Introduction of Corporate Finance

Introduction to Corporate Finance
corporatefinanceinstitute.com
Learning objectives
By the end of this course, you will be able to:
Discuss the main capital

01. investment activities and
valuation techniques
04. Outline the capital
raising process
Explain the process of

02. mergers and acquisitions, and
key considerations for the deal
05. Explore various career
paths in corporate finance
Compare debt financing with

03. equity financing and explain
the optimal capital structure
Introduction
Corporate finance overview
The ultimate purpose of corporate finance is to maximize the value of a business through planning and
implementing management resources while balancing risk and profitability.
Capital Investments Capital Financing Dividends & Return

of Capital
• Decide what projects / • Determine how to fund capital
businesses to invest in investments • Decide how and when to
• Earn the highest possible risk- • Optimize the firm’s capital structure return capital to investors
adjusted return
Players in corporate finance – primary market
Public
accounting
firms Bonds or shares
$
“Sell side”
$
Contacts Contacts “Buy side”
Fund
Manager
$
Corporations Investment Institutions

Banks Investors
Capital
Players in corporate finance – secondary market
Wants to sell Wants to buy

Stock
Fund Manager exchange
Fund Manager
/
OTC
Investment bank Investment bank
Sales, trading Sales, trading

and research and research
Types of participants
Retail Institutional Public Private

Investors Corporations
• High net worth • Mutual funds • Traded on stock • Owned and traded
• Individuals • Pension funds exchanges by a few private
investors
• Private equity firms
• Venture capital firms
• Seed / angel investors
Types of transactions
Initial public Follow-on Private

offering (IPO) offering placement
Mergers & Leverage Divestiture

acquisitions buyout (LBO)
(M&A)
Capital Investments
What is a capital investment?
Any investment for which the economic benefit is great than one year.
Opening a new Entering a new Acquiring another Research and

factory market business development of new
products
Capital investment
Capital investments will increase the assets of a company.
Debt
Assets
Equity
Techniques for valuing an investment
Whether such investments are worthwhile depends on the approach that the company uses
to evaluate them. A company may value the projects based on:
Net Present Value (NPV): The value of all future cash

flows (positive and negative) over the entire life of an
investment discounted to the present.
Internal Rate of Return (IRR): The expected

compound annual rate of return that will be earned
on a project or investment
Net Present Value (NPV)
$100 $100 $100 $100 $100 $1,200
2019 2020 2021 2022 2023 Terminal

Forecast Period value
Net Present Value (NPV)
Future Value $100 $100 $100 $100 $100 $1,200

x 1 x 1 x 1 x 1 x 1 x 1 x 1
(1+i)n 1.10 1.102 1.103 1.104 1.105 1.105
Discount Rate
(Cost of Capital)
745
Present Value 91 83 75 68 62
2019 2020 2021 2022 2023 Terminal

value
NPV Value of the firm = $1,124

Terminal Value: Value of FCF beyond 2023
Terminal value
Terminal Value: Value of free cash flow beyond the forecast period
Growing perpetuity formula
Free cash flow x (1 + growth)

Terminal value
= Cost of capital - growth
Exit multiple formula
x Multiple
Terminal value
= [i.e. Earnings, EBITDA, Revenue]
Terminal value
Terminal value $100 x (1 + 1.54%)

Perpetual growth = 10.00% - 1.54% = $1,200
Terminal value
Exit multiple = 12 x $100

= $1,200
Unlocking the drivers of value
• Business strategy
• Revenue • Organic growth?
• Cost structure • What’s
• Asset utilization sustainable?
Free cash flow x (1 + growth)

Terminal value
= Cost of capital - growth
• Risk • Organic growth?

