corporation

  17. The Goal of Financial Management • What is the correct goal? • Maximize profit? • Minimize costs? • Maximize market share? • Maximize shareholder wealth?

  18. The Agency Problem • Agency relationship • Principal hires an agent to represent his/her interest • Stockholders (principals) hire managers (agents) to run the company • Agency problem • Conflict of interest between principal and agent

  19. Financial Markets • Primary Market • Issuance of a security for the first time • Secondary Markets • Buying and selling of previously issued securities • Securities may be traded in either a dealer or auction market

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