Q.1.what are 4 Finance decisions taken by a Finance Manager.

Answer: Corporate finance is the field of finance dealing with financial decisions that business enterprises 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 firms 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, short term decisions deal 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).[citation needed] The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms corporate finance and corporate financier may be associated with transactions in which capital is raised in order to create, develop, grow or acquire businesses. Capital investment decisions are long-term corporate finance decisions relating to fixed assets and capital structure. Decisions are based on several inter-related criteria. (1) 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 in consideration of risk. (2) These projects must also be financed appropriately. (3) If no such opportunities exist, maximizing shareholder value dictates that management must return excess cash to shareholders (i.e., distribution via dividends). Capital investment decisions thus comprise an investment decision, a financing decision, and a dividend decision. 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 investment, or capital allocation, decision requires estimating the value of each opportunity or project, which is a function of the size, timing and predictability of future cash flows. Project valuation further information: Business valuation, 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. Such 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. See financial modeling. The NPV is greatly affected by the discount rate. Thus, identifying the proper discount rate - often termed, the project "hurdle rate"[5] - is critical to making an appropriate 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. Alternatives (complements) to NPV include MVA / EVA (Joel Stern, Stern Stewart &Co) and APV (Stewart Myers). See list of valuation topics. Valuing flexibility In many cases, for example R&D projects,
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a project may open (or close) the 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 flexible and staged nature of the investment is modeled, 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);[9] they may often be used interchangeably: DTA values flexibility by incorporating possible events (or states) and consequent management decisions. (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 modeled separately.) 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, and assuming rational decision making, management chooses the actions corresponding to the highest value path probability weighted; (3) this path is then taken as representative of project value. See Decision theory: Choice under uncertainty. ROA is usually used when the value of a project is contingent on the value of some other asset or underlying variable. (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, and management will develop the ore body. Again, a DCF valuation would capture only o ne of these outcomes.) Here: (1) using financial option theory as framework, the decision to be taken is identified as corresponding to either a call option or a put option; (2) an appropriate valuation technique is then employed - usually a variant on the Binomial options model or a bespoke simulation model, while Black Scholes type formulae are used less often; see Contingent claim valuation. (3) The "true" value of the project is then the NPV of the "most likely" scenario plus the option value. (Real options in corporate finance were first discussed by Stewart Myers in 1977; viewing corporate strategy as a series of options was originally per Timothy Luehrman, in the late 1990s.)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, and is calculated as a "slope": NPV /Factor. For example, the analyst will determine NPV at various growth rates in annual revenue as specified (usually at set increments, e.g. -10%, -5%, 0%, 5 %....), and then determine the sensitivity using this formula. Often, several variables may be of interest, and their various combinations produce a "value-surface" (or even a "value-space"), where NPV is then a function of several variables. See also Stress testing. Using a related technique, analysts also run scenario based forecasts of NPV. Here, a scenario comprises a particular outcome for economy-wide, "global" factors (demand for the product, exchange rates, commodity prices, etc...) as well as for company-specific factors (unit costs, etc...). As an example, the analyst may specify various revenue growth scenarios (e.g. 5% for "Worst Case", 10% for "Likely Case" and 25% for "Best Case"), where all key inputs are adjusted so as to be consistent with the growth assumptions, and calculate the NPV for each. Note that for scenario based analysis, the various combinations of inputs must be internally consistent, whereas for the sensitivity approach above, the simulation produces several thousand random but possible outcomes, or "trials"; see Monte Carlo Simulation versus What If Scenarios. The output is then a histogram of project NPV, and 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
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present value greater than zero (or any other value).Continuing the above example: instead of assigning three discrete values to revenue growth, and to the other relevant variables, the analyst would assign an appropriate probability distribution to each variable (commonly triangular or beta), and, where possible, specify the observed or supposed correlation between the variables. These distributions would then be "sampled" repeatedly - incorporating this correlation - so as to generate several thousand random but possible scenarios, with corresponding valuations, which are then used to generate the NPV histogram. The resultant statistics (average NPV and standard deviation of NPV) will be a more accurate mirror of the projects randomness" than the variance observed under the scenario based approach. These are often used as estimates of the underlying "spot price" and volatility for the real option valuation as above; see Real options valuation: Valuation inputs. A more robust Monte Carlo model would include the possible occurrence of risk events (e.g., a credit crunch) that drive variations in one or more of the DCF model inputs.[edit] The financing decision Main article: Capital structure Achieving the goals of corporate finance requires that any corporate investment be financed appropriately.[12] 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 structures those 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. Financing a project through debt results in a liability or obligation that must be serviced, thus entailing cash flow implications independent of the project's degree of success. Equity financing is less risky with respect to cash flow commitments, but results in a dilution of share ownership, control 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 Trade-Off Theoryin which firms are assumed to trade-off the tax benefits of debt with the bankruptcy costsof 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. The dividend decision Main article: The Dividend Decision Whether to issue dividends,[13] and what amount, is calculated mainly on the basis of the companys un appropriated profit and its earnings prospects for the coming year. The amount is also often calculated based on expected free cash flows i.e. cash remaining after all business expenses, and capital investment needs have been met. If there are no NPV positive opportunities, i.e. projects where returns exceed the hurdler ate, then - finance theory suggests - management must return excess cash to investors as dividends. This is the general case, however there are exceptions. For example, shareholders of 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 dividend distribution, generally as cash dividends or via a share buyback. Various factors may be taken into consideration: where shareholders must pay tax on dividends, firms may elect to retain earnings or to perform a stock buyback, in both cases increasing the value of shares outstanding. Alternatively, 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).

