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7/17/2019 1 Introductiontocorporatefinance 130216005349 Phpapp02
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Introduction to CorporateFinance
7/17/2019 1 Introductiontocorporatefinance 130216005349 Phpapp02
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Topics Covered
What is Corporate Finance
Key Concepts of Corporate Finance
Compounding & Discounting
Corporate Structure
The Finance Function
Role of The Financial Manager Separation of Onership and Management
!gency Theory and Corporate "o#ernance
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Corporate Finance
is concerned ith the efficient and effectivemanagement of the finances of an organi$ation
in order to achieve the objectives of that
organization% This in#ol#es
lanning & Controlling the pro#ision of resources
'here funds are raised from(
!llocation of resources 'here funds are deployed to(
Control of resources 'hether funds are )eing used
effecti#ely or not(
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Diff. b/w Corporate Finance &
Financial Accounting
Corporate Finance is inherently forard*loo+ing and )ased on
cash flos%
Financial !ccounting is historic in nature and focuses on profit rather than
cash%
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Diff. b/w Corporate Finance &
anagement Accounting
Corporate Finance is concerned ith raising funds and pro#iding a
return to in#estors%
Management !ccounting is concerned ith pro#iding information to assist
managers in ma+ing decisions ithin the company%
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Two !e" Concepts in Corporate Finance
The fundamental concepts in helping managers
to #alue alternati#e choices are
Relationship )eteen Ris+ and Return
Time ,alue of Money
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#elationship between #is$ and #eturn
This concept states that an in#estor or a companyta+es on more ris+ only if higher return is offered in
compensation%
#eturn refers to
Financial reards gained as a result of ma+ing an
in#estment%
The nature of return depends on the form of the
in#estment% ! company that in#ests in fi-ed assets & )usiness
operations e-pects return in the form of profit
'measured on )efore*interest. )efore*ta- & an after*
ta- )asis(& in the form of increased cash flos%
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#elationship between #is$ and #eturn
#is$ refers to ossi)ility that actual return may )e different from the
e-pected return%
When !ctual Return / 0-pected Return
This is a Welcome Occurrence% When !ctual Return 1 0-pected Return
This is a Ris+y In#estment%
In#estors. Companies & Financial Managers are more
li+ely to )e concerned ith• ossi)ility that !ctual Return 1 0-pected Return
In#estors & Companies demand higher e-pected return
• ossi)ility of actual return )eing different from e-pected
return increases%
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Time %alue of one"
Time #alue of money is rele#ant to )oth Companies
In#estors
In ider conte-t. !nyone e-pecting to pay or recei#e money o#er a
period of time%
Time #alue of money refers to the facts that ,alue of money changes o#er time%
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Time %alue of one"
Imagine that your friend offers you eitherRs%2333 today or Rs%2333 in one year4s time%
Faced ith this choice. you ill 'hopefully(
prefer to ta+e Rs%2333 today%
The uestion is to as$ that wh" do "ou prefer
#s.'((( toda")
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Time %alue of one"
*olution+ There are three ma5or factors Time+ If you ha#e the money no. you can spend it no% It
is human nature to ant things no rather than ait for
them% !lternati#ely. if you do not ant to spend money
no. you can in#est it. so that in one year4s time you illha#e Rs%2333 plus any in#estment income earned%
,nflation+ Rs%2333 spent no ill )uy more goods &
ser#ices that Rs%2333 spent in one year4s time )ecause
inflation undermines the purchasing poer of your money% #is$+ If you ta+e Rs%2333 no you definitely ha#e the
money in your possession% The alternati#e of the promise of
Rs%2333 in a year4s time carries the ris+ that the payment
may )e less that Rs%2333 or may not )e paid at all%
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Compounding is the ay to determine the future #alue of a sum of money
