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Financial Study Guide

Course

Lecturer

University

Date
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Financial Study Guide

Overview

This study guide covers ten finance topics, including capital forms and raising capital,

integrating theoretical frameworks and practical applications. It is a powerful tool for business

students and professionals, focusing on capital structures, financial reporting, risk and return,

valuation techniques, and comprehensive financial planning.

Forms of Capital
Overview

This section explores the various forms of capital and their impact on corporate financial

strategy, focusing on how firms fund their operations and growth.

Key Topics:

Types of Assets:

Real Assets: These include the actual physical structures, machinery, and equipment that

are required to conduct operations. As physical assets, their value can actually be measured in

financial terms.

Intangible Assets: Examples are intellectual property, goodwill, and trademarks. They

enhance competitive advantage, but value ascribing to them is a challenge (Crouzet et al.,2022,

p.30).

Financial Assets: This consists of legal claims and includes stocks and bonds, which

again represent sources of income or ownership

Debt vs. Equity Capital:

Debt Capital:

Characteristics of Debt: It does not involve giving rights of ownership. This is debt

financing. Periodic interest on payments is allowed to be deducted for tax purposes.

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Risks and Returns: Here, the debt holders have fixed returns and priority in liquidation,

and the risks associated with debt are much lesser than those associated with equity.

Equity Capital:

Common Equity: It confers ownership rights, residual claims, and voting rights.

Preferred Equity: It provides fixed dividend payments and has a priority over common

equity in liquidation but no voting rights.

Uses and Users:

Firms evaluate cost, risk, and other implications of debt versus equity in firm financial

policy. Investors study these variables to achieve an optimal portfolio return with a minimum

amount of risk.

Financial Reporting
Overview

Financial reporting is a set of procedures that communicates a business's financial status

and performance to interested users, promoting clarity and responsibility (Jorge, 2021, p. 3).

Key Topics:

Types of Financial Statements:

Balance Sheet: Carries an account of all the assets, liabilities, and equity; this statement

provides information about a firm's stability.

Income Statement: Represents net income derived for a certain period by showing

revenues and gains and expenses and losses, sometimes also known as a profit-and-loss

statement.

Cash Flow Statement: Summarizes inflows and outflows of cash, depicting the liquidity

and efficiency of the operations.

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Statement of Stockholders' Equity: This represents changes in equity, and from this, one

could determine what value it is to the shareholders.

Users and Sources:

Internal users are the decision-makers such as managers and employees, relying on the

content of financial statements.

Other external users who would need financial reports include investors and regulators

for risk and performance evaluation.

sources: regulatory filings (e.g., SEC reports), corporate websites.

Applications:

Financial statements help stakeholders assess a company's solvency, profitability, and

growth potential (Olayinka, 2022, p. 50). Practical illustrations show that keen interpretation of

such reports is of vital importance.

Risk and Return

Overview

Understanding risk and return provides insight, enabling investors to construct efficient

portfolios by weighing the potential gain against the intrinsic risks.

Key Topics:

Types of Returns:

Single-period Return: Performance of a single period, which is therefore crucial for

short-term decision-making.

Holding-period Return: Conveys the returns of many successive periods into an extended

view of performance.
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Expected Return: This can be seen as an average outcome that helps the investor build

expectations.

Measures of Risk: Variance and Standard Deviation: Measures of volatility are useful

when comparing several investments.

Beta: A measure that enables the assessment of the sensitivity of the security to changes

in the marketplace, therefore allowing for a proper diversification strategy.

Portfolio Theory:

Diversification reduces risk by incorporating assets whose correlations are low.

CAPM Capital Asset Pricing Model relates risk with expected return and provides a

yardstick against which investments can be judged.

Applications: Various real-world applications show the diversification of risk and the

risk/return trade-offs that sharpen portfolio robustness and profitability.

Cost of Capital
Overview

Accurate capital cost estimation is crucial for evaluating investment viability, creating

shareholder value, setting project thresholds, and evaluating corporate strategy.

Key Topics

Cost of Equity: gotten from models like CAPM or DDM; this is the return demanded by

investors for their equity investment.

Debt Cost: While one typically gets the current yield for the bond or credit spread from

the market, the actual cost to the firm has to consider the tax benefit:

Weighted Average Cost of Capital (WACC):

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Combining Cost of Equity and Debt: weighted together by each component's respective

capital structure proportion to arrive at a single consolidated rate applicable for discounting

future cash flows.