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Required, and from where it will come. It shows a schedule of the money coming into the business and expenses that need to be paid. The result is the profit or loss at the end of the month or year. In a cash-flow statement, both profits and losses are carried over to the next column to show the cumulative amount. Keep in mind that if you run a loss on your cash-flow statement, it is a strong indicator that you will need additional cash in order to meet expenses. Like the income statement, the cash-flow statement takes advantage of previous financial tables developed during the course of the business plan. The cash-flow statement begins with cash on hand and the revenue sources. The next item it lists is expenses, including those accumulated during the manufacture of a product. The capital requirements are then logged as a negative after expenses. The cash-flow statement ends with the net cash flow. The cash-flow statement should be prepared on a monthly basis during the first year, on a quarterly basis during the second year, and on an annual basis thereafter. Items that youll need to include in the cash-flow statement and the order in which they should appear areas follows: 1. Cash sales-- Income derived from sales paid for by cash. 2. Receivables-- Income derived from the collection of receivables. 3. Other income-- Income derived from investments, interest on loans that have been extended, and the liquidation of any assets. 4. Total income-- The sum of total cash, cash sales, receivables, and other income. 5. Material/Merchandise-- The raw material used in the manufacture of a product (for manufacturing operations only), the cash outlay for merchandise inventory (for merchandisers such as wholesalers and retailers), or the supplies used in the performance of a service. 6. Production labor-- The labor required to manufacture a product (for manufacturing operations only) or to perform a service. 7. Overhead-- All fixed and variable expenses required for the production of the product and the operations of the business. 8. Marketing/Sales-- All salaries, commissions, and other direct costs associated with the marketing and sales departments. 9. R&D-- All the labor expenses required to support the research and development operations of the business. 10. G&A-- All the labor expenses required to support the administrative functions of the business. 11. Taxes-- All taxes, except payroll, paid to the appropriate government institutions. 12. Capital-- The capital required to obtain any equipment elements that are needed for the generation of income. 13. Loan payment-- The total of all payments made to reduce any long-term debts. 14. Total expenses-- The sum of material, direct labor, overhead expenses, marketing, sales, G&A, taxes, capital, and loan payments. 15. Cash flow-- The difference between total income and total expenses. This amount is carried over to the next period as beginning cash. 16. Cumulative cash flow-- The difference between current cash flow and cash flowfrom the previous period. As with the income statement, you will need to analyze the cash-flow statement in a short summary in the business plan. Once again, the analysis statement doesn't have to be long and should cover only key points derived from the cash-flow statement. The Balance Sheet The last financial statement you'll need to develop is the balance sheet. Like the income and cash-flow statements, the balance sheet uses information from all of the financial models developed in earlier sections of the business plan; however, unlike the previous statements, the balance sheet is generated solely on an annual basis for the business plan and is, more or less, a summary of all the preceding financial information broken down into three areas: 1. Assets2. Liabilities3. Equity To obtain financing for a new business, you may need to provide a projection of the balance sheet over the period of time the business plan covers. More importantly, youll need to include a personal financial statement or balance sheet instead of one that describes the business. A personal balance sheet is generated
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in the same manner as one for a business. As mentioned, the balance sheet is divided into three sections. The top portion of the balance sheet lists your company's assets. Assets are classified as current assets and longterm or fixed assets. Current assets are assets that will be converted to cash or will be used by the business in a year or less. Current assets include: 1. Cash -- The cash on hand at the time books are closed at the end of the fiscal year. This refers to all cash in checking, savings, and short-term investment accounts. 2. Accounts receivable-- The income derived from credit accounts. For the balance sheet, it is the total amount of income to be received that is logged into the books at the close of the fiscal year. 3. Inventory-- This is derived from the cost of goods table. It is the inventory of material used to manufacture a product not yet sold. 4. Total current assets-- The sum of cash, accounts receivable, inventory, and supplies. Other assets that appear in the balance sheet are called long-term or fixed assets. They are called long-term because they are durable and will last more than one year. Examples of this type of asset include: 1. Capital and plant-- The book value of all capital equipment and property (if you own the land and building), less depreciation. 