in#ested no%
F, 6 C3'27i(n
Where8 F, 6 Future ,alue
C3 6 Sum deposited no i 6 Interest Rate
n 6 num)er of years until the cash flo occurs
-ample+ Rs% 93 deposited for fi#e years at an annual
interest rate of :; ill ha#e future #alue of8
F, 6 93 - '27%3:(< 6 Rs%9:%=:
Compounding ta+es us forard from current #alue of an
in#estment to its future #alue%
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Discounting is the ay to determine the present #alue of future cash flos%
, 6 F, > '27i(n
Where8 F, 6 Future ,alue
, 6 resent ,alue
i 6 Interest Rate
n 6 num)er of years until the cash flo occurs
-ample+ In#estor choice )eteen recei#ing Rs%2333 no &
Rs%2933 in one year4s time% !nnual Interest rate is 23;%
, 6 2933 > '2 7 3%2(2 6 Rs%23?2
!lternati#ely. , of Rs%2333 into a F,
F, 6 2333 - '2 7 3%2(2 6 Rs%2223
Discounting ta+es us )ac+ard from future #alue of a cash
flo to its present #alue%
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Corporate bjectives
The o)5ecti#e should )e to ma+e decisions that
ma-imise the #alue of the company for its oners%
Financial O)5ecti#e of Corporate Finance is stated as 0aimisation of shareholder wealth1%
Shareholder recei#e their ealth through increase in
#alue of their shares. in the form of Di#idends
Capital "ains
Shareholder ealth ill )e ma-imised )y ma-imising
the #alue of di#idends and capital gains that
shareholders recei#e o#er time%
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Corporate *tructure
Sole roprietorships
artnerships
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Corporate *tructure
Sole roprietorships
artnerships
@nlimited Aia)ility
ersonal ta- on profits
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Corporate *tructure
Sole roprietorships
Corporations
artnerships
@nlimited Aia)ility
ersonal ta- on profits
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Corporate *tructure
Sole roprietorships
Corporations
artnerships
@nlimited Aia)ility
ersonal ta- on profits
Aimited Aia)ility
Corporate ta- on profits 7
ersonal ta- on di#idends
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The Finance Function
Chief Financial Officer
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The Finance Function
Chief Financial Officer
Comptroller Treasurer
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#ole of The Financial anager
Financial
manager
FirmBs
operations
Financial
mar+ets
'2( Cash raised from in#estors
2'3
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#ole of The Financial anager
Financial
manager
FirmBs
operations
Financial
mar+ets
'2( Cash raised from in#estors
'9( Cash in#ested in firm
2'3243
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#ole of The Financial anager
Financial
manager
FirmBs
operations
Financial
mar+ets
'2( Cash raised from in#estors
'9( Cash in#ested in firm
'( Cash generated )y operations
2'3243
253
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#ole of The Financial anager
Financial
manager
FirmBs
operations
Financial
mar+ets
'2( Cash raised from in#estors
'9( Cash in#ested in firm
'( Cash generated )y operations
'a( Cash rein#ested
2'3243
253
26a3
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#ole of The Financial anager
Financial
manager
FirmBs
operations
Financial
mar+ets
'2( Cash raised from in#estors
'9( Cash in#ested in firm
'( Cash generated )y operations
'a( Cash rein#ested
')( Cash returned to in#estors
2'3243
253
26a3
26b3
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While accountancy plays an important roleithin corporate finance. the fundamental
pro)lem addressed )y corporate finance is
economic. i%e% ho )est to allocate the scarceresource of capital%
!im of Financial Manager is the optimalallocation of the scarce resources a#aila)le
to them%
Aim of Financial anager
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Financial managers are responsi)le forma+ing decisions a)out raising funds 'the
financing decision(. allocating funds 'the
in#estment decision( and how much todistribute to shareholders 'the di#idend
decision(%
#ole of The Financial anager
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The high le#el of interdependence e-isting )eteen these decision areas should )e
appreciated )y financial managers hen
ma+ing decisions
Can you thin+ ho these decisions may )e
inter*relatedE
#ole of The Financial anager
, t l ti hi b/ , t t
