CORPORATE FINANCE

Corporate finance is an area of finance dealing with the financial

decisions corporations make and the tools and analysis used to make these decisions.
The primary goal of corporate finance is to maximize corporate value while managing
the firm's financial risks. Although it is in principle different from managerial finance
which studies the financial decisions of all firms, rather than corporations alone, the
main concepts in the study of corporate finance are applicable to the financial problems
of all kinds of firms.
The discipline can be divided into long-term and short-term
decisions and techniques. Capital investment decisions are long-term choices about
which projects receive investment, whether to finance that investment with equity or
debt, and when or whether to pay dividends to shareholders. On the other hand, the short
term decisions can be grouped under the heading "Working capital management". This
subject deals with the short-term balance of current assets and current liabilities; the
focus here is on managing cash, inventories, and short-term borrowing and lending (such
as the terms on credit extended to customers).
The terms Corporate finance and Corporate financier are also
associated with investment banking. The typical role of an investment banker is to
evaluate company's financial needs and raise the appropriate type of capital that best fits
those needs.
1 Capital investment decisions
1.1 The investment decision
1.1.1 Project valuation
1.1.2 Valuing flexibility
1.1.3 Quantifying uncertainty
1.2 The financing decision
1.3 The dividend decision
1. Capital investment decisions
Capital investment decisions [1] are long-term corporate finance decisions relating to
fixed assets and capital structure. Decisions are based on several inter-related criteria.
Corporate management seeks to maximize the value of the firm by investing in projects
which yield a positive net present value when valued using an appropriate discount rate.
These projects must also be financed appropriately. If no such opportunities exist,
maximizing shareholder value dictates that management return excess cash to
shareholders. Capital investment decisions thus comprise an investment decision, a
financing decision, and a dividend decision.
1.1 The investment decision
Main article: Capital budgeting
Management must allocate limited resources between competing opportunities
("projects") in a process known as capital budgeting. Making this capital allocation
decision requires estimating the value of each opportunity or project: a function of the
size, timing and predictability of future cash flows.

1.1.1Project valuation
Further information: stock valuation and fundamental analysis
In general, each project's value will be estimated using a discounted cash flow (DCF)
valuation, and the opportunity with the highest value, as measured by the resultant net
present value (NPV) will be selected (applied to Corporate Finance by Joel Dean in
1951; see also Fisher separation theorem, John Burr Williams: Theory). This requires
estimating the size and timing of all of the incremental cash flows resulting from the
project. These future cash flows are then discounted to determine their present value (see
Time value of money). These present values are then summed, and this sum net of the
initial investment outlay is the NPV.
The NPV is greatly affected by the discount rate. Thus selecting the proper discount rate
the project "hurdle rate"is critical to making the right decision. The hurdle rate is
the minimum acceptable return on an investmenti.e. the project appropriate discount
rate. The hurdle rate should reflect the riskiness of the investment, typically measured by
volatility of cash flows, and must take into account the financing mix. Managers use
models such as the CAPM or the APT to estimate a discount rate appropriate for a
particular project, and use the weighted average cost of capital (WACC) to reflect the
financing mix selected. (A common error in choosing a discount rate for a project is to
apply a WACC that applies to the entire firm. Such an approach may not be appropriate
where the risk of a particular project differs markedly from that of the firm's existing
portfolio of assets.)
In conjunction with NPV, there are several other measures used as (secondary) selection
criteria in corporate finance. These are visible from the DCF and include discounted
payback period, IRR, Modified IRR, equivalent annuity, capital efficiency, and ROI; see
list of valuation topics.
1.1.2 Valuing flexibility
Main articles: Real options analysis and decision tree
In many cases, for example R&D projects, a project may open (or close) paths of action
to the company, but this reality will not typically be captured in a strict NPV approach.
Management will therefore (sometimes) employ tools which place an explicit value on
these options. So, whereas in a DCF valuation the most likely or average or scenario
specific cash flows are discounted, here the flexibile and staged nature of the
investment is modelled, and hence "all" potential payoffs are considered. The difference
between the two valuations is the "value of flexibility" inherent in the project.
The two most common tools are Decision Tree Analysis (DTA) and Real options
analysis (ROA); they may often be used interchangeably:
DTA values flexibility by incorporating possible events (or states) and consequent
management decisions. In the decision tree, each management decision in response to an
"event" generates a "branch" or "path" which the company could follow; the
probabilities of each event are determined or specified by management. Once the tree is
constructed: (1) "all" possible events and their resultant paths are visible to management;
(2) given this knowledge of the events that could follow, management chooses the
actions corresponding to the highest value path probability weighted; (3) (assuming
rational decision making) this path is then taken as representative of project value. See

Decision theory: Choice under uncertainty. (For example, a company would build a
factory given that demand for its product exceeded a certain level during the pilot-phase,
and outsource production otherwise. In turn, given further demand, it would similarly
expand the factory, and maintain it otherwise. In a DCF model, by contrast, there is no
"branching" - each scenario must be modelled separately.)
ROA is usually used when the value of a project is contingent on the value of some other
asset or underlying variable. Here, using financial option theory as a framework, the
decision to be taken is identified as corresponding to either a call option or a put option valuation is then via the Binomial model or, less often for this purpose, via Black
Scholes; see Contingent claim valuation. The "true" value of the project is then the NPV
of the "most likely" scenario plus the option value. (For example, the viability of a
mining project is contingent on the price of gold; if the price is too low, management
will abandon the mining rights, if sufficiently high, management will develop the ore
body. Again, a DCF valuation would capture only one of these outcomes.)
1.1.3 Quantifying uncertainty
Further information: Sensitivity analysis, Scenario planning, and Monte Carlo methods
in finance
Given the uncertainty inherent in project forecasting and valuation, analysts will wish to
assess the sensitivity of project NPV to the various inputs (i.e. assumptions) to the DCF
model. In a typical sensitivity analysis the analyst will vary one key factor while holding
all other inputs constant, ceteris paribus. The sensitivity of NPV to a change in that
factor is then observed (calculated as NPV / factor). For example, the analyst will set
annual revenue growth rates at 5% for "Worst Case", 10% for "Likely Case" and 25%
for "Best Case" and produce three corresponding NPVs.
Using a related technique, analysts may also run scenario based forecasts so as to
observe the value of the project under various outcomes. Under this technique, a
scenario comprises a particular outcome for economy-wide, "global" factors (exchange
rates, commodity prices, etc...) as well as for company-specific factors (revenue growth
rates, unit costs, etc...). Here, extending the example above, key inputs in addition to
growth are also adjusted, and NPV is calculated for the various scenarios. Analysts then
plot these results to produce a "value-surface" (or even a "value-space"), where NPV is a
function of several variables. Another application of this methodology is to determine an
"unbiased NPV", where management determines a (subjective) probability for each
scenario the NPV for the project is then the probability-weighted average of the
various scenarios. Note that for scenario based analysis, the various combinations of
inputs must be internally consistent, whereas for the sensitivity approach these need not
be so.
A further advancement is to construct stochastic or probabilistic financial models as
opposed to the traditional static and deterministic models as above. For this purpose, the
most common method is to use Monte Carlo simulation to analyze the projects NPV.
This method was introduced to finance by David B. Hertz in 1964, although has only
recently become common; today analysts are even able to run simulations in spreadsheet
based DCF models, typically using an add-in, such as Crystal Ball.
Using simulation, the cash flow components that are (heavily) impacted by uncertainty
are simulated, mathematically reflecting their "random characteristics". In contrast to the