2. Investment-- All investments by the company that cannot be converted to cash in less than one year. For the most part, companies just starting out have not accumulated long-term investments. 3. Miscellaneous assets-- All other long-term assets that are not "capital and plant" or "investments." 4. Total long-term assets-- The sum of capital and plant, investments, and miscellaneous assets. 5. Total assets-- The sum of total current assets and total long-term assets. After the assets are listed, you need to account for the liabilities of your business. Like assets, liabilities are classified as current or long-term. If the debts are due in one year or less, they are classified as a current liability. If they are due in more than one year, they are long-term liabilities. Examples of current liabilities are as follows: 1. Accounts payable-- All expenses derived from purchasing items from regular creditors on an open account which are due and payable. 2. Accrued liabilities-- All expenses incurred by the business which are required for operation but have not been paid at the time the books are closed. These expenses are usually the company's overhead and salaries. 3. Taxes-- These are taxes that are still due and payable at the time the books are closed. 4. Total current liabilities-- The sum of accounts payable, accrued liabilities, and taxes. Long-term liabilities include: 1. Bonds payable-- The total of all bonds at the end of the year that is due and payable over a period exceeding one year. 2. Mortgage payable-- Loans taken out for the purchase of real property that are repaid over a long-term period. The mortgage payable is that amount still due at the close of books for the year. 3. Notes payable-- The amount still owed on any long-term debts that will not be repaid during the current fiscal year. 4. Total long-term liabilities-- The sum of bonds payable, mortgage payable, and notes payable. 5. Total liabilities-- The sum of total current and long-term liabilities. Once the liabilities have been listed, the final portion of the balance sheet -- owners equity -- needs to be calculated. The amount attributed to owner's equity is the difference between total assets and total liabilities. The amount of equity the owner has in the business is an important yardstick used by investors when evaluating the company. Many times it determines the amount of capital they feel they can safely invest in the business. In the business plan, you'll need to create an analysis statement for the balance sheet Justas you need to do for the income and cashflow statements. The analysis of the balance sheet should be kept short and cover key points about the company Q.3. what is the relationship between the coupon rate & the required rate of return that will result in a bond? Answer: If the coupon rate is lower, the bond is selling at a discount If the coupon rate is the same, the bond is selling at a face value
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If the coupon rate is higher , the bond is selling at a premium So coupon has an inverse relationship with required rate of return. Q.4. Discuss the implication of financial leverage for a firm. Answer: In finance, leverage is a general term for any technique to multiply gains and losses.[1]Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are: A public corporation may leverage its equity by borrowing money. The more it borrows, the less equity capital it needs, so any profits or losses are shared among a smaller base band are proportionately larger as a result. A business entity can leverage its revenue by buying fixed assets. This will increase the proportion of fixed, as opposed to variable, costs, and meaning that a change in revenue willresult in a larger change in operating income.Hedge funds often leverages their assets by using derivatives. A fund might get any gains or losses on $20 million worth of crude oil by posting $1 million of cash as margin. Measuring leverage good deal of confusion arises in discussions among people who use different definitions of leverage. The term is used differently in investments and corporate finance, and has multiple definitions in each field. [7]Investments Accounting leverage is total assets divided by total assets minus tot a liabilities. Notional leverage is total notional amount of assets plus total notional amount of liabilities divided by equity.[1] Economic leverage is volatility of equity divided by volatility of an unlevered investment in the same assets. To understand the differences, consider the following positions, all funded with $100 of cash equity. Buy $100 of crude oil. Assets are $100 ($100 of oil), there are no liabilities. Accounting leverage is 1 to 1. Notional amount is $100 ($100 of oil), there are no liabilities and there is $100 of equity. Notional leverage is 1 to 1. The volatility of the equity is equal to the volatility of oil, since oil is the only asset and you own the same amount as your equity, so economic leverage is 1 to 1.Borrow $100 and buy $200 of crude oil. Assets are $200; liabilities are $100 so accounting leverage is 2 to 1. Notional amount is $200; equity is $100 so notional leverage is 2 to 1. The volatility of the position is twice the volatility of an unlevered position in the same assets, so economic leverage is 2 to 1.Buy $100 of crude oil, borrow $100 worth of gasoline and sell the gasoline for $100. You now have $100 cash, $100 of crude oil and owe $100 worth of