Unit I Financial MGT & Corporate Governance
Unit I Financial MGT & Corporate Governance
Unit I Financial MGT & Corporate Governance
Unit I
Corporate finance understands the financial problems of the organization beforehand and prevents
them. Capital investments become an important part of corporate financial decisions such as, if
dividends should be offered to shareholders or not, if the proposed investment option should be
rejected or accepted, managing short-term investment and liabilities.
Corporate finance includes, planning, raising, investing and monitoring of finance in order to achieve the
financial goals of the organization.
Financial Planning: Corporate finance includes preparation, raising funds, investing plus tracking
each finance of organization. At short, it offers all financial aspects for the firm.
Fund Raising: An important features of corporate finance is to raise funds for the company.
Finance can be accumulated through shares, bank loans, debentures, bonds, etc.
Goal Oriented: The main goal of corporate finance are to maximize profits, giving good
dividends to shareholders, as well as creating fund reserves for future expansion activities.
Investing Objective: The nature of corporate finance notes for every company is to optimize
investing needs for maximizing profits.
Finance Options: There are two main options in the nature of corporate finance, i.e. working
capital and fixed capital.
Connecting with Other Divisions
Dynamic in Nature
Business Management
Legal Requirements
Managing and Controlling
KEY POINTS:
Corporate finance is the process of obtaining and managing finances in order to optimize a
company’s growth and value for its shareholders.
The concept focusses on investment, financing and dividend principle.
The main functional areas are capital budgeting, capital structure, working capital management
and dividend decisions. For example, judging whether to invest in debt or equity as a medium to
raise funds for the business is the primary focus of capital structure decisions.
Going over the risk-return aspect of investment alternatives, ensuring working capital
management, etc. are some aspects of this branch of finance.
Corporate governance is the system of rules, practices, and processes by which a firm is directed and
controlled. Corporate governance essentially involves balancing the interests of a company's many
stakeholders, such as shareholders, senior management executives, customers, suppliers, financiers, the
government, and the community.
Since corporate governance also provides the framework for attaining a company's objectives, it
encompasses practically every sphere of management, from action plans and internal controls to
performance measurement and corporate disclosure.
Accountability
Transparency
Freedom / Independence
Fairness
KEY POINTS
Corporate governance is the structure of rules, practices, and processes used to direct and
manage a company.
A company's board of directors is the primary force influencing corporate governance.
Bad corporate governance can cast doubt on a company's operations and its ultimate
profitability.
Corporate governance entails the areas of environmental awareness, ethical behavior,
corporate strategy, compensation, and risk management.
The basic principles of corporate governance are accountability, transparency, fairness, and
responsibility.
An agency problem is a conflict of interest inherent in any relationship where one party is expected to
act in another's best interests. In corporate finance, an agency problem usually refers to a conflict of
interest between a company's management and the company's stockholders. The manager, acting as
the agent for the shareholders, or principals, is supposed to make decisions that will maximize
shareholder wealth even though it is in the manager’s best interest to maximize their own wealth.
The agency problem does not exist without a relationship between a principal and an agent. In this
situation, the agent performs a task on behalf of the principal. Agents are commonly engaged by
principals due to different skill levels, different employment positions, or restrictions on time and access.
For example, a principal will hire a plumber—the agent—to fix plumbing issues. Although the plumber‘s
best interest is to collect as much income as possible, they are given the responsibility to perform in
whatever situation results in the most benefit to the principal.
The agency problem arises due to an issue with incentives and the presence of discretion in task
completion. An agent may be motivated to act in a manner that is not favorable for the principal if the
agent is presented with an incentive to act in this way.
For example, in the plumbing example, the plumber may make three times as much money by
recommending a service the agent does not need. An incentive (three times the pay) is present, causing
the agency problem to arise.
A Corporate valuation is a general process of determining the economic value of a whole business or
company unit. Corporate valuation can be used to determine the fair value of a business for a variety of
reasons, including sale value, establishing partner ownership, taxation, and even divorce proceedings.
Owners will often turn to professional business evaluators for an objective estimate of the value of the
business.
Information to Stakeholders
Comparision with similar entities
Public listing
In case of events like Merge, Demerger, Acquisition
Corporate Valuation Model
Asset-Based Valuation:
Asset-based valuation is a form of valuation in business that focuses on the value of a company’s assets
or the fair market value of its total assets after deducting liabilities.
Earnings-based business valuation methods value your company by its ability to be profitable in the
future. It is best to use earnings-based valuation methods for a company that is stable and profitable.
An important feature of these methods is the possibility to adapt to the available information,
allowing a more detailed or simplified analysis depending on the quantity and quality of data
available to the appraiser.
WHAT IS CAPM?
The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and
expected return for assets, particularly stocks.
CAPM is widely used throughout finance for pricing risky securities and generating expected returns for
assets given the risk of those assets and cost of capital.
FORMULA
E(Ri) = Rf+bi(E(Rm)-Rf)
bi = Sensitivity
ASSUMPTION:
Risk Taker
Purchase & Sale of assets
No taxes No transaction Cost
Perfect competition
Investors should be rational
Availablity of information
Liquidity
Funds are available at risk rate
ADVANTAGES:
LIMITATION OF CAPM:
The Arbitrage Pricing Theory (APT) is a theory of asset pricing that holds that an asset’s returns can be
forecasted with the linear relationship of an asset’s expected returns and the macroeconomic factors
that affect the asset’s risk.
