Corporate Finance New

8/3/2019 Corporate Finance New

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Prepared by:-

Arvind singh

Shivani babbar


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Corporate finance Corporate finance is the area of finance dealing

with monetary decisions that business

enterprises make and the tools and analysis usedto make these decisions. The primary goal ofcorporate finance is to maximize shareholdervalue while managing the firm's financial risks.


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Different forms of organization

Sole proprietorshipPartnership

CorporationCooperative


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The Role of Finance Manager The routine working capital .

cash management decisions.

Dividend decisions.Investment decisions.Financial forecasting.International financial decisions.

Portfolio management.Risk management.


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Time Value ofMoney (TVM)


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Time Value of Money (TVM)

The idea that money available at the present time isworth more than the same amount in the future due toits potential earning capacity. This core principle offinance holds that, provided money can earn interest, anyamount of money is worth more the sooner it is received.


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Future value

How much what you got now grows to whencompounded at a given rate

FV = Future Value

PV = Present Valuei = the interest rate per periodn= the number of compounding periods


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Discounting It is a process of finding the present value of a future

cash flows

It is a reciprocal of compounding


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'Present Value (PV)'

The current worth of a future sum of money orstream of cash flows given a specified rate of

return. Future cash flows are discounted at thediscount rate, and the higher the discount rate, thelower the present value of the future cash flows


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PV is the value at time=0

FV is the value at time=nI= is the discount rate, or the interest rate at which theamount will be compounded each periodn= is the number of periods


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The cost of capital


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The cost of capital The cost of capital determines how a company can raise

money (through a stock issue, borrowing, or a mix of thetwo).

This is the rate of return that a firm would receive if itinvested in a different vehicle with similar risk.

as the cost of capital is the appropriate discount rate to

apply to the future cash flows that security will pay


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valuation models.1)The capital asset pricing model (CAPM) is a method ofvaluing not just securities, but any investment, usinga DCF with a risk adjusted discount rate.The method used tocalculate an appropriate discount rate uses theinvestment's beta.

r = rf+ ( (rm- rf))

2) Arbitrage pricing theory(APT)


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'Cost Of Equity'

the return that stockholders require for a company. Thetraditional formula for cost of equity (COE) is thedividend capitalization model:

A firm's cost of equity represents the compensation that themarket demands in exchange for owning the asset and

bearing the risk of ownership..


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Where Beta= sensitivity to movements in the relevant market:

Es -The expected return for a security

Rf -The expected risk-free return in that market (governmentbond yield

s-

The sensitivity to market risk for the security

RM- The historical return of the stock market/ equity market(RM-Rf)

.

Cost of equity = Risk free rate of return +Premium expected for risk

Cost of equity = Risk free rate of return + Beta x (marketrate of return- risk free rate of return)

The risk premium of market assets over risk free assets


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'Cost Of Debt

The effective rate that a company pays on itscurrent debt.

This can be measured in either before- or after-taxreturns;

however, because interest expense is deductible, theafter-tax cost is seen most often.

where T is the corporate tax rate and

Rf is the risk free rate.

(

Rf + credit risk rate)(1-T),


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Weighted average cost of capital

a companys assets are financed by either debt or equity.WACC is the average of the costs of these sources offinancing, each of which is weighted by its respective usein the given situation. By taking a weighted average, wecan see how much interest the company has to pay forevery dollar it finances.


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Where:Re = cost of equity

Rd = cost of debtE = market value of the firm's equityD = market value of the firm's debtV = E + D

E/V = percentage of financing that is equityD/V = percentage of financing that is debtTc = corporate tax rate


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Capital structure Capital structure refers to the way a corporation finances

its assets through some combination of equity, debt,or hybrid securities. A firm's capital structure is then the

composition or 'structure' of its liabilities For example, a firm that sells $20 billion in equity and

$80 billion in debt is said to be 20% equity-financed and80% debt-financed.

The firm's ratio of debt to total financing, 80% in thisexample, is referred to as the firm's leverage.


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tax advantages on debt issuance, it will be cheaper to issue debt

rather than new equity the cost of issuing new debt will be greater than the cost of

issuing new equity. This is because adding debt increasesthe default risk - and thus the interest rate that the company

must pay in order to borrow money By utilizing too much debt in its capital structure, this increased

default risk can also drive up the costs for other sources (suchas retained earnings and preferred stock) as well.