gasoline. Your assets are$200; liabilities are $100 so accounting leverage is 2 to 1. You have $200 notional amount of assets plus $100 notional amount of liabilities, with $100 of equity, so youre notional Leverage is 3 to 1. The volatility of your position might be half the volatility of an unlevered investment in the same assets, since the price of oil and the price of gasoline are positively correlated, so your economic leverage might be 0.5 to 1.Buy $100 of a 10-year fixed-rate treasury bond, and enter into a fixed-for-floating 10-year interest rate swap to convert the payments to floating rate. The derivative is off-balance sheet, so it is ignored for accounting leverage. Accounting leverage is therefore 1 to 1.The notional amount of the swap does count for notional leverage, so notional leverage is2 to 1. The swap removes most of the economic risk of the Treasury bond, so economic leverage is near zero. Corporate finance Degree of Operating Leverage (DOL)= (EBIT + Fixed costs) / EBIT; Degree of Financial Leverage (DFL)= EBIT / ( EBIT - Total Interest expense );Degree of Combined Leverage (DCL)= DOL * DFL Accounting leverage has the same definition as in investments. There are several ways to define operating leverage, the most common. is:

Financial leverage is usually defined as: Operating leverage is an attempt to estimate the percentage change in operating income (earnings before interest and taxes or EBIT) for a one percent change in revenue. Financial leverage tries to estimate the percentage change in net income for a one percent change in operating income. The product of the two is called Total leverage, and estimates the percentage change innet
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income for a one percent change in revenue. There are several variants of each of these definitions, and the financial statements are usually adjusted before the values are computed. Moreover, there are industryspecific conventions that differ somewhat from the treatment above. Leverage and ROE If we have to check real effect of leverage on ROE, we have to study financial leverage. Financial leverage refers to the use of debt to acquire additional assets. Financial leverage may decrease or increase return on equity in different conditions. Financial over-leveraging means incurring a huge debt by borrowing funds at a lower rate of interest and utilizing the excess funds in high risk investments in order to maximize returns. Leverage and risk The most obvious risk of leverage is that it multiplies losses. A corporation that borrows too much money might face bankruptcy during a business downturn, while a less-levered corporation might survive. An investor who buys a stock on 50% margin will lose 40% of his money if the stock declines 20%.There is an important implicit assumption in that account, however, which is that the underlying levered asset is the same as the unlevered one. If a company borrows money to modernize, or add to its product line, or expand internationally, the additional diversification might more than offset the additional risk from leverage.[9] Or if an investor uses a fraction of his or her portfolio to margin stock index futures and puts the rest in a money market fund, he or she might have the same volatility and expected returns an investor in an unlevered equity index fund, with a limited downside.[6] So while adding leverage to a given asset always adds risk, it is not the case that a levered company or investment is always riskier than an unlevered one. In fact, many highly-levered hedge funds have less return volatility than unlevered bond funds,[6] and public utilities with lots of debt are usually less risky stocks than unlevered technology companies. Popular risks There is a popular prejudice against leverage rooted in the observation that people who borrow a lot of money often end up badly. But the issue here is those people are not leveraging anything, they're borrowing money for consumption. In finance, the general practice is to borrow money to buy an asset with a higher return than the interest on the debt. That at least might work out. People who consistently spend more than they make have a problem, but it's overspending (or under earning), not leverage. The same point is more controversial for governments. People sometimes borrow money out of desperation rather than calculation. That also is not leverage. But it is true that leverage sometimes increases involuntarily. When Long-Term Capital Management collapsed with over 100 to 1 leverage, it wasn't that the principals tried to run the firm at 100 to 1 leverage, it was that as equity eroded and they were unable to liquidate positions, the leverage level was beyond their control. One hundred to one leverage was a symptom of their problems, not the cause (although, of course, part of the cause was the 27 to 1 leverage the firm was running before it got into trouble, and the 55 to 1 leverage it had been forced up to by mid-August 1998 before the real troubles started).[9] But the point is the fact that collapsing entities often have a lot of leverage does not mean that leverage causes collapses. Involuntary leverage is a risk. It means that as things get bad, leverage goes up, multiplying losses as things continue to go down. This can lead to rapid ruin, even if the underlying asset value decline is mild or temporary. The risk can be mitigated by negotiating the terms of leverage, and by leveraging only liquid assets. Forced position reductions A common misconception is that levered entities are forced to reduce positions as they lose money. This is only true if the entity is run at maximum leverage.