Applications: WACC is one of the basic means of discounting flows, evaluating the feasibility

of projects, and making strategic decisions in corporate finance.

Capital Structure

Overview

This module explores the theoretical and empirical aspects of capital structure decisions,

which significantly impact a firm's financial risk, manager flexibility, and value.

Key Topics:

Capital structure represents the mix of debt and equity used to finance business

operations and growth.

Optimal capital structure balances risk and return for the lowest possible cost of capital.

Theories:

M&M propositions show that in perfect markets, the capital structure is irrelevant, while

including taxes and leverage is desirable.

Static Trade-off Theory presumes a trade-off between tax shield gains and bankruptcy risks.

Applications: Theories of capital structure are applied by firms to relate financing policy and

strategies to the long-term goals of the firm.

Valuation and Capital Budgeting for Levered Firms

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Overview

Valuation approaches for levered companies help determine the impact of indebtedness

on firm value, providing guidance in corporate finance and considering financing and operating

variables within a firm's business strategy.

Key Topics

Methods: Adjusted Present Value: This approach enables the separation of the unlevered

operating value from various effects caused by the financing, such as tax shields; in this method,

flexibility is given during analysis with respect to different levels of debt.

FTE: Focuses on cash flows available to the equity owners, discounted at the cost of

equity; it is a model that would be ideal for the assessment of equity specifically

WACC: A blended discount rate combining the costs of debt and equity. This will be

suitable for projects where the debt-to-value ratio remains constant.

Applications: These project valuation techniques enable firms to evaluate a project for

different levels of leverage while permitting consistency with strategic goals along with optimum

capital structure.

Cash Flows
Overview

Cash flows are, in fact, the very foundation of valuation, as they most accurately reflect

the true underlying financial health and operational performances of the firms.

Key Topics:

Types:

Operating Cash Flows (OCF): represents core business activities.

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Free Cash Flows (FCF): is the amount of cash available after covering capital

expenditures.

Equity Cash Flows (FCFE): underlines the returns available for shareholders.

Applications: Forecasting of cash flows and estimation of terminal value become

immensely vital for long-term investment decisions.

Options in Finance

Overview

Options provide both investors and corporations with financial flexibility, as they allow

their holders to either control risk or realize an opportunity.

Key Issues:

Fundamentals: Options are contracts conveying a right to purchase or sell some security

that provides an opportunity for strategic positioning, given changing market conditions.

Valuation Models: The Black-Scholes model and Binomial model determine the fair

values of options; some variables include volatility and time.

Applications

Options could be used to compensate workers, control risks, and engage in other

speculative activities.

Options in Finance (Advanced)

Overview

Advanced options are complex financial instruments that offer flexibility and innovative

solutions to financial problems, combining equity and debt in a single package for better

decision-making.

Key Topics
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The complex instruments provide an ability to tailor financing strategy. Though

instruments like convertible bonds and hybrid securities have some unique advantages in

offering debt-like stability with the growth potential of equity.

Applications: These case studies highlight the use of advanced options to attain optimal

capital structure, management of financial risks, and making strategic investment decisions to

facilitate growth in the long run.

Raising Capital
Overview

This section discusses corporate finance strategies using venture capital, private

placement, and initial public offerings—all essential components for expansion, innovation, and

competitiveness in volatile markets.

Key Topics

Mechanisms: IPOs and SEOs: Private placements offer tailored funding with even greater

flexibility in relation to access to equity markets.

Costs and Risks: Businesses should balance the direct expenses of underwriting fees

against the indirect costs of management time and the impact of underpricing on overall

productivity.

Applications: While the long-term objectives of expansion are achieved, a carefully

considered and implemented capital-raising strategy guarantees that the company will continue

to be strong and maintain its competitive advantage.

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References

Crouzet, N., Eberly, J.C., Eisfeldt, A.L. and Papanikolaou, D., 2022. The economics of

intangible capital. Journal of Economic Perspectives, 36(3), pp.29-52.

Jorge, S., 2021. Scope of general purpose financial reporting: an accountability perspective.

Olayinka, A.A., 2022. Financial statement analysis as a tool for investment decisions and

assessment of companies’ performance. International Journal of Financial, Accounting,

and Management, 4(1), pp.49-66.