Management must identify the "optimal mix" of financingthe capital structure where the cost of capital is minimized sothat the firm's value can be maximized.


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ModiglianiMiller theorem

The basic theorem states that, under a certain market priceprocess in the absence of

taxes

bankruptcy costs,

agency costs, and asymmetric information, and

in an efficient market,

the value of a firm is unaffected by how that firm is

financed. It does not matter if the firm's capital is raised byissuing stock or selling debt. It does not matter what thefirm's dividend policy is. Therefore, the ModiglianiMillertheorem is also often called the capital structureirrelevance principle.


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CAPITAL BUDGETING


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CAPITAL BUDGETING

BUDGETING The process in which a business determines whether

projects such as building a new plant or investing in along-term venture are worth pursuing. Oftentimes, a

prospective project's lifetime cash inflows and outflowsare assessed in order to determine whether the returns

generated meet a sufficient target benchmark.

Also known as "investment appraisal".


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Project A project is a series of activities aimed at bringing about

clearly specified objectives within a defined time-periodand within a defined budget

PROJECT CYCLE-Refers to a logical sequence of activities to

accomplish the projects goals or objectives. Project Cycleensures that:Problem analysis is thorough.Objectives are clearly stated.

Stakeholders are clearly identified and monitored.Assessment of the project results against objectives.


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Stages of Project Cycle


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Project Appraisal:Project Appraisal process involves following

activities:

Technical Analysis.Social Profitability Analysis.

Financial Analysis.

Commercial Analysis.


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Appraisal Techniques

Simple Rate of Return.

Payback Period.

Net Present Value.Internal Rate of Return.


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Simple Rate of Return:

Expresses the average net profits (Net Cash Flows)generated each year by an investment as apercentage of investment over the investmentsexpected life.

Simple Rate of Return = Y/I

Where, Y = the average annual net profit afterallowing depreciation from the investment.

I = the initial investment.


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Payback Period:

The length of time required to recover the cost of an

investment.

PBP = I/E

Where, I = the initial investment.

E = the projected net cash flows per year from

the investment.

PBP = Pay Back Period expressed in number of

years.

All other things being equal, the better investment is the one

with the shorter payback period.


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Internal Rate of Return:

Internal Rate of Return (IRR) is a discount rate which makesthe net present value (NVP) of the cash flow equals to zero.

Represents the average earning power of the money used in the

project over the project life.

IRR is that discount rate i such that,

=0

Where,

Bn = Benefits in each year of the project.

Cn = Costs in each year of the project.

n = number of years in the project.


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Internal Rate of Return:

Internal Rate of Return (IRR) is a discount rate which makesthe net present value (NVP) of the cash flow equals to zero.

Represents the average earning power of the money used in the

project over the project life.

IRR is that discount rate i such that,

=0

Where,

Bn = Benefits in each year of the project.

Cn = Costs in each year of the project.

n = number of years in the project.


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Use of appraisal techniques:

Calculating Simple Return Rate

Assume, Investment cost=Rs. 100000

Planning horizon=6 years

Yearly cash inflow=25000

Total net cash flow=Rs.150000

SRR= average annual profit/initial investmentTherefore, SRR=(25000/100000)

=25%


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Contd:

Payback Period

Assume, Investment cost=Rs. 100000

Planning horizon=6 years

Yearly cash inflow=25000

PBP = I/E

Therefore, PBP=100000/25000

= 4 years.


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Contd.Net Present Value

Timeperiod(years)

Cashflow(Rs.)

PV factor12%

Presentvalue(Rs.)

Cumulative

presentvalue

0 -100000 1.000 -100000 -100000

1 25000 0.941 23525 -76475

2 25000 0.840 21000 -55475

3 25000 0.750 18750 -367254 25000 0.670 16750 -19975

5 25000 0.598 14950 -5025

6 25000 0.534 13350 +8325

50000 8325


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Contd.Internal Rate of Return

NPV= =0

NPV=-100000+ + + + + +

=0

So, IRR=12.98


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Thanks

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Corporate Finance New