OVERVIEW CORPORATE FINANCE

Scope of Financial Management Key activities of Financial Manager Objectives of Financial Management- Profit Maximization vs Wealth Maximization Agency Problem

FINANCIAL MANAGEMENT AND ITS SCOPE OF WORK

What is Financial Management? Financial Management is that managerial activity which is concerned with the planning and controlling of firm's financial resources

Key Decision Areas

1. Investment Decision - Long term asset mix - Liquidity position 1. Financing Decision - Optimal Equity-Debt mix 1. Dividend decision - Profit allocation
Investment Decisions Key Decision Areas

Financing Decisions

Dividend Decisions

Capital Budgeting

Working Capital

SCOPE OF FINANCIAL MANAGEMENT

Investment Decision
Investment Decisions

1. Capital Budgeting Decision

- Commitment of funds to long term assets that would yield benefits in future - Invest in assets only it is expected to earn a return greater than a minimum acceptable return (opportunity cost of capital) - Minimum return called as Hurdle rate or Cut Off rate 2. Working Capital Decision - Investment in short term assets - Maintaining liquidity position of the firm - Profitability liquidity trade off

Capital Budgeting (Fixed Assets)

Working Capital (Current Assets)

SCOPE OF FINANCIAL MANAGEMENT

Financing Decision - Concerned with acquisition of funds - Optimal capital structure i.e. the best mix of debt and equity - Choosing a mix of equity and debt that minimizes hurdle rate

Financing Decisions

Internal Funds (Shareholders)

External Funds (Borrowed)

SCOPE OF FINANCIAL MANAGEMENT

Dividend Decision - Deals with appropriation of profits after tax - Dividend payout ratio
Dividend Decision

- Retention ratio
- Firms sometimes cannot find decisions that earn their minimum require rate of return or hurdle rate
Retained Earnings (Reserves) Distribution of Profits (Dividend)

KEY ACTIVITIES OF FINANCIAL MANAGER

1. Fund Raising - Procuring of funds required at lowest cost 2. Funds Allocation - Investing these funds into the various assets - Concerned with both fixed assets and current assets 3. Profit Planning - Pricing, cost, volume of output - Fixed costs and variable cost - Distributing returns to all the stakeholders 4. Understanding Capital Market - Capital market brings investors and borrowers together - Must understand operations of capital market and the way it values the securities

OBJECTIVE : PROFIT MAXIMIZATION vs. WEALTH MAXIMIZATION

Profit Maximization - Maximize profits i.e. maximize output for a given level input or minimize input for a given level of output

Objections - Definition of profit: PAT or EPS?

- PAT: Could increase PAT without necessarily maximising economic welfare of owners (e.g. investing in G secs) - EPS: MV is not function of EPS. Calls for zero DPR

- Ignores TVM
- Ignores uncertainty of returns

OBJECTIVE : PROFIT MAXIMIZATION vs. SHAREHOLDERS' WEALTH MAXIMIZATION

Shareholders' Wealth Maximization (SWM) - Maximize NPV of a course of action to shareholders - A financial action that creates positive NPV creates wealth for shareholders - Benefits to be measured in terms of Cash Flows and NOT Profits - Takes into account TVM and Risk
Dividend Decisions

- According to shareholders, wealth created by the company is reflected in its market value
- Hence SWM implies that the fundamental objective of a firm is to maximize market value of its shares
Investment decisions

Market Price Of Share

Financing Decisions

PRIMARY GOAL OF FINANCIAL MANAGEMENT

Three equivalent goals of financial management: Maximize shareholder wealth or shareholder value. Maximize share price. Maximize firm value. .goal is to increase shareholder value

AGENCY PROBLEM
Separation of ownership & Management can lead to conflicting goals of shareholders & managers. Principal-agent problems Shareholders are principals & managers their agents Shareholders want management to increase the value of the firm But managers may have their own motives like higher perks, avoid taking high investment risk that may increase shareholder's wealth etc
Agency Costs incur when: Managers do not attempt to maximize the value of the firm & Shareholders incur costs to monitor the managers & influence their actions.