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,nterrelationship b/w ,nvestment7
Financing & Dividend Decisions,nvestment+
Company decides tota+e on a large num)erof attracti#e nein#estment pro5ects
Finance+
Company ill need toraise finance in order tota+e up pro5ects
Dividends+
If finance is not a#aila)le frome-ternal sources. di#idends mayneed to )e cut in order toincrease internal financing%
Dividends+
Company decides to payhigher le#els of di#idendto its shareholders
Finance+
Aoer le#el of retainedearnings a#aila)le forin#estment meanscompany may ha#e tofind finance from
e-ternal sources%
,nvestment+
If finance is not a#aila)le frome-ternal sources than companymay ha#e to postpone futurein#estment pro5ects%
Finance+
Company finances itselfusing more e-pensi#esources. resulting in a
higher cost of capital%
,nvestment+
Due to a higher cost ofcapital the num)er of
pro5ects attracti#e to the
company decreases%
Dividends+
The company4s a)ility to paydi#idends in the future ill )ead#ersely affected%
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Ma-imisation of a company4s ordinary share price isused as a surrogate o)5ecti#e to that of ma-imisation
of shareholder ealth%
#ole of The Financial anager
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wnership vs. anagement
Difference in Information
Stoc+ prices and returns
Issues of shares andother securities
Di#idends
Financing
Different O)5ecti#es
Managers #s%
stoc+holders Top mgmt #s% operating
mgmt
Stoc+holders #s% )an+s
and lenders
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Agenc" & Corporate 8overnance
Managers do not alays act in the )estinterest of their shareholders. gi#ing rise to
hat is called the agency4 pro)lem%
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Agenc" & Corporate 8overnance
Customers
Shareholders
including institutions and
private individuals Creditors
including banks, suppliers
and bond holders
Management
Employees
THECOMPANY
Diagram showing the agency relationships that exist between the
various stakeholders of a company
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Agenc" & Corporate 8overnance
!gency is most li+ely to )e a pro)lem henthere is a di#ergence of onership and
control. hen the goals of management differ
from those of shareholders and henasymmetry of information e-ists%
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Agenc" & Corporate 8overnance
!n e-ample of ho the agency pro)lem canmanifest itself ithin a company is here
managers di#ersify to reduce the o#erall ris+
of the company. there)y safeguarding their 5o) prospects%
Shareholders could achie#e this themsel#es )y di#ersification%
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Agenc" & Corporate 8overnance
Monitoring and performance*related )enefitsare to potential ays to optimise managerial
)eha#ior and encourage goal congruence4%
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Agenc" & Corporate 8overnance
Due to difficulties associated ithmonitoring. incenti#es such as performance*
related pay and e-ecuti#e share options can
)e a more practical ay of encouraging goalcongruence%
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Agenc" & Corporate 8overnance
Institutional shareholders no onappro-imately :3 per cent of all @K ordinary
share capital% Recently. they ha#e )rought
pressure to )ear on companies ho do notcomply ith corporate go#ernance standards%
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Agenc" & Corporate 8overnance
The pro)lem of corporate go#ernance hasrecei#ed a lot of attention folloing a num)er
of high profile corporate collapses and a
plethora of self*ser#ing e-ecuti#eremuneration pac+ages%
In the @K. e ha#e the e-ample of Transportand Gan+ing
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Agenc" & Corporate 8overnance
@K corporate go#ernance systems ha#etraditionally stressed internal controls and
financial reporting rather than e-ternal
legislation%
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Agenc" & Corporate 8overnance
Corporate go#ernance in the @K asaddressed )y the 2??9 Cad)ury Report and its
Code of Gest ractice. and the 2??<
"reen)ury Report%
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! financial manager can ma-imise acompany4s mar+et #alue )y ma+ing good
in#estment. financing and di#idend decisions%
Agenc" & Corporate 8overnance