• Current capital • What’s
structure sustainable?
• Macro factors
Enterprise value vs. equity value
Market value
of net debt
=Equity Value + Debt – Cash Enterprise

=NPV of the business value
Market value
of equity =Share Price x Outstanding Shares
(market =NPV of the business – Debt + Cash
capitalization)
Internal Rate of Return (IRR)
Internal Rate of Return

IRR = 22%
22% IRR is economically equivelant to earning a 22% compound annual growth rate
Mergers and Acquisitions (M&A)
Mergers and acquisitions is the process of companies buying, selling, or combining businesses.
Benefits: Potential drawbacks:

• Cost savings • Overpaying
• Revenue enhancements • Large expenses associated
• Increase market share with the investment
• Enhance financial resources • Negative reaction to the
mergers or acquisition
10 step acquisition process
10
9 Integration
8 Financing
7 Purchase &
Sales Contract
6 Due
Diligence
5 Negotiation
4 Data & Detailed
Valuation
3 Approaching
Targets
2 Searching
1 for Target
Acquisition
Criteria
Acquisition
Strategy
Strategic versus financial buyers
Strategic buyers
VS Financial buyers
• Operating businesses • Private equity (financial sponsor)

• Horizontal or vertical expansions • Professional investor (non-operator)
• Involves identifying and delivering • Leverage for maximum equity returns
operating synergies
Rival bidders
The vast majority of acquisitions are

competitive or potentially competitive.
• Companies normally have to offer more than rival bidders

• To pay more than rival bidders, the buyer may:
• Be able to “do more” with the acquisition
• Accept a lower expected return
• Have a different view or forecast for future
Acquisition valuation process
1. Value the target 2. Value synergies

as stand-alone
Hard and soft
Enterprise value • Sales (volume & price)
• Sales growth • EBIT margin
• Product mix
• EBIT margin • Overhead reductions
• Operating tax • Operating tax
• Tax efficiency
• Working capital requirements • Tax losses
• Capital expenditures • Working capital
• Vendor relationships
• Capital expenditures
• Efficiencies
Best practice acquisition analysis
1 2 3 4 5 6
Soft Transaction
synergies costs
Hard Net Value created

synergies synergies
Stand-alone Stand- Consideration

enterprise alone (price paid)
value value
Issues to consider when structuring a deal
Market Environment
Contract Structuring Antitrust

law Environment rules
Strategic Competing
plan bidders
Accounting Deal Available

rules financing
Hostile vs Public vs
friendly private
Capital
structure
Corporate
Tax
Law
Market
conditions
Capital Financing

of Capital
adjusted return
What is a capital financing?
Any type of funding that is used finance the purchase of an asset/project (an
investment).
Equity Debt
Capital financing
Capital financing will increase the liabilities and/or equity of a company.
Debt
Assets
Equity
The business life cycle
LAUNCH GROWTH SHAKE MATURITY

-OUT
$ Life cycle
extension
Sales
Cash flow
Profit
Time
The corporate funding life-cycle
LAUNCH GROWTH SHAKE MATURITY

-OUT
Debt funding
Business risk
Stage of the firm life cycle
Capital structure
Capital Structure: the amount of debt and/or equity employed by a firm to fund its operations and finance its assets.
In order to optimize the structure, a firm will decide if it needs more debt or equity and can issue whichever it requires.
Low Leverage High Leverage
Optimal capital structure
The equity versus debt decision relies on a large number of factors:
The current economic climate
The business’ existing capital structure
The business’ life cycle stage
Having too much debt may increase the risk of default in repayment
Depending too heavily on equity may dilute earnings and value for original investors.
Optimal capital structure
Companies are usually looking for the optimal combination of debt and equity to minimize the cost of capital.
Weighted Average Cost of Capital (WACC)
Debt/Total Capital (Leverage)
Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC) is the proportion of debt and equity a firm has multiple by their respective costs.
Cost of Equity: Cost of Debt:

The rate of return a shareholder requires The rate of return that a lender requires
for investing equity into a business given the risk of the business
The optimal capital structure of a firm is often defined as the proportion of debt and equity that result
in the lowest weighted average cost of capital (WACC) for the firm.
WACC formula
Net debt % net debt x Cost of debt = Contribution
Assets
Market
value % equity x Cost of equity = Contribution
of equity
Cost of capital
Example
$32bn 14% x 3.5% = 0.5%
$225bn
$193bn 86% x 9.0% = 7.7%
8.2%
Capital stack
How to optimally finance the capital investments through the business’ equity, debt, or a mix of both?
Senior debt
Subordinated debt
Equity
Types of equity
Senior debt
Subordinated debt
S/holder loans Higher liquidation position; no dividend but pays interest
Equity
Pref. shares Higher liquidation and higher dividend priority (vs Common)
Common shares Last liquidation position and last dividend position
Common shares
Terms Issues
Typically the majority of a firm’s
equity capital: • Last level of priority (highest
• Proportional share of residual risk) for investors
value of the business
• Proportional payment of
common dividends
• Voting rights (or not)
Preferred shares
Terms Issues
The ‘norm’ is for private equity to Preferred shares are becoming less
subscribe for preferred shares attractive as:
which are:
• More costly than Common
• Liquidity preference shares
• Have a fixed dividend • Even if company has cash,
payment may not be made if
• Anti-dilution rights
lack of distributable reserves.
Shareholder loans
Shareholder loans are a means for private equity houses to invest sufficient equity into a buyout
situation, whilst still allowing management a significant equity stake.
Max debt
$30m
Enterprise
value
$50m
Shareholder
loan - PIK
Equity $16m
$20m
Private equity $2m
Management $2m
Sources of equity
Private Markets Public Markets
Founders Institutional
Venture Capital Retail
Private Equity
Private equity and venture capital firms
Private equity firms manage funds or pools of capital that invest in companies that represent an opportunity for a high rate of return.
Private equity funds invest for limited time periods. Exit strategies include IPOs, selling to another private equity firm, etc.
Private equity funds are typically split into two categories:
1 2
Venture capital funds typically invest in Buyout or LBO funds typically invest in more
early stage or expanding businesses that have mature businesses, usually taking a controlling interest
limited access to other forms of financing and leveraging the equity investment with a substantial
amount of external debt. Buyout funds tend to be
significantly larger than venture capital funds.
• Sequoia Capital • Blackstone
• Y Combinator • KKR
• Andreessen Horowitz • Carlyle Group
Typical exit routes for private equity
Total Exit Partial Exit
Private Corporate
Sale to Strategic Sale to Sponsor
Placement Restructuring
Flotation/IPO
Why use debt
Corporation: (1) to lower the cost of Investor: to increase their equity return
capital, and (2) avoid equity dilution
Senior debt
Senior debt Three to five years

Weighted Average Cost
of Capital (WACC)
Equity
Equity IRR = 28%
Debt/Total Capital
(Leverage)
Assessing debt capacity
General measures Balance sheet measures Cash flow measures

• Level of EBITDA • Debt to equity • Total debt / EBITDA
• Volatility and hence stability • Debt to capital • Senior debt / EBITDA
of EBITDA • Debt to assets • Net debt / EBITDA
• Capital expenditures • Etc. • Cash interest cover
• Cyclicality
• Risk • EBITDA-Capex / interest
• Competition
Senior debt overview
Revolver
Senior debt capacity
Senior debt
Term loan A 2.0x to 3.0x EBITDA
Term loan B 2.0x interest coverage
Term loan C Typically provided by
Commercial Insurance
Credit companies
Subordinated banks companies
debt
Equity
Types of subordinated debt
Increasing Increasing
subordination return
Senior debt
Subordinated debt
High yield bonds

Increasing
Mezz warrantless dilution
Mezz warranted
PIK notes Subordinated

Vendor notes debt is used to fill
the funding gap.
Equity
How much subordinated debt?
Subordinated debt holders will only supply so much debt.
Total debt / EBITDA ~ 5 to 6 times
xEBITDA / Cash interest ~ 2 times
Equity funding ~ 30% to 35%.
The appropriate financial structure has to be constructed within these

constraints.
Credit ratings and high yield debt
Moody’s S&P Fitch DBRS
Aaa AAA AAA AAA

Aa1 AA+ AA+ AA (high)
Aa2 AA AA AA
Investment grade Aa3 AA- AA- AA (low)
A1 A+ A+ A (high)
• Low risk A2 A A A
• Low return A3 A- A- A (low)
• Low fees Baa1 BBB+ BBB+ BBB (high)
Baa2 BBB BBB BBB
Baa3 BBB- BBB- BBB (low)
Ba1 BB+ BB+ BB (high)

