CF - Study Material

Jeppiaar Engineering College Department of Management Studies
JEPPIAAR ENGINEERING COLLEGE

Jeppiaar Nagar, Rajiv Gandhi Salai, Chennai – 600 119
DEPARTMENT OF MANAGEMENT STUDIES
II YEAR MBA / III SEMESTER / FINANCE ELECTIVE
BA 9260 – CORPORATE FINANCE
STUDY MATERIAL
Faculty In-Charge
P.MATHURASWAMY
Associate Professor in Management Studies
III Semester Elective: BA9260, Corporate Finance Page 1

JEPPIAAR ENGINEERING COLLEGE

NBA accredited ISO 9001:2000 certified institution
Rajiv Gandhi Salai, Chennai – 600 119.
LIST OF CONTENTS
TITLE PAGE NO.
SYLLABUS
3-4
CORPORATE FINANCE
UNIT I
5 - 32
INDUSTRIAL FINANCE
UNIT II
SHORT TERM-WORKING CAPITAL 33 - 40
FINANCE
UNIT III
ADVANCED FINANCIAL 41 - 51
MANAGEMENT
UNIT IV
52 - 61
FINANCING DECISION
UNIT V
62 – 70
CORPORATE GOVERNANCE
(FAQS)
FREQUENTLY ASKED QUESTIONS 71 - 72

BA 9260 CORPORATE FINANCE LT P C

3003
UNIT – I INDUSTRIAL FINANCE 9

Indian Capital Market – Basic problem of Industrial Finance in India. Equity – Debenture
financing – Guidelines from SEBI, advantages and disadvantages and cost of various sources
of Finance - Finance from international sources, financing of exports – role of EXIM bank
and commercial banks.– Finance for rehabilitation of sick units.
UNIT – II SHORT TERM-WORKING CAPITAL FINANCE 6

Estimating working capital requirements – Approach adopted by Commercial banks,
Commercial paper- Public deposits and inter corporate investments.
UNIT – III ADVANCED FINANCIAL MANAGEMENT 12

Appraisal of Risky Investments, certainty equivalent of cash flows and risk adjusted discount
rate, risk analysis in the context of DCF methods using Probability information, nature of
cash flows, Sensitivity analysis; Simulation and investmentdecision, Decision tree approach in
investment decisions.
UNIT – IV FINANCING DECISION 10

Simulation and financing decision - cash inadequacy and cash insolvency- determining
the probability of cash insolvency- Financing decision in the Context of option pricing
model and agency costs- Inter-dependence of investment- financing and Dividend decisions.
UNIT – V CORPORATE GOVERNANCE 8

Corporate Governance - SEBI Guidelines- Corporate Disasters and Ethics- Corporate
Social Responsibility- Stakeholders and Ethics- Ethics, Managers and Professionalism.
TOTAL: 45 PERIODS
TEXT BOOKS

1. Richard A.Brealey, Stewat C.Myers and Mohanthy, Principles of Corporate

Finance, Tata McGraw Hill, 8th Edition, 2008
2. I.M.Pandey, Financial Management, Vikas Publishing House Pvt., Ltd., 11th
Edition,
2008.
REFERENCES
1. Brigham and Ehrhardt, Corporate Finance - A focused Approach, Cengage

Learning,
1st Edition, 2008.
2. M.Y Khan, Indian Financial System, Tata McGraw Hill, 5th Edition, 2008
3. Smart, Megginson, and Gitman, Corporate Finance, 1st Edition, 2008.
4. Krishnamurthy and Viswanathan, Advanced Corporate Finance, PHI Learning,
2008.
5. Website of SEBI
II Year / III Semester Elective: BA9260, Corporate Finance Page 4

CORPORATE FINANCE
UNIT – I INDUSTRIAL FINANCE
Indian Capital Market – Basic problem of Industrial Finance in India. Equity – Debenture
financing – Guidelines from SEBI, advantages and disadvantages and cost of various
sources of Finance - Finance from international sources, financing of exports