CORPORATE FINANCE

UNIT – I

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PART - A

DEFINE FINANCE:
Finance is the process of conversion of accumulated funds to the productive use.

Finance may be defined as the administrative area or the set of administrative

function in an organization which relate with the arrangement of cash and credit so that
the organization may have the means to carryout its objectives as satisfactorily as
possible.

DEFINE FINANCIAL MANAGEMENT:

Financial management is the managerial activity which is concerned with the
planning and controlling of the firm’s financial resources.

Define corporate finance:

Corporate finance deals with the financial problems of corporate enterprises.
These problems include the financial aspects of the promotion of new enterprises and
their administration during early development, the accounting problems connected with
the distinction between capital and income, the administration questions created by
growth and expansion and the financial adjustments required for the rehabilitation of
companies.

What is the relation between risk and return?

An asset has both risk and return. Greater the risk, greater will be the return and
vice versa.
Return = Risk free rate + Risk premium
Risk free rate is the compensation for time and risk premium is the compensation
for risk. Eg. Investing in Government bonds may be less risky but yields less returns. But
investing in shares may be more risky but yields more return.

Mention the different sources of finance:

There are different sources of finance.
a. Short term source of finance
b. Medium term source of finance
c. Long term source of finance
Short term source of finance includes trade credit, accrued expenses, deferred
income, bank finance and factoring. Medium term source includes loans from
financial institutions, rights or public debentures, public deposits and loan from
commercial banks. Long term source includes equity shares, preference shares,
debentures and term loans.
Define working capital. Mention its types.
The capital which is required for day today operations of the business is called as
working capital. There are two concepts of working capital namely Gross working capital
and net working capital. The two types of working capital are temporary working capital
and permanent working capital.

Differentiate shares and debenture:

Share is a corporate security through which long term finance can be raised. It is
off two forms
1. Equity or ordinary shares
2. Preference shares
Shares yield a return called as dividend. Equity share has voting rights and
variable dividend to the shareholders whereas preference shares have no voting
rights and fixed dividend to the shareholders.

Debenture is a long term promissory note for raising loan capital. If the investors
purchase debenture then they are called as debenture holders and they receive
fixed percentage of interest from the company. Debenture holders are the
creditors of the company.

What is meant by agency problem?

The problem between different persons involved in business like shareholders,
managers, customers, creditors etc are called as agency problem. Each and everyone
involved in the business want to maximize their own welfare. This creates agency
problem. Agency problem can occur in the relationship between shareholders and
managers and in the relationship between shareholders and creditors.

Define merger. Mention its types.

It is nothing but two or more companies combine together into one company. It
involves absorption or consolidation.
Merger through absorption: One company acquires another company. Eg: Hindustan
lever limited absorbed Tata oil Mills Company. Eg: Tata Chemicals Ltd (TCL) absorbed
Tata Fertilizer Ltd
Merger through consolidation: Two or more companies combine to form a new
company. Eg: Hindustan computers Limited, Hindustan Instruments Limited, Indian
Software Company limited and Indian Reprographics limited combined to form HCL
Limited. The different types of merger are Horizontal merger, Vertical merger and
Conglomerate merger.

Mention the symptoms of sick units:

Delay or default in payment to suppliers, irregularity in bank account, delay or
default to banks, decline in capacity utilization, poor maintenance of plant and
machinery, low turnover of assets, accumulation of inventories, excessive turnover of
personnel and decline in the price of equity shares and debentures.
What is meant by trade credit?
It is the facility that a customer gets from the supplier of goods in business. In this
the buying customer will not pay the cash immediately to the suppliers for the purchase
made. It is a major source of finance for the companies. It is off three types
1. Open credit – Informal arrangement. Also known as accounts payable.
2. Notes payable – Formal acknowledgement. Also known as promissory note.
3. Trade acceptance – Used instead of open account. Formal obligation of debt.

Who is called as owners of residue?

Equity shareholders or Ordinary shareholders are called as owners of residue.
Equity shareholders being the owners of the company, bear the risk of ownership. Equity
shareholders will be given dividend only after satisfying the claims of others. Even when
the company wound up, ordinary shareholders can claim on assets of the firm at last only.
So, they are called as owners of residue.