Ba2 BB BB BB
Ba3 BB- BB- BB (low)
High yield B1 B+ B+ B (high)
• High risk B2 B B B
• High return B3 B- B- B (low)
• High fees Caa1 CCC+ CCC+ CCC (high)
Caa2 CCC CCC CCC
Caa3 CCC- CCC- CCC (low)
- D D D
Mezzanine debt characteristics
Mezzanine is non-traded debt, which is subordinated to senior debt.
Bullet repaid
Pays a cash and accrued return
Can have equity warrants attached
Convertible
Debt with warrants Convertible loan stock
preference shares
Mezzanine returns
Warrants
3% to 10%
of post
exit value
Total
Accrued return
Contractual
interest (IRR 14%

to 20%)
return
Cash pay
interest
Debt repayment profiles
Mezzanine finance – high yield debt
Equal Balloon Bullet Bullet

amortizing repayment repayment repayment
time
Tradeoffs between debt and equity
Pros and cons of equity: Pros and cons of debt:
• No interest payments or mandatory fixed payments • Has interest payments (typically)

• No maturity dates (no capital repayment) • Has a fixed repayment schedule
• Has ownership and a degree of control over the business • Has first claim on the firm’s assets in the event of liquidation
• Has voting rights (typically) • Requires covenants and financial performance metrics that
• Has a high implied cost of capital must be met
• Expects a high rate of return (dividends and capital appreciation) • Contains restrictions on operational flexibility
• Has last claim on the firm’s assets in the event of liquidation • Has a lower cost than equity
• Provides maximum operational flexibility • Expects a lower rate of return than equity
• Prevents dilution of equity
• Can push a company into default / bankruptcy
Capital Raising Process
Underwriting
The process where a bank raises capital for a

corporation, or institution from investors in the form of equity
or debt securities.
Underwriting involves conducting research, financial
modeling, valuation, and marketing and a deal.
Types of underwriting
Types of underwriting commitment:
Firm Commitment Best Efforts

The underwriter agrees to buy the Underwriter commits to selling as
entire issue and assume full financial much of the issue as possible at the
responsibility for any unsold shares. agreed-on offering price, but can
return any unsold shares to the issuer
without financial responsibility.
Underwriting advisory services
Planning Issue Structure Timing and Demand

• Identify investor themes • Domestic or international • Hot or cold issue market
• Investment rationale • Institutional investor focus • Supported by positive news-flow
• Financial modeling & valuation • Retail investor focus • Investor appetite
• Is IPO the best option • Offer for sale • Precedents and benchmark
• Size of float and lock-up issues • Intermediaries offer offerings
• Preliminary view on investor • Introduction • Pricing

demand
Underwriting - the book building process
Institutional Price is
Indicative price Book of set to
investor Allocation
range demand ensure
commitment
built clearing
@ firm price
Underwriting - the road show
The roadshow is an opportunity for management to convince investors of the strength of the business cases
Areas that are critical include:
Management structure,
A thorough analysis of the industry/sector
governance and quality
Strategy, both tactical and long-term Key risks
Funding requirements and purpose:

Cash in versus cash out
Pricing the issue
Key issues in pricing
Price stability
Buoyant after market
Depth of investor base
Pricing the issue
After market price

performance Maximizing price
Under-pricing
There are two costs associated with a flotation:
Direct cost / Fees Indirect cost / Under-pricing
There is a temptation for the advising bank to

underprice the issue - why?
• Reduces the risk of equity overhang

• Ensures after market is buoyant, but
• This fails to make the best possible returns for the current
owners and could lead to profit-taking and hence volatility
The IPO pricing process
IPO
discount
Indicative maximum
Full value
10 to 15%
Pricing
range
Indicative minimum
• Relative valuation
• Intrinsic valuation
Dividends and Return of Capital

of Capital
adjusted return
Dividends and return of capital
Corporate managers to decide:
Distribute the earnings to shareholders in the form of

dividends or share buybacks
Retain the excess earnings for future investments

and operational requirements
Internal Rate of Return (IRR)
Internal Rate of Return