[1] For example, if a person has $100, borrows another $100 and buys $200worth of oil, he has 2 to 1 accounting leverage. If the price of oil declines 25%, he has$50 of equity supporting $150 worth of oil, 3 to 1 accounting leverage. If 2 to 1 is the maximum his counterparties will allow him, he has to sell one-third of his position to pay his debt down to $50. Now if oil goes back up to the original price, he has only $83 of equity. He lost 17 percent of his equity, even though the p (say) $10 of cash margin to enter into $200 of long oil futures contracts. Now if the price of oil declines 25%, the investor has to put up an additional $50 of margin, but she still has $40 of unencumbered cash. She may or may not wish to reduce the position, but she is not forced to do so. The point is that it is using maximum leverage that can force position reductions, not simply using leverage. [6] It often surprises people to learn that hedge funds running at 10 to 1 or higher notional leverage ratios hold 80 percent or 90 percent cash. Q.5 Year The cash flows associated with a project are given below: Cash flow
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0 1 2 3 4 5 Calculate the

(100,000) 25000 40000 50000 40000 30000 a) payback period. b) Benefit cost ratio for 10% cost of capital

Q6. A companys earnings and dividends are growing at the rate of 18% pa. The growth rate is expected to continue for 4 years. After 4 years, from year5 onwards, the growth rate will be 6% forever. If the dividend per share last year was Rs.2 and the investors required rate of return is 10% pa, what is the intrinsic price per share or the worth of one share? These need not be so. An 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. 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, themost 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. Here, 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 random but possible outcomes, or "trials"; seeMonte Carlo Simulation versus What If Scenarios. The output is then a histogram of project NPV, and 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).Continuing the above example: instead of assigning three discrete values to revenue growth, and to the other relevant variables, the analyst would assign an appropriate probability distribution to each variable (commonly triangular or beta), and, where possible, specify the observed or supposed correlation between the variables. These distributions would then be "sampled" repeatedly - incorporating this correlation - so as to generate several thousand random but possible scenarios, with corresponding valuations, which are then used to generate the NPV histogram. The resultant statistics (average NPVand standard deviation of NPV) will be a more accurate mirror of the projects randomness" than the variance observed under the scenario based approach. These are often used as estimates of the underlying "spot price" and volatility for the real option valuation as above; see Real options valuation: Valuation inputs. A more robust Monte Carlo model would include the possible occurrence of risk events (e.g., a credit crunch)that drive variations in one or more of the DCF model inputs.[edit] The financing decision Main article: Capital structure Achieving the goals of corporate finance requires that any corporate investment be financed appropriately.[12] As above, since both hurdle rate and cash flows (and hence the rockiness 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. Financing a project through debt results in a liability or obligation that must be serviced, thus entailing cash flow implications independent of the project's degree of success. Equity financing is less risky with respect to cash flow commitments, but results in a dilution of share ownership, control and earnings. The cost of equity is also typically higher than the cost of debt (see CAPM and WACC), and so equity financing may resulting 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 Trade-Off Theory in which firms
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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. The dividend decision Main article: The Dividend Decision Whether to issue dividends,[13] and what amount, is calculated mainly on the basis of the companys inappropriate profit and its earning prospects for the coming year. The amount is also often calculated based on expected free cash flows i.e. cash remaining after all business expenses, and capital investment needs have been met. If there are no NPV positive opportunities, i.e. projects where returns exceed the hurdle rate, then - finance theory suggests - management must return excess cash to investors as dividends. This is the general case, however there are exceptions. For example, shareholders of 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 opportunitys 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 dividend distribution, generally as cash dividends or via a share buyback. Various factors may be taken into consideration: where shareholders must pay tax on dividends, firms may elect to retain earnings or to perform stock buyback, in both cases increasing the value of shares outstanding. Alternatively, 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).

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