The theory was created in 1976 by American economist, Stephen Ross. The APT offers analysts and
investors a multi-factor pricing model for securities based on the relationship between a financial asset’s
expected return and its risks.
Where:
ASSUMPTION:
CONSTRAINT
Economic Value Added (EVA) or Economic Profit is a measure based on the Residual Income technique
that serves as an indicator of the profitability of projects undertaken.
Its underlying premise consists of the idea that real profitability occurs when additional wealth is
created for shareholders and that projects should create returns above their cost of capital.
Formula of EVA
ADVANTAGES OF EVA
Limitations
EVA and similar other metrics encourages managers of a company to have a short-sighted
approach, inasmuch as they are more inclined to focus on immediate benefits
Calculation is complicated
it is relates to “result orientation”, which implies that it is not a supportive tool to “point
towards the root causes of operational inefficiencies”.
The time value of money (TVM) is the concept that a sum of money is worth more now than the same
sum will be at a future date due to its earnings potential in the interim.
This is a core principle of finance. A sum of money in the hand has greater value than the same sum to
be paid in the future.
KEY POINTS
Time value of money means that a sum of money is worth more now than the same sum of
money in the future.
This is because money can grow only through investing. An investment delayed is an
opportunity lost.
The formula for computing the time value of money considers the amount of money, its future
value, the amount it can earn, and the time frame.
For savings accounts, the number of compounding periods is an important determinant as well.
REASONS
Risk involve
Inflation
Investment opportunities
Personal Consumption Preference
FV = PV x [ 1 + (i / n) ] ^(n x t)
Where
FV=Futurevalueofmoney
PV=Presentvalueofmoney
i=interestrate
n=numberofcompoundingperiodsperyear
t=numberofyears
TIME VALUE OF MONEY EXAMPLES
Assume a sum of 10,000 is invested for one year at 10% interest compounded annually. The future value
of that money is:
The number of compounding periods has a dramatic effect on the TVM calculations. Taking the 10,000
example above, if the number of compounding periods is increased to quarterly, monthly, or daily, the
ending future value calculations are:
PV = FV / (1 + (i / n) ^ ( n x t)
DEFINING ANNUITY
Annuity = series of cash flows of the same value occurring at equal intervals
TYPES OF ANNUITY
Perpetuity = never-ending sequence of cash flows = cash flows occur at the end of each period
indefinitely
The formula for the present value of an ordinary annuity, as opposed to an annuity due, is below.
Calculating the Future Value of an Ordinary Annuity
let's assume that you invest $1,000 every year for the next five years, at 5% interest.
In contrast to the future value calculation, a present value (PV) calculation tells you how much money
would be required now to produce a series of payments in the future, again assuming a set interest rate.
An annuity due, you may recall, differs from an ordinary annuity in that the annuity due's payments are
made at the beginning, rather than the end, of each period.
To account for payments occurring at the beginning of each period, it requires a slight modification to
the formula used to calculate the future value of an ordinary annuity and results in higher values, as
shown below.
The reason the values are higher is that payments made at the beginning of the period have more time
to earn interest. For example, if the $1,000 was invested on January 1 rather than January 31 it would
have an additional month to grow.
KEY Points
Recurring payments, such as the rent on an apartment or interest on a bond, are sometimes
referred to as "annuities."
In ordinary annuities, payments are made at the end of each period. With annuities due, they're
made at the beginning of the period.
The future value of an annuity is the total value of payments at a specific point in time.
The present value is how much money would be required now to produce those future
payments.
START-UP FINANCING (beginning of activity phase). In this stage the investor finances the production
activity even if the commercial success or flop of the product/service is not yet known. The level of
financial contributions and risk is high. Early stage financing (first development phase).
SOURCES OF FINANCE
A Personal Investment
When it comes to sources of finance, this one may be obvious. When starting a business, you
can choose to make a personal investment. This may include your savings or other assets you
have.
You can ask for a loan from your friends, parents, spouse, or other family members. Bankers call
this “patient capital.” It is money that is repaid once your business becomes profitable.
When it comes to sources of finance for small and startup companies, turning to the Small
Business Association (SBA) is a popular option. The SBA microloan program partners with
intermediary, nonprofit, and community-based lenders to provide borrowers.
Angel Investors
An angel investor is a wealthy person or retired company executive who wants to make a direct
investment in a small firm or startup company.
Usually, angel investors are considered leaders or experts in a specific niche or field.
Incubators
An incubator is an organisation, company, or university that will provide you with resources for
your startup company. The resources may include cash, consulting, marketing, laboratories,
office space, or anything else you may require for operations.
Some government agencies offer financing, such as subsidies and grants that your business may
qualify for.
Equipment Financing
If you require startup funding to buy equipment, consider equipment financing as a funding
option. One of the benefits of this is the self-secured nature that it offers.
Crowdfunding
crowdfunding is when you get funding from crowds, which means the general public. Usually, an
entrepreneur will use this option if they develop a product that is needed by people and not
available anywhere else.
Bank Loans
Bank loans are another source of financing you may want to consider. These offer several
benefits and customised repayment schedules. It is a good idea to shop around and find the
right lender in this situation.