scenario approach above, the simulation produces several thousand trials (i.e. random
but possible outcomes) and the output is a histogram of project NPV. The average NPV
of the potential investment as well as its volatility and other sensitivities is then
observed. This histogram provides information not visible from the static DCF: for
example, it allows for an estimate of the probability that a project has a net present value
greater than zero (or any other value). See: Monte Carlo Simulation versus What If
Scenarios.
Here, continuing the above example, instead of assigning three discrete values to
revenue growth, the analyst would assign an appropriate probability distribution
(commonly triangular or beta). This distribution and that of the other sources of
uncertainty would then be "sampled" repeatedly so as to generate the several thousand
realistic (but random) scenarios, and the output is a realistic, representative set of
valuations. The resultant statistics (average NPV and standard deviation of NPV) will be
a more accurate mirror of the project's "randomness" than the variance observed under
the traditional scenario based approach.
1.2 The financing decision Main article: Capital structure
Achieving the goals of corporate finance requires that any corporate investment be
financed appropriately. As above, since both hurdle rate and cash flows (and hence the
riskiness of the firm) will be affected, the financing mix can impact the valuation.
Management must therefore identify the "optimal mix" of financingthe capital
structure that results in maximum value. (See Balance sheet, WACC, Fisher separation
theorem; but, see also the Modigliani-Miller theorem.)
The sources of financing will, generically, comprise some combination of debt and
equity. Financing a project through debt results in a liability that must be servicedand
hence there are cash flow implications regardless of the project's success. Equity
financing is less risky in the sense of cash flow commitments, but results in a dilution of
ownership and earnings. The cost of equity is also typically higher than the cost of debt
(see CAPM and WACC), and so equity financing may result in an increased hurdle rate
which may offset any reduction in cash flow risk.
Management must also attempt to match the financing mix to the asset being financed as
closely as possible, in terms of both timing and cash flows.
One of the main theories of how firms make their financing decisions is the Pecking
Order Theory, which suggests that firms avoid external financing while they have
internal financing available and avoid new equity financing while they can engage in
new debt financing at reasonably low interest rates. Another major theory is the TradeOff Theory in which firms are assumed to trade-off the tax benefits of debt with the
bankruptcy costs of debt when making their decisions. An emerging area in finance
theory is right-financing whereby investment banks and corporations can enhance
investment return and company value over time by determining the right investment
objectives, policy framework, institutional structure, source of financing (debt or equity)
and expenditure framework within a given economy and under given market conditions.
One last theory about this decision is the Market timing hypothesis which states that
firms look for the cheaper type of financing regardless of their current levels of internal
resources, debt and equity.

1.3 The dividend decision Main article: The Dividend Decision

The dividend is calculated mainly on the basis of the company's unappropriated profit
and its business prospects for the coming year. If there are no NPV positive
opportunities, i.e. where returns exceed the hurdle rate, then management must return
excess cash to investors. These free cash flows comprise cash remaining after all
business expenses have been met.
This is the general case, however there are exceptions. For example, investors in a
"Growth stock", expect that the company will, almost by definition, retain earnings so as
to fund growth internally. In other cases, even though an opportunity is currently NPV
negative, management may consider investment flexibility / potential payoffs and
decide to retain cash flows; see above and Real options.
Management must also decide on the form of the distribution, generally as cash
dividends or via a share buyback. There are various considerations: where shareholders
pay tax on dividends, companies may elect to retain earnings, or to perform a stock
buyback, in both cases increasing the value of shares outstanding; some companies will
pay "dividends" from stock rather than in cash; see Corporate action. Today, it is
generally accepted that dividend policy is value neutral (see Modigliani-Miller theorem).
2 Working capital management
2.1 Decision criteria
2.2 Management of working capital
2.Working capital management Main article: Working capital
Decisions relating to working capital and short term financing are referred to as working
capital management. These involve managing the relationship between a firm's shortterm assets and its short-term liabilities.
As above, the goal of Corporate Finance is the maximization of firm value. In the
context of long term, capital investment decisions, firm value is enhanced through
appropriately selecting and funding NPV positive investments. These investments, in
turn, have implications in terms of cash flow and cost of capital.
The goal of Working capital management is therefore to ensure that the firm is able to
operate, and that it has sufficient cash flow to service long term debt, and to satisfy both
maturing short-term debt and upcoming operational expenses. In so doing, firm value is
enhanced when, and if, the return on capital exceeds the cost of capital; See Economic
value added (EVA).
2.1 Decision criteria
Working capital is the amount of capital which is readily available to an organization.
That is, working capital is the difference between resources in cash or readily
convertible into cash (Current Assets), and cash requirements (Current Liabilities). As a
result, the decisions relating to working capital are always current, i.e. short term,
decisions.
In addition to time horizon, working capital decisions differ from capital investment
decisions in terms of discounting and profitability considerations; they are also
"reversible" to some extent. (Considerations as to Risk appetite and return targets remain

