INTRODUCTION TO

CORPORATE FINANCE
 What is Corporate Finance?

Corporate Finance addresses the following

three questions:
1. What long-term investments should the firm
choose?
2. How should the firm raise funds for the
selected investments?
3. How should short-term assets be managed and
financed?
Balance Sheet Model of the Firm
Total Value of Assets: Total Firm Value to Investors:
Current
Liabilities
Current Assets
Long-Term
Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity
The Capital Budgeting Decision

Current
Liabilities
Current Assets
Long-Term
Debt

Fixed Assets
What long-term
1 Tangible investments Shareholders’
should the firm
2 Intangible Equity
choose?
 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.
 Capital Structure

The value of the firm can be

thought of as a pie.
The goal of the manager is 70%50%30%
25%
to increase the size of the DebtDebt
Equity
pie.
75%
50%
The Capital Structure Equity
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.
The Capital Structure Decision

Current
Liabilities
Current Assets
Long-Term
How should the Debt
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible Shareholders’
2 Intangible Equity
 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.)
Short-Term Asset Management

Current
Liabilities
Current Assets
Net
Working Long-Term
Capital Debt

How should
Fixed Assets
short-term assets
1 Tangible be managed and
financed? Shareholders’
2 Intangible Equity
 The Financial Manager
The Financial Manager’s primary goal is to
increase the value of the firm by:
1. Selecting value creating projects
2. Making smart financing decisions
 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
 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.
 Hypothetical Organization Chart
Board of Directors

Chairman of the Board and

Chief Executive Officer (CEO)

President and Chief

Operating Officer (COO)

Vice President and

Chief Financial Officer (CFO)

Treasurer Controller

Cash Manager Credit Manager Tax Manager Cost Accounting

Capital Expenditures Financial Planning Financial Accounting Data Processing

The Firm and the Financial Markets

Firm Firm issues securities (A) Financial

markets
Invests
Invests in assets
(B) Retained Short tem debt
in assets
Current and Fixed cash flows (F) Long term debt
(B) Equity shares
Assets
Short-term debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Taxes (D)

Ultimately, the firm The cash flows from

the firm must exceed
must be a cash Government
the cash flows from
generating activity.
the financial markets.
 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.
 Forms of Business Organization
• The Sole Proprietorship
• The Partnership
• The Corporation
The Goal of Financial Management
• What is the correct goal?
– Maximize profit?
– Minimize costs?
– Maximize market share?
– Maximize shareholder wealth?
 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
 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