IRR = 22%
WACC
Net debt % net debt x Cost of debt = Contribution
Assets
Market
value % equity x Cost of equity = Contribution
of equity
Cost of Capital = 28%
Decision
Internal Rate of Return Cost of Capital

= 22% = 28%
Return Capital
(Dividend or Buyback)
Retained earnings and excess cash
Balance Sheet
Retained earnings / excess cash decision flowchart
Retained earnings /
Cash balance
Rate of return on capital Rate of return on capital

investment < WACC investment > WACC
Repurchase Pay cash Reinvest in

shares dividends other projects
Dividend vs Share Buyback
Dividend Buyback (Repurchase)

• Can be one-time or ongoing • Reduces the number of shares
• Contribute to the “yield” on a stock outstanding
if ongoing regular dividends • Increases EPS
• No impact on shares outstanding
or EPS

of Capital
adjusted return
Corporate Finance Careers
Career map
Roles in corporate finance
Banks (‘Sell side’) Public Accounting Institutions (‘Buy side’) Corporates
• Client facing / sales • Mix of client or inward focus • More internally focused • Internally focused
component • Hire from schools or from • Hire from banks • Hire from banks, accounting
• Capital Markets hire from other accounting firms • Hire grad schools students firms, institutions and schools
schools • Long / medium hours • Hire across all entry points
• Long hours
• Retail hires at various points • Competitive • Hours vary
• Competitive
• Long hours • Clear career path • Competitiveness varies by
• Quick career progression
• Competitive company
• Quick career progression • Career progression varies

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Introduction to Corporate Finance

By the end of this course, you will be able to:

Discuss the main capital

Explain the process of

Compare debt financing with

Capital Investments Capital Financing Dividends & Return

Corporations Investment Institutions

Wants to sell Wants to buy

Investment bank Investment bank

Sales, trading Sales, trading

Retail Institutional Public Private

Initial public Follow-on Private

Mergers & Leverage Divestiture

Opening a new Entering a new Acquiring another Research and

Capital investments will increase the assets of a company.

Net Present Value (NPV): The value of all future cash

Internal Rate of Return (IRR): The expected

$100 $100 $100 $100 $100 $1,200

2019 2020 2021 2022 2023 Terminal

Future Value $100 $100 $100 $100 $100 $1,200

2019 2020 2021 2022 2023 Terminal

NPV Value of the firm = $1,124

Growing perpetuity formula

Free cash flow x (1 + growth)

Exit multiple formula

Terminal value $100 x (1 + 1.54%)

Exit multiple = 12 x $100

Free cash flow x (1 + growth)

• Risk • Organic growth?

=Equity Value + Debt – Cash Enterprise

Internal Rate of Return

Benefits: Potential drawbacks:

• Operating businesses • Private equity (financial sponsor)

The vast majority of acquisitions are

• Companies normally have to offer more than rival bidders

1. Value the target 2. Value synergies

Hard Net Value created

Stand-alone Stand- Consideration

Contract Structuring Antitrust

Accounting Deal Available

Capital Investments Capital Financing Dividends & Return

Capital financing will increase the liabilities and/or equity of a company.

LAUNCH GROWTH SHAKE MATURITY

LAUNCH GROWTH SHAKE MATURITY

Stage of the firm life cycle

Low Leverage High Leverage

The equity versus debt decision relies on a large number of factors:

The current economic climate

The business’ existing capital structure

The business’ life cycle stage

Weighted Average Cost of Capital (WACC)

Debt/Total Capital (Leverage)

Cost of Equity: Cost of Debt:

Net debt % net debt x Cost of debt = Contribution

$32bn 14% x 3.5% = 0.5%

$193bn 86% x 9.0% = 7.7%

S/holder loans Higher liquidation position; no dividend but pays interest

Common shares Last liquidation position and last dividend position

Private Markets Public Markets

Venture Capital Retail

Private equity funds are typically split into two categories:

• Sequoia Capital • Blackstone

• Andreessen Horowitz • Carlyle Group