identical, although some constraints - such as those imposed by loan covenants - may be
more relevant here).
Working capital management decisions are therefore not taken on the same basis as long
term decisions, and different criteria are applied here: the main considerations are cash
flow and liquidity - cashflow is probably the more important of the two.
The most widely used measure of cash flow is the net operating cycle, or cash
conversion cycle. This represents the time difference between cash payment for raw
materials and cash collection for sales. The cash conversion cycle indicates the firm's
ability to convert its resources into cash. Because this number effectively corresponds to
the time that the firm's cash is tied up in operations and unavailable for other activities,
management generally aims at a low net count. (Another measure is gross operating
cycle which is the same as net operating cycle except that it does not take into account
the creditors deferral period.)
In this context, the most useful measure of profitability is Return on capital (ROC). The
result is shown as a percentage, determined by dividing relevant income for the 12
months by capital employed; Return on equity (ROE) shows this result for the firm's
shareholders. As above, firm value is enhanced when, and if, the return on capital,
exceeds the cost of capital. ROC measures are therefore useful as a management tool, in
that they link short-term policy with long-term decision making.
2.2 Management of working capital
Guided by the above criteria, management will use a combination of policies and
techniques for the management of working capital. These policies aim at managing the
current assets (generally cash and cash equivalents, inventories and debtors) and the
short term financing, such that cash flows and returns are acceptable.
Cash management. Identify the cash balance which allows for the business to meet day
to day expenses, but reduces cash holding costs.
Inventory management. Identify the level of inventory which allows for uninterrupted
production but reduces the investment in raw materials - and minimizes reordering costs
- and hence increases cash flow; see Supply chain management; Just In Time (JIT);
Economic order quantity (EOQ); Economic production quantity (EPQ).
Debtors management. Identify the appropriate credit policy, i.e. credit terms which will
attract customers, such that any impact on cash flows and the cash conversion cycle will
be offset by increased revenue and hence Return on Capital (or vice versa); see
Discounts and allowances.
Short term financing. Identify the appropriate source of financing, given the cash
conversion cycle: the inventory is ideally financed by credit granted by the supplier;
however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors
to cash" through "factoring".
3 Financial risk management
3.Financial risk management Main article: Financial risk management
Risk management is the process of measuring risk and then developing and
implementing strategies to manage that risk. Financial risk management focuses on risks
that can be managed ("hedged") using traded financial instruments (typically changes in
commodity prices, interest rates, foreign exchange rates and stock prices). Financial risk
management will also play an important role in cash management.

This area is related to corporate finance in two ways. Firstly, firm exposure to business
risk is a direct result of previous Investment and Financing decisions. Secondly, both
disciplines share the goal of creating, or enhancing, firm value. All large corporations
have risk management teams, and small firms practice informal, if not formal, risk
management.
Derivatives are the instruments most commonly used in Financial risk management.
Because unique derivative contracts tend to be costly to create and monitor, the most
cost-effective financial risk management methods usually involve derivatives that trade
on well-established financial markets. These standard derivative instruments include
options, futures contracts, forward contracts, and swaps.
See: Financial engineering; Financial risk; Default (finance); Credit risk; Interest rate
risk; Liquidity risk; Market risk; Operational risk; Volatility risk; Settlement risk.
4 Relationship with other areas in finance
4.1 Investment banking
4.2 Personal and public finance
4.Relationship with other areas in finance
4.1 Investment banking
Use of the term corporate finance varies considerably across the world. In the United
States it is used, as above, to describe activities, decisions and techniques that deal with
many aspects of a companys finances and capital. In the United Kingdom and
Commonwealth countries, the terms corporate finance and corporate financier tend
to be associated with investment banking - i.e. with transactions in which capital is
raised for the corporation.
4.2 Personal and public finance
Corporate finance utilizes tools from almost all areas of finance. Some of the tools
developed by and for corporations have broad application to entities other than
corporations, for example, to partnerships, sole proprietorships, not-for-profit
organizations, governments, mutual funds, and personal wealth management. But in
other cases their application is very limited outside of the corporate finance arena.
Because corporations deal in quantities of money much greater than individuals, the
analysis has developed into a discipline of its own. It can be differentiated from personal
finance and public finance.
5 Related professional qualifications
5. Related professional qualifications
Qualifications related to the field include:
Finance qualifications:
Degrees: Masters degree in Finance (MSF), Master of Financial Economics
Certifications: Chartered Financial Analyst (CFA), Corporate Finance Qualification
(CF), Certified International Investment Analyst(CIIA), Association of Corporate
Treasurers (ACT), Certified Market Analyst (CMA/FAD) Dual Designation, Master
Financial Manager (MFM), Master of Finance & Control (MFC), Certified Treasury
Professional (CTP) Association for Financial Professionals.
Business qualifications:

Degrees: Master of Business Administration (MBA), Master of Commerce (M Comm),

Doctor of Business Administration (DBA)
Certifications: Certified Business Manager (CBM), Certified MBA (CMBA)
Accountancy qualifications:
Qualified accountant: Certified Public Accountant (CPA), Chartered Certified
Accountant (ACCA), Chartered Management Accountant (CIMA), Chartered
Accountant (ACA)
Non-statutory qualifications: Chartered Cost Accountant (CCA Designation from
AAFM), Certified Management Accountant (CMA),
INTRODUCTION TO CORPORATE FINANCE
Corporate finance has two basic functions: Acquisition of Resources
Acquisition of resource means fund generation at lowest possible cost. Resource
generation can be done through :Equity --- It includes proceeds obtained from stock selling, retained earnings, and
investment returns.
Liability --- It includes bank loans, warranties of products and payable account.
Allocation of Resources
Investment of funds for profit maximization motive is known as allocation of resources.
Investment can be categorized into two groups :Fixed Asset --- Land, Machinery, buildings, etc.
Current Asset --- Inventory, cash, receivable accounts, etc.