Mention the basic financial decisions:

The four important financial decisions are
a. Financing decisions or capital mix decisions – to decide mix of debt
and equity
b. Investment decisions or Long term asset mix decisions – investment in
long term assets
c. Dividend decisions or Profit allocation decisions – to decide about
dividend payment
d. Liquidity decisions or Short term asset mix decisions- to maintain
profitability liquidity tradeoff

What is meant by risk return trade off?

An asset has both risk and return. Greater the risk, greater will be the return and
vice versa.
Return = Risk free rate + Risk premium
Risk free rate is the compensation for time and risk premium is the compensation
for risk. Eg. Investing in Government bonds may be less risky but yields less returns. But
investing in shares may be more risky but yields more return.
A proper balance should be maintained between risk and return to maximize the
market value of share. This balance is called as risk-return trade off.

Define profitability liquidity tradeoff:

Investment in current assets affects the firm’s profitability and liquidity. Firm
should not invest more in current assets or less in current assets. If more fund invested in
current assets the affects the profitability of the company. If less funds are invested in
current assets that affects the liquidity position of the company. So, a proper balance has
to be maintained between profitability and liquidity and this is called as profitability
liquidity trade off.
Is profit maximization an operationally feasible criterion?
Profit maximization is not an operationally feasible criterion because it fails to
maximize the shareholders economic welfare. This objective is vague or unclear. This
objective ignores time value of money. It ignores risk. So, this objective of profit
maximization is not an operationally feasible criterion.

What are the different short term sources of finance?

1. Trade credit
a. Open credit
b. Notes payable
c. Trade acceptance
2. Accrued expenses
3. Deferred income
4. Bank finance
a. Overdraft
b. Cash credit
c. Bills discounting
5. Factoring

Mention the different long term sources of finance.

1. Shares
a. Equity shares
b. Preference shares
2. Debentures
a. Non convertible debentures (NCD)
b. Fully convertible debentures (FCD)
c. Partly convertible debentures (PCD)
3. Term loans

Define factoring:
The sale of bills receivables to a company that is specialized in buying receivables
to acquire short term financing is called as factoring.. Companies buying the receivables
are called as factors. The types of factoring are (a) Full service non-recourse (b) Full
service recourse factoring (c ) Bulk / agency factoring (d) Non-notification factoring.

Differentiate debenture and preference share

Debenture: Debenture is a long term promissory note for raising loan capital. The
purchasers of debentures are called as debenture holders. An alternative form of
debenture is bond in India. A debenture is a long term, fixed income financial security.
Debenture holders are the creditors of the firm.
Preference share: It is called as a hybrid security because it has both the features
of equity shares and debentures. The dividend rate is fixed for preference share. It has no
voting rights. It can be redeemable or irredeemable preference share.

Differentiate Consolidation and liquidation:

 Consolidation: Consolidation is the combination of two or more companies into a
new company. Eg: Hindustan computers Ltd., Hindustan Instruments Ltd., Indian
Software Company Ltd., and Indian Reprographics Ltd., combined to form a new
company called HCL Ltd.
Liquidation: It is nothing but liquidating the company or selling the company’s
assets to realize cash if the business is terminated. It includes only tangible assets and not
intangibles like goodwill, patents etc.

Mention the different source of finance for rehabilitation of sick units:

What is called as sick units?

PART – B

What are the specific factors affecting the value of a particular company’s share?

Explain the important basic executive finance functions.

