Corporate Finance PDF

# Corporate Finance ## Overview 1. **Definition:** How companies manage their finances: * **Frances:** Investment decisions * **Structure capital:** To maximise shareholder value 2. **Main objectives:** * a) Maximise shareholder worth * b) Balance risk/profitability * c) Ensure...

# Corporate Finance ## Overview 1. **Definition:** How companies manage their finances: * **Frances:** Investment decisions * **Structure capital:** To maximise shareholder value 2. **Main objectives:** * a) Maximise shareholder worth * b) Balance risk/profitability * c) Ensure efficient allocation of resources ## Financial Statements & Analysis 1. **Key financial statements:** * a) **Income statement:** Shows revenue, expenses, and profits over a specific period. * b) **Balance sheet:** Provides a snapshot of assets, liabilities, and shareholders' equity at a specific time. * c) **Cashflow statement:** Details cash inflows and outflows, segmented into operating, investing, and financing activities. 2. **Financial ratios:** * a) **Profitability:** Measures company's ability to generate profit. * e.g., Gross margin, net margin, return on equity * b) **Liquidity:** Ability to cover short-term obligations * e.g., Current ratio, quick ratio * c) **Leverage:** Assesses a company's use of debt * e.g., Debt to equity, interest coverage * d) **Efficiency:** Evaluate how well assets are utilized * e.g., Inventory turnover, asset turnover ## Capital Budgeting & Investment Decisions 1. **Goal:** Evaluate and select projects or investments that add value to the company. 2. **Key Methods:** * a) **Net Present Value (NPV):** Present value of cash flows minus the initial investment. Projects with a positive NPV are generally accepted. * b) **Internal Rate of Return (IRR):** Discount rate at which NPV is zero. If IRR is greater than the required returns, the project is considered a good investment. * c) **Payback Period:** Time required to recover the initial investment. Shorter payback periods are preferred. * d) **Profitability Index (PI):** Ratio of present value of future cash flows to initial investment. PI > 1 indicates a viable project. ## Cost of Capital 1. **Definition:** Rate of return a company must earn on its investments to maintain its market value and satisfy investors. 2. **Components:** * a) **Cost of Equity:** Return required by equity investors. Calculated using models like CAPM (Capital Asset Pricing Model). * b) **Cost of Debt:** Effective interest rate on a company's debt, usually lower than the cost of equity due to tax benefits. * c) **Weighted Average Cost of Capital (WACC):** Average cost of capital across all sources of capital, weighted by respective proportions. ## Capital Structure 1. **Definition:** The mix of debt, equity, and other securities a company uses to finance its operations and growth. 2. **Trade-off Theory:** Balances tax benefits of debt with the risk of financial distress. 3. **Pecking Order Theory:** Companies prefer financing sources in this order: * Internal funds * Debt * Equity 4. **Optimal Capital Structure:** Debt-equity ratio that minimizes WACC and maximises firm value. ## Dividends Policy 1. **Purpose:** Provide returns to shareholders, signal financial health. 2. **Types of Dividends:** * a) **Cash:** Direct cash payments to shareholders * b) **Stock:** Extra shares issued to shareholders (not cashflow). 3. **Dividends Theories:** * a) **Dividend irrelevance:** In perfect markets, dividends don't affect company value. * b) **Bird-In-The-Hand:** Investors prefer dividends over potential future gains. * c) **Tax preference:** Some investors prefer capital gains over dividends for tax efficiency. ## Working Capital Management 1. **Definition:** Managing short-term assets and liabilities to ensure sufficient liquidity for daily operations. 2. **Key components:** * a) **Cash management:** Ensuring enough cash is available for expenses, optimizing any excess cash. * b) **Inventory management:** Balancing inventory to meet demand without overstocking (e.g., just-in-time inventory). * c) **Accounts Receivable management:** Managing credit extended to customers, aiming for shorter collection periods. * d) **Accounts Payable management:** Optimizing payment terms with suppliers without affecting relationships. ## Mergers & Acquisitions (M&A) 1. **Types of Mergers:** * a) **Horizontal:** Between companies in the same industry. * b) **Vertical:** Between companies at different stages of the supply chain. * c) **Conglomerate:** Between companies in unrelated industries. 2. **Reasons for Mergers:** * a) **Achieve synergies:** Combined effort. * b) **Expand market reach:** * c) **Diversify risk:** * d) **Gain economies of scale:** Cost advantages achieved when production increases. 3. **Valuation Methods in M&A:** * **DCF (Discounted cash flow):** Present value of future cash flows based on expected future cash flows. * **Comparable company analysis (CCA):** Assessing company valuation by comparing it to similar companies. * **Precedent transactions:** Examining company value based on prices paid in similar past M&A transactions. ## Risk Management 1. **Types of financial risk:** * a) **Market risk:** From changes in market conditions. * b) **Credit risk:** From counterparty not fulfilling obligations. * c) **Operational risk:** From errors in processing. 2. **Risk mitigation Techniques:** * a) **Hedging:** Using financial instruments (derivatives) to offset potential losses. * b) **Diversification:** Investing in various assets to spread risk. * c) **Insurance:** Transferring risk to insurance providers for events like property damage/liability. ## Corporate Governance 1. **Definition:** System of rules and practices ensuring accountability, fairness, and transparency in a company's relationship with stakeholders. 2. **Key components:** * a) **Board of Directors:** Elected group overseeing company management and decision making. * b) **Shareholder Rights:** Ensures shareholders' interests are represented and protected. * c) **Transparency:** Accurate and timely disclosure of financial and operational information. ## Investments ### Overview 1. **Definition:** The allocation of capital with the expectation of generating a return/profit. 2. **Types of Investments:** * a) **Equity:** Ownership in a company, usually in the form of stocks. * b) **Debt:** Lending money to an entity such as bonds. * c) **Alternative Investments:** Real estate, commodities, hedge funds, private equity, etc.