Corporate or business finance is all about raising and allocation of funds for increasing
profit. Senior management chalks out long-term plan for fulfilling future objectives.
Value of the company's stock is a very important issue for the management because it is
directly related to the wealth of the share-holders of the company.
Functions of Corporate Finance are :Raising of Capital or Financing
Budgeting of Capital
Corporate Governance
Financial management
Risk Management
All the above functions are interrelated and interdependent. For example, in order to
materialize a project a company needs to raise capital. So, budgeting of capital and
financing are interdependent.
Decision making of the corporate finance are basically of two types based on the time
period for the same, namely, Long term and Short term.
i . Long term decisions :It is basically concerned with the capital investment decisions such as viability
assessment of the project, financing it through equity or debt, pay dividend or reinvest
out of the profit. Long term Corporate finance which are generally related to fixed assets
and capital structure are called Capital Investment Decisions. Senior managements
always target to maximize the value of the firm by investing in positive NPV (Net

Present Value) projects. If such opportunities don't arise then reinvestment of profits
should be stalled and the excess cash should be returned to the shareholders in the form
of dividends. Hence, Capital Investment Decisions constitute three decisions:You might get confused to know how to get the best Car Financing Option. However,
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Decision on Investment

Decision on Financing

Decision on Dividend
ii. Short term decisions :These are also known as working capital management which tries to strike a balance
between current assets (cash, inventories, etc.) and current liabilities (a company's debts
or obligations impending for less than one year).
Corporate finance is slightly different from the accounting one. This can be understood
by the help of the following example:A Steel firm sells steel to a car manufacturer at $100 per ounce (suppose) but has not
received the payment for the same. Let the Steel firm's cost of production be $90. Now,
according to the accounting rule the profit will be calculated as $(100-90) = $10 per
ounce. But according to Corporate Finance the calculation specifications will be :Inflow of Cash = 0
Outflow of Cash = -90
Corporate Financial Services
To keep the financial wheels moving, corporate finance services are provided to by the
corporate finance companies. One way of providing corporate finance service is by asset
based business loans. Business loans are also used to improve cash flow, restructuring
the business, debt consolidation and as working capital.
The financial services offered by the corporate finance company may be discussed in
detail under the following heads:
Asset Based Lending
Asset based financing is the method of obtaining loans by keeping assets as security. The
corporate company can use either liquid, current assets or fixed asset as collateral to
obtain the asset based corporate finance service. The volume of the asset-based finances
is a function of the value of the underlying asset that is used as the collateral. The assetbased lenders are known as the secured lenders. The asset-based finances provide the
following corporate finance solutions:
The Asset based lending is used at the time of merger, acquisition or buy
out.
The Asset based lending is used for debt restructuring and commercial
refinancing.
The Asset Based Lending is used to meet the working capital needs.
Cash Flow Lending
Cash lending need can arise in response to seasonal requirements, business expansion or
cyclical business swings. The cash flow financing experts can share their knowledge and
expertise to help in the cash flow management. The cash flow financing instruments
provide the following corporate finance solutions:

Cash flow lending is required at the time of acquisition, merger or buy

out.
Cash flow lending is required to meet working capital needs.
Cash flow lending is required to meet mezzanine financing,
recapitalization and spin-offs.
Second Lien Loans
The second Lien Loans are also known as Secondary Collateralized Institutional Loans
used mainly for recapitalization. Recapitalization is the process of drawing out dividends
and substituting the more expensive mezzanine with the less expensive SCIL financing
and buying out financing. The SCIL is a much more flexible corporate finance service as
compared to mezzanine and other corporate capital solutions.
The Secondary Collateralized Institutional Loans provide the following corporate
financial solutions:

Recapitalization

Refinancing

Corporate Debt Restructuring

This corporate financial service is meant to clear the past debt burden. Debt
Restructuring adds gives a different and new look to the company. Business restructuring
can be done by the use of cash flow provided by commercial refinancing.

For proper corporate debt restructuring the following corporate financial solutions are
provided:
Asset based loans are provided for Corporate Debt Restructuring.
Debtor-in -possession financing is provided for Corporate Debt
Restructuring.
Plan of Reorganization Financing is provided for Corporate Debt
Restructuring
Revolving Credit Facilities are provided for Corporate Debt
Restructuring.
Senior Secured Debt is provided for Corporate Debt Restructuring.
The corporate finance solutions as mentioned earlier may be explained as follows:
Acquisition, merger and buy out financing: Such corporate finance services are lent out
to companies who wish to leverage the economies of scale, new technologies or choose
to enter into new markets. Different financial packages are available, like the Asset
based lending and cash flow loans to meet such ends.
Business Debt consolidation financing: This corporate financial service helps to
restructure business by refinancing past term and equipment loans to match cash flow.
Growth and working capital needs : Working capital needs may arise from the desire to
expand business, globalize or updating infrastructure. The different corporate finance
services are available to fulfill these desires.
Corporate Debt Restructuring and commercial refinancing : Corporate debt
Restructuring helps to clear the past debt and adds new spirit to the company.
Commercial refinancing is no longer the best method of corporate debt restructuring but
other methods like the asset based lending, revolving loan facilities, term loans and
senior debt are much more valuable.

Corporate Financial Management

Corporate financial management deals with managing the working capital of the
company. it includes issues such as cash management, inventory management, debtor's
management and short term financing. Each of these means of corporate financial
management can be discussed in detail under the following heads:
Cash Management Cash management services are offered by banks to the large
corporate bodies. The cash management services required for corporate financial
management are listed as follows:
1.Account Reconcilement Services : It becomes very difficult for companies to keep
track of cheques that have cleared and that have not. Any error in this respect may not
project the true balance situation. To avoid this problem, banks maintain a list of cheques
that have cleared and those that have not. This process is known as positive pay.
2.Advanced Web Services: The online services offered by many banks help in the
corporate financial management.
3.Armored Car Services : Banks assume the responsibility of picking the cash on behalf
of the large retailers who collect huge cash volumes.
4.Automated Clearing House : This is an electronic system used by companies to pay to
its employees.
5.Balance Reporting Services : The companies subscribe to the websites of the banks
that inform the company regularly about its account and cash position.
Sweep Accounts: In the case of any excess fund in the company's bank account, the extra
amount is shifted to the money market mutual fund overnight and again moved back the
next morning.
6.Zero Balance Accounting : By this system each store of a company is given a specific
account and money accumulated from all these stores are transferred to the main account
of the bank.
7.Inventory Management: Inventory management is yet another mode of this whereby
the company manages the inventory so that production may continue uninterruptedly.
This is done by minimizing further investments in raw materials and reordering costs so
as to maximize cash flow.
8.Debtors management : It is essential to formulate a proper credit policy so as to attract
the customers. It should be so designed so as to nullify any effect on the cash conversion
cycle and the cash flows by increased revenue.
ii. Short term financing:
Bank loans are availed for the purpose of short term financing
Financial risk management: Another aspect of this is the corporate risk management.
The following tools are used for the financial risk management:
Futures : The futures contract is standardized contract, which is traded on a futures
exchange. It is designed to buy or sell an underlying asset at a specific date and time.
The buyer or seller of the futures contract is obliged to fulfill the terms of the contract.
Options : the options contract is almost the same as the futures contract with the
exception that the contract holder has the choice to exercise the contract. There are two
types of contracts- the call option and the put option. Options are traded through a
clearinghouse. The buyer of the option is said to take the long position while the seller is
considered to take the short position..
Investment banking : This is yet another method of corporate financial management.
The role of the investment bank is to issue and sell securities in the primary market on
behalf of the international companies. They raise capital for the international
corporations through debt and equity.

Hedge Funds : Hedge funds are basically investment funds, which charge a
performance fee. Hedge funds are different from the mutual funds, pension funds and
insurance companies. Hedge funds can deal with the futures, swaps and other derivative
markets.
Private Equity : The private equity is any equity investment that cannot be traded in the
public markets. There are various categories of private equity investment. They are:
Leveraged Buyout : Leveraged Buyout occurs when a financial sponsor has control
over the company's majority equity through the use of debt.
Venture Capital: the professionals, institutionally backed by outside investors to the new
and nascent businesses, give this type of private equity capital.
Growth Capital: The money that is borrowed under the Growth Capital is used for any
corporate purpose.
Angel investing : this is the method of investment by a very financially well off
individual in lieu of ownership equity.
Mezzanine capital: This is a wide term meant to cover unsecured, high yield,
subordinated and preferred stock.
Principle of Corporate Finance
Principle of Corporate Finance constitutes the theories and their implementations by the
managers of the companies in the practical field for maximization of profit. Corporate
Finance deals with a company's financial or monetary activity (promotion, financing,
investment, organization, capital budgeting etc.). All these activities are accomplished
with the sole objective of profit maximization. For meeting the fund requirements for
any project of a corporation, a company can get it from various sources such as internal,
external or equities at the lowest cost possible. This fund is then used for investment
purposes for the production of the desirable asset.
Principle of Corporate Finance shows how the different corporate financial theories help
to formulate the policies for the growth of a company. Finance is a science of managing
money and other assets. It is the process of channelization of funds in the form of
invested capital, credits, or loans to those economic agents who are in need of funds for
productive investments or otherwise. E.g. On one hand, the consumers, business firms,
and governments need funds for making their expenditures, pay their debts, or complete
other transactions. On the other hand, savers accumulate funds in the form of savings
deposits, pensions, insurance claims, savings or loan shares, etc which becomes a source
of investment funds. Here, finance comes to the fore by channeling these savings into
proper channels of investment.
Broadly, finance can be classified into three fields:
Public Sector Finance: Financing in the government or public level
is known as public sector finance. Government meets its expenditures mainly through
taxes. Government budget generally don't balance, hence it has to borrow for these
deficits which in turn gives rise to public debt.

Corporate or Business Finance: It tries to optimize the goals (profit,

sales, etc.) of a corporation or other business organization by estimating future asset
requirements and then allocating funds in accordance to the availability of funds.

Personal Finance: It basically deals with the optimization of

finances in the individual (single consumer, family, personal savings, etc.) level
subjected to the budget constraint. E.g. A consumer can finance his/her purchase of a car
by taking a loan from any bank or financial institutions.

Corporate or business finance is all about raising and allocation of funds for increasing
profit. Senior management chalks out long-term plan for fulfilling future objectives.
Value of the company's stock is a very important issue for the management because it is
directly related to the wealth of the share-holders of the company.
Some of the terms important in principle of Corporate finance are:Net Present Value (NPV)
Net Present Value = (Present Value of Inflow of Cash) (Present Value of
Outflow of Cash)
NPV helps to measure the value of a currency today with that of the
future, after taking into consideration returns and inflation.
Positive Net Present Value for a project means that the project is viable
because cash flows will be positive for the same.
Senior managements always target to maximize the value of the firm by
investing in positive NPV (Net Present Value) projects. If such opportunities don't arise
then reinvestment of profits should be stalled and the excess cash should be returned to
the shareholders in the form of dividends.
Financial Risk management
According to Financial Economics, those projects which increases the value of the
shareholders wealth should be taken on. Financial Risk Management is the creation of
value of the shareholders of a firm by managing the exposure to risk by the use of
financial instruments (loans, deposits, bonds, equity stocks, future and options, etc.).
Financial risk management involves :Identification of the source of risk
Risk measurement
Chalking out of plans to manage the risks
Financial Risk Management always tries to find out viable opportunity to hedge the
costly risk exposures by using financial instruments.
Global Corporate Finance
Global corporate finance deals with global cross border funding of various corporations.
Global Corporate Finance follows a global lending program by taking into consideration
the tax and foreign exchanges consequences.
The services provided by the global corporate finance are as follows:
Payables Financing
Companies, which are availing the global corporate finance, enjoy early payment
discounts from customers. The financial institutions that provide the global corporate
finance open an account with each of the suppliers giving them the option of receiving
payments as soon as possible. As time comes the suppliers get paid through their
account.
Inventory Financing
In order to maintain a regular flow of cash, 100% inventory financing is provided to the
companies availing this service. The consumers who opt for inventory financing enjoy
the following benefits:
Increased credit capacity
Free financing for the sponsored suppliers
Simple and common repayment dates each month
100% advance rates

Online account management

Match repayment terms to accounts receivable terms have flexible
structures
Accelerated cash flow
Maximized business volumes
Improved days payables outstanding
Receivables financing
The most relevant part of a growing company is cost management of higher accounts
receivable and inventory level. The asset based finance solutions offered under the
global corporate finance provide working capital for the growth of the company. The
revolving line of credit helps to obtain cash advances by using the accounts receivable
and inventory. Under this finances are provided by following 3 steps:
Checking the eligibility of clients to receive it
Purchasing the receivables at a discount or for cash
Collecting the full invoice amount from the customers over time.
The benefits attached with receivables financing are:
Acceleration of cash flow
Mitigation of collection risk
Enhancing productivity
Outsourcing collection activity
Optimization of asset potential.
Term loans
Term loan financing is generally coupled with other commercial financing offering. This
sort of financing is made to help in the purchase of equipments and other important
assets. The benefits of term loans include:
Additional source of business finance
The spread of the cost of assets and infrastructure investments over time.
Flexible Credit Scheme it provides flexible credit to the customers. The advantages of a
flexible credit regime is:
No interest payments are required for the financing periods 30,45 or 60
days
The principle can be repaid at the end of the free period.
CORPORATE FINANCE INDIA
This site provides comprehensive information on Corporate Finance India. It also
focuses on types of services offered by Corporate Financing Community in India. The
economic renaissance in the 1990s brought by liberation of Indian economy had a
stupendous effect on the financial health of India. The Indian financial market which
was previously insulated from foreign investors were thrown open for foreign
investments. And with modern economic policies (at par with western countries) in
operation large quantum of foreign direct investments / FDI started to flow into the
Indian market. The rise in business activities and its subsequent rise in financial
activities led to the need of proper and accurate financing for corporates in India.
Corporate Finance India provides businessman, investors and entrepreneurs with finance
and advice for proper and risk free investments with an eye for maximum returns.
Corporate Finance India community relies on ready-to-use data, projections and
informations on India's economy. The projections / future-movements of the financial
market are based on information and data collected from daily activities of the finance
market. Corporate Financiers in India advices their clients after taking into consideration

financial environment of the market along with important decisions taken by the
Government which, compliments the financial health of the country.
Corporate Finance India focuses on the provision of corporate advice and funding for
Indian companies who wish to take advantage of the liquidity of the Indian financial
markets. Corporate Finance India provides the following services to the Indian
Corporate Markets.
Corporate Finance .
Debt and equity funding.
Start up and Growth capital.
Pre-IPO finance.
Real Estate Sales and Acquisition.
Company Sales and Acquisitions.
Corporate Finance India focus has been on entrepreneurial clients, whether individuals
or businesses, and on providing funding and investment in entrepreneurial businesses.
Corporate Finance India offers a complete solution to its clients objectives through
market research. Corporate Finance India companies has an extensive network of
investors and funding institutions and group of corporate associates. The Corporate
Finance India community offers professional, personalized service and expertise both
responsively and pro-actively.
Corporate Finance
Arguably, the role of a corporation's management is to increase the value of the firm to
its shareholders while observing applicable laws and responsibilities. Corporate finance
deals with the strategic financial issues associated with achieving this goal, such as how
the corporation should raise and manage its capital, what investments the firm should
make, what portion of profits should be returned to shareholders in the form of
dividends, and whether it makes sense to merge with or acquire another firm.
Balance Sheet Approach to Valuation
If the role of management is to increase the shareholder value, then managers can make
better decisions if they can predict the impact of those decisions on the firm's value. By
observing the difference in the firm's equity value at different points in time, one can
better evaluate the effectiveness of financial decisions. A rudimentary way of valuing the
equity of a company is simply to take its balance sheet and subtract liabilities from
assets to arrive at the equity value. However, this book value has little resemblance to
the real value of the company. First, the assets are recorded at historical costs, which
may be much greater than or much less their present market values. Second, assets such
as patents, trademarks, loyal customers, and talented managers do not appear on the
balance sheet but may have a significant impact on the firm's ability to generate future
profits. So while the balance sheet method is simple, it is not accurate; there are better
ways of accomplishing the task of valuation.
Cash vs. Profits
Another way to value the firm is to consider the future flow of cash. Since cash today is
worth more than the same amount of cash tomorrow, a valuation model based on cash
flow can discount the value of cash received in future years, thus providing a more
accurate picture of the true impact of financial decisions.
Decisions about finances affect operations and vice versa; a company's finances and
operations are interrelated. The firm's working capital flows in a cycle, beginning with
cash that may be converted into equipment and raw materials. Additional cash is used to
convert the raw materials into inventory, which then is converted into accounts
receivable and eventually back to cash, completing the cycle. The goal is to have more
cash at the end of the cycle than at the beginning.

The change in cash is different from accounting profits. A company can report consistent
profits but still become insolvent. For example, if the firm extends customers
increasingly longer periods of time to settle their accounts, even though the reported
earnings do not change, the cash flow will decrease. As another example, take the case
of a firm that produces more product than it sells, a situation that results in the
accumulation of inventory. In such a situation, the inventory will appear as an asset on
the balance sheet, but does not result in profit or loss. Even though the inventory was not
sold, cash nonetheless was consumed in producing it.
Note also the distinction between cash and equity. Shareholders' equity is the sum of
common stock at par value, additional paid-in capital, and retained earnings. Some
people have been known to picture retained earnings as money sitting in a shoe box or
bank account. But shareholders' equity is on the opposite side of the balance sheet from
cash. In fact, retained earnings represent shareholders' claims on the assets of the firm,
and do not represent cash that can be used if the cash balance gets too low. In this regard,
one can say that retained earnings represent cash that already has been spent.
Shareholder equity changes due to three things:
Net income or losses
Payment of dividends
Share issuance or repurchase.
Changes in cash are reported by the cash flow statement, which organizes the sources
and uses of cash into three categories: operating activities, investing activities, and
financing activities.
Cash Cycle
The duration of the cash cycle is the time between the date the inventory (or raw
materials) is paid for and the date the cash is collected from the sale of the inventory. A
company's cash cycle is important because it affects the need for financing. The cash
cycle is calculated as: days in inventory + days in receivables - days in payables
Financing requirements will increase if either of the following occurs:
Sales increase while the cash cycle remains fixed in duration. Increased sales increase
the value of assets in the cycle.Sales remains flat but the cash cycle increases in
duration.
While financially it makes sense to reduce the length of the cash cycle, such a reduction
should not be done without considering the impact on operations. For example, one must
consider the impact on customer and supplier relations as well as the impact on order
fills rates.
Revenue, Expenses, and Inventory:
A firm's income is calculated by subtracting its expenses from its revenue. However, not
all costs are considered expenses; accounting standards and tax laws prohibit the
expensing of costs incurred in the production of inventory. Rather, these costs must be
allocated to inventory accounts and appear as assets on the balance sheet. Once the
finished goods are drawn from inventory and sold, these costs are reported on the
income statement as the cost of goods sold (COGS). If one wishes to know how much
product the firm actually produced, the cost of goods produced in an accounting period
is determined by adding the change in inventory to the COGS.
Assets
Assets can be classified as current assets and long-term assets. It is useful to know the
number of days of certain assets and liabilities that a firm has on hand. These numbers
are easily calculated from the financial statements as follows:

Accounts Receivable (A/R)

Number of days of A/R = ( accounts receivable / annual credit sales ) ( 365 ).
This also is known as the collection period.
Inventory Number of days of inventory = ( inventory / annual COGS ) ( 365 ).This also
is known as the inventory period.
On the liabilities side:
Payables
Number of days of accounts payable = ( accounts payable / COGS ) ( 365 ), assuming
that all accounts payable are for the production of goods. This also is known as the
payables period.
Financial Ratios
A firm's performance can be evaluated using various financial ratios. Ratios are used to
measure leverage, margins, turnover rates, return on assets, return on equity, and
liquidity. Additional insight can be gained by comparing ratios among firms in the
industry.
Bank Loans
Bank loans can be classified according to their durations. There are short-term loans
(one year or less), long-term loans (also known as term loans), and revolving loans that
allow one to borrow up to a specified credit level at any time over the duration of the
loan. Some revolving loans automatically renew at maturity; these loans are said to be
"evergreen."
Sources and Uses of Cash
It can be worthwhile to know where a firm's cash is originating and how it is being used.
There are two sources of cash: reducing assets or increasing liabilities or equity.
Similarly, a company uses cash either by increasing assets or decreasing liabilities or
equity.
Sustainable Growth
A company's sustainable growth rate is calculated by multiplying the ROE by the
earnings retention rate.
Firm Value, Equity Value, and Debt Value
The value of the firm is the value of its assets, or rather, the present value of the
unlevered free cash flow resulting from the use of those assets. In the case of an allequity financed firm, the equity value is equal to the firm value. When the firm has
issued debt, the debt holders have a priority claim on their interest and principal, and the
equity holders have a residual claim on what remains after the debt obligations are met.
The sum of the value of the debt and the value of the equity then is equal to the value of
the firm, ignoring the tax benefits from the interest paid on the debt. Considering taxes,
the effective value of the firm will be higher since a levered firm has a tax benefit from
the interest paid on the debt. If there is outstanding preferred stock, the firm value is the
sum of the equity value, debt value, and preferred stock value, plus the value of the
interest tax shield.
The debt holders and stock holders each have a claim on the cash flows of the firm. In a
given time period, the debt holders have a claim equal to the interest payments during
that period plus any principal payments that are due. The stock holders then have a claim
equal to the unlevered free cash flow in that period plus the cash generated by the
interest tax shield, minus the claims of the debt holders.
Capital Structure

The proportion of a firm's capital structure supplied by debt and by equity is reported as
either the debt to equity ratio (D/E) or as the debt to value ratio (D/V), the latter of
which is equal to the debt divided by the sum of the debt and the equity.
One can quickly convert between the D/E ratio and the D/V ratio by using the following
relationships:
D/V=(D/E)/(1+D/E)
D/E=(D/V)/(1-D/V)
Risk Premiums
Business risk is the risk associated with a firm's operations. It is the undiversifiable
volatility in the operating earnings (EBIT). Business risk is affected by the firm's
investment decisions. A measure for the business risk is the asset beta, also known the
unlevered beta. In terms of the discount rate, the return on assets of a firm can be
expressed as a function of the risk-free rate and the business risk premium (BRP):
rA = rF + BRP
Financial risk is associated with the firm's capital structure. Financial risk magnifies the
business risk of a firm. Financial risk is affected by the firm's financing decision. Total
corporate risk is the sum of the business and financial risks and is measured by the
equity beta, also known as the levered beta. The business risk premium (BRP) and
financial risk premium (FRP) are reflected in the levered (equity) beta, and the return on
levered equity can be written as:
rE = rF + BRP + FRP
Debt beta is a measure of the risk of a firm's defaulting on its debt. The return on debt
can be written as:
rD = rF + default risk premium
Cost of Capital
The cost of capital is the rate of return that must be realized in order to satisfy investors.
The cost of debt capital is the return demanded by investors in the firm's debt; this return
largely is related to the interest the firm pays on its debt. In the past some managers
believed that equity capital had no cost if no dividends were paid; however, equity
investors incur an opportunity cost in owning the equity of the firm and they therefore
demand a rate of return comparable to what they could earn by investing in securities of
comparable risk.
The return required by debt holders is found by applying the CAPM:
rD = rF + betadebt ( rM - rF )
The required rate of return on assets (that is, on unlevered equity) can be found using the
CAPM:
rA = rF + betaunlevered ( rM - rF )
Using the CAPM, a firm's required return on equity is calculated as:
rE = rF + betalevered ( rM - rF )
Under the Modigliani-Miller assumptions of constant cash flows and constant debt level,
the required return on equity is:

rE = rA + (1-)(rA - rD)(D / E) where is the corporate tax rate.