Or
Define finance function. Explain its components
OR
What are the basic financial decisions?
Financial management is the managerial activity which is concerned with the
planning and controlling of the firm’s financial resources.
Four important financial decisions or finance functions
1. Financing decisions or capital mix decisions
2. Investment decisions or Long term asset mix decisions
3. Dividend decisions or Profit allocation decisions
4. Liquidity decisions or Short term asset mix decisions
Financing decisions:
 The finance manager should decide how much fund to acquire and
wherefrom to acquire
 Mix of debt and equity should be decided which is known as
capital structure
 The finance manager should achieve optimum capital structure
which is nothing but maximizing the market value of the share
Investment decisions:
 Also known as capital expenditure decisions or capital budgeting
decisions
 Capital budgeting decisions are nothing but the firm’s decision to
invest their current fund in long term assets in anticipation of
future benefits over a series of years
 The main elements are long term assets, risk in investment and cost
of capital
Dividend decisions:
 The finance manager should decide whether the firm should
distribute all the profits to shareholders as dividend or retain all the
 profits for future investments or distribute a portion and retain the
balance
 Portion of profit distributed as dividend called Payout ratio or
dividend ratio
 Portion of profit retained called retention ratio
 Manager should achieve optimum payout ratio which is nothing
but maximizing the market value of share
Liquidity decisions:
 Investments in current assets affects profitability and liquidity of
firm
 More investment in current assets affects the profitability and less
investments in current assets affects the liquidity
 A balance between profitability and liquidity called as profitability
and liquidity trade off

Briefly explain the aims of corporate finance function.

Or
What is the importance of corporate finance?
Corporate finance deals with the financial problems of corporate enterprises.
These problems include the financial aspects of the promotion of new enterprises and
their administration during early development, the accounting problems connected with
the distinction between capital and income, the administrative questions created by
growth and expansion and the financial adjustments required for the rehabilitation of
companies.
Aims or importance of corporate finance:
 Determines role of state on capital issues, impose tax on corporate income
 Provides finance directly and indirectly to corporate
 Assesses financial needs of industries
 Indicates internal and external source of finance
 Analyses the efficiency of financial institutions in mobilizing savings
 Describes various means of mobilizing savings and its investment
 Directs regulation against fraud practices of management
 Examines the relationship between industry and financial institutions

Define the term Economic Value Added (EVA). Can it be a good means of the
performance of financial manager?
EVA is defined as the net earnings (PAT) in excess of the charges for
shareholders invested capital
EVA = PAT – (Cost of equity X Equity capital)
Suppose if information o debt and equity not available separately, the following
popular method can be used to calculate EVA
EVA = NOPAT – COCE
EVA – Economic Value Added
NOPAT = Net Operating profit after tax = PBIT – tax (or) PAT + interest – tax
COCE = Charges on capital employed
Advantages of EVA:
1. It can be calculated for divisions and even projects
2. It is a measure that takes into the performance over a series of years
not on particular time only.
3. It depends on the ongoing and future operations of the firm
4. It is not bound by Generally Accepted Accounting Principles (GAAP)
5. It is a measure of firm’s economic profit
6. It is an effective tool for investor communication
7. It is an anchor for internal corporate governance which motivates
employees to work better.

It can be a good measure for the performance of financial manager because,

1. There is a EVA bonus plan for managers and shareholders
2. Bonus is linked to increases in EVA
3. There is no floor or ceiling on the bonus
4. The target bonus is generous
5. A bonus bank is established
Implementing EVA system:
1. Develop top management commitment
2. Customize the definitions of EVA
3. Identify EVA centers
4. Analyze the drivers of EVA
5. Tailor an incentive compensation system
6. Train all the employees

What is agency problem? How conflicts can be resolved in this case?

 Agency relationship develops when owners or shareholders
hires agents or mangers to manage their business
 Each and everyone wants to maximize their own wealth in the
business which creates agency problem
 Problems that arise in agency relationships are called as agency
problems
 Agency problem may occur in the following agency
relationship
i. Relationship between shareholders and managers
1. Managers act according to management and
neglects dividend payment to shareholders and
this creates problem between shareholders and
managers.
2. To overcome this problem management should
do
a. Monitoring managers’ performance
b. Performance based Incentives to
managers
c. Periodically audit financial statements
and limit managers roles
 d. Provide shares to managers (Stock
option)
ii. Relationship between shareholders and creditors
1. Creditors have fixed claim on company
resources in the form of long term debt, bank
loans, leases etc
2. Creditors have fixed return whereas
shareholders have variable returns. This creates
problem between shareholders and creditors
3. Sometimes in loan covenants creditors restrict
dividend payment to shareholders and getting
new debt.
4. These agency problem lead to agency cost and
affect the long survival of the firm

Explain the role played by the financial institutions in fulfilling the financial needs of the
corporations.

Bring out the scope of corporate finance

 It describes current and past financial practices of the company
 Helps to formulate principles for sound financial procedure
 Deals with financial problems
 Studies financial operation of firm from inception to growth
 It studies about causes and remedies for sickness of industries
 Studies about corporate restructuring like mergers, acquisition, takeover
etc
 Deals with leasing, mutual funds, venture capital
 Studies the nature, extent and form of capital required
 Studies about the different source of finance
 Explains the valuation of securities like share, bonds etc
 Describes hedging techniques like futures and options
 Also studies about the dividend decisions by the firm
 Studies about the financial assistance by domestic and international
financial institutions
 Studies about MNC’s, inflation and capital budgeting decisions

How financial institutions help in reducing the cost of capital of firms?

Why companies use debt capital? What are the limitations on it?

What do you mean by corporate finance? Discuss its nature

Corporate finance deals with the financial problems of corporate enterprises.
These problems include the financial aspects of the promotion of new enterprises and
their administration during early development, the accounting problems connected with
the distinction between capital and income, the administrative questions created by
growth and expansion and the financial adjustments required for the rehabilitation of
companies.
Nature of corporate finance:
 It describes current and past financial practices of the company
 Helps to formulate principles for sound financial procedure
 Deals with financial problems
 Studies financial operation of firm from inception to growth
 It studies about causes and remedies for sickness of industries
 Studies about corporate restructuring like mergers, acquisition, takeover
etc
 Deals with leasing, mutual funds, venture capital
 Studies the nature, extent and form of capital required
 Studies about the different source of finance
 Explains the valuation of securities like share, bonds etc
 Describes hedging techniques like futures and options
 Also studies about the dividend decisions by the firm
 Studies about the financial assistance by domestic and international
financial institutions
 Studies about MNC’s, inflation and capital budgeting decisions
 Determines role of state on capital issues, impose tax on corporate income
 Provides finance directly and indirectly to corporate
 Assesses financial needs of industries
 Indicates internal and external source of finance
 Analyses the efficiency of financial institutions in mobilizing savings
 Describes various means of mobilizing savings and its investment
 Directs regulation against fraud practices of management
 Examines the relationship between industry and financial institutions

Explain the concept of corporate finance. What are the decisions that a finance manager
takes in this regard
Corporate finance deals with the financial problems of corporate enterprises.
These problems include the financial aspects of the promotion of new enterprises and
their administration during early development, the accounting problems connected with
the distinction between capital and income, the administrative questions created by
growth and expansion and the financial adjustments required for the rehabilitation of
companies.
Four important financial decisions or finance functions
5. Financing decisions or capital mix decisions
6. Investment decisions or Long term asset mix decisions
7. Dividend decisions or Profit allocation decisions
8. Liquidity decisions or Short term asset mix decisions
Financing decisions:
 The finance manager should decide how much fund to acquire and
wherefrom to acquire
  Mix of debt and equity should be decided which is known as
capital structure
 The finance manager should achieve optimum capital structure
which is nothing but maximizing the market value of the share
Investment decisions:
 Also known as capital expenditure decisions or capital budgeting
decisions
 Capital budgeting decisions are nothing but the firm’s decision to
invest their current fund in long term assets in anticipation of
future benefits over a series of years
 The main elements are long term assets, risk in investment and cost
of capital
Dividend decisions:
 The finance manager should decide whether the firm should
distribute all the profits to shareholders as dividend or retain all the
profits for future investments or distribute a portion and retain the
balance
 Portion of profit distributed as dividend called Payout ratio or
dividend ratio
 Portion of profit retained called retention ratio
 Manager should achieve optimum payout ratio which is nothing
but maximizing the market value of share
Liquidity decisions:
 Investments in current assets affects profitability and liquidity of
firm
 More investment in current assets affects the profitability and less
investments in current assets affects the liquidity
 A balance between profitability and liquidity called as profitability
and liquidity trade off

Discuss the importance of financial management

Discuss the scope of financial management

Explain briefly the basic objectives of financial management

Or
What are the objectives of financial management?