The overall cost of capital is a weighted-average of the cost of its equity capital and the
after-tax cost of its debt capital. The weighted average cost of capital (WACC) then is
given by: WACC = rE (E / VL) + rD (1-)(D / VL)
Assuming perpetuities for the cash flows, the weighted average cost of capital can be
calculated as:
WACC = rA [ 1 - (D / VL)]
Neglecting taxes, the WACC would be equal to the expected return on assets because the
WACC is the return on a portfolio of all the firm's equity and all of its debt, and such a
portfolio essentially has claim to all of the firm's assets.
For arbitrary cash flows, and under the assumption that the debt to value ratio is held
constant, the following relationship derived by James A. Miles and John R. Ezzell is
applicable: WACC = rA - rD (D / VL)(1+rA) / (1+rD)
Under the same assumptions, the cost of equity capital can be calculated from rA and rD
using the following relationship from Miles and Ezzell:
rE = rA + [ 1 - rD / (1+rD)] [ rA - rD ] D/E
For low values of rD, [ 1 - rD / (1+rD)] is approximately equal to one, and the
expression can be simplified if high precision is not required.
If one cannot assume a constant debt to value ratio, then the APV method should be
used.
Estimating Beta
In order to use the CAPM to calculate the return on assets or the return on equity, one
needs to estimate the asset (unlevered) beta or the equity (levered) beta of the firm. The
beta that often is reported for a stock is the levered beta for the firm. When estimating a
beta for a particular line of business, it is better to use the beta of an existing firm in that
exact line of business (a pure play) rather than an average beta of several firms in similar
lines of business that are not exactly the same.
Expressing the levered beta, unlevered beta, and debt beta in terms of the covariance of
their corresponding returns with that of the market, one can derive an expression relating
the three betas. This relationship between the betas is:
betalevered = betaunlevered [ 1 + (1 - ) D/E ] - betadebt(1- ) D/E
betaunlevered = [ betalevered + betadebt(1- ) D/E ] / [ 1 + (1 - ) D/E ]
The debt beta can be estimated using CAPM given the risk-free rate, bond yield, and
market risk premium.
Unlevered Free Cash Flows
To value the operations of the firm using a discounted cash flow model, the unlevered
free cash flow is used. The unlevered free cash flow represents the cash generated by the
firm's operations and is the cash that is free to be paid to stock and bond holders after all
other operating cash outlays have been performed.
Terminal Value

The value of the firm at the end of the last year for which unique cash flows are
projected is known as the terminal value. The terminal value is important because it can
represent 50% or more of the total value of the firm.
Three Discounted Cash Flow Methods for Valuing Levered Assets
APV (Adjusted Present Value) Method
The APV approach first performs the valuation under an unlevered all-equity
assumption, then adjusts this value for the effect of the interest tax shield. Using this
approach,
VL = VU + PVITS
where VL = value if levered
VU = value if financed 100% with equity
PVITS = present value of interest tax shield
The unlevered value is found by discounting the unlevered free cash flow at the required
return on assets. The present value of the interest tax shield is found by discounting the
interest tax shield savings at the required return on debt, rD.
The APV method is useful for valuing firms with a changing capital structure since the
return on assets is independent of capital structure. For example, in a leveraged buyout,
the debt to equity ratio gradually declines, so the required return on equity and the
weighted average cost of capital change as the lenders are repaid. However, when
calculating the terminal value it may be appropriate to assume a stable capital structure,
so in calculating the terminal value in a leveraged buyout situation the WACC method
may be a better approach.
Flows to Equity Method
The flows to equity method sums the NPV of the cash flows to equity and to debt.
Then, VL = E + D
WACC Method
The WACC method discounts the unlevered free cash flow at the weighted average cost
of capital to arrive at the levered value of the firm.
Cash Flows to Debt and Equity
When calculating the amount of cash flowing to debt and equity holders, it is not
appropriate to use the unlevered free cash flows because these cash flows do not reflect
the tax savings from the interest paid. Starting with the UFCF, add back the taxes saved
to obtain the total amount of cash available to suppliers of capital.
Hurdle Price
At times a firm may wish to know at what price it would have to sell its product for a
particular investment to have a positive net present value. A procedure for determining
this price is as follows:
Express the operating cash flow in terms of price. There may be multiple
phases such as a short start-up period, a long operating period, and a final year in which
the terminal value is calculated.
Write out the expression for the NPV using the appropriate discount rate.
For the longer operating period, one can calculate an annuity factor to multiply by the
operating cash flow expression. Solve the expression for the cash flow that would result
in an NPV of zero.
Since the operating cash flow was written in terms of price, the price now can be found.
Debt Valuation

While debt may be issued at a particular face value and coupon rate, the debt value
changes as market interest rates change. The debt can be valued by determining the
present value of the cash flows, discounting the coupon payments at the market rate of
interest for debt of the same duration and rating. The final period's cash flow will include
the final coupon payment and the face value of the bond.
Investment Decision
If the unlevered NPV of a project is negative, aside from potential strategic benefits, the
project is destroying value, even if the levered NPV is positive. The firm always could
benefit from the tax shield of debt by borrowing money and putting it to other uses such
as stock buybacks.
Optimal Capital Structure
The total value of a firm is the sum of the value of its equity and the value of its debt.
The optimal capital structure is the amount of debt and equity that maximizes the value
of the firm.
Share Buyback
If a firm has extra cash on hand it may choose to buy back some of its outstanding
shares. One interesting aspect of such transactions is that they can be based on
information that the firm has that the market does not have. Therefore, a share buyback
could serve as a signal that the share price has potential to rise at above average rates.
Mergers and Acquisitions
Companies may combine for direct financial reasons or for non-financial ones such as
expanding a product line. The target firm usually is acquired at a premium to its market
value, with the hope that synergies from the merger will exceed the price premium.
Mergers and acquisitions do not always achieve their goals, as promised syngeries may
fail to materialize.
Compounding and Discounting
Compound annual growth rate (CAGR): ( FV/C )1/T - 1
Continuous compounding: FVt = C er t
Perpetuity: PV = C / r
Growing perpetuity: PV = C / ( r - g )
T-year annuity (T equally spaced payments): PV = ( C / r ) [ 1 - 1/(1+r)T ]
T-year growing annuity: PV = [C / (r - g)] { 1 - [(1+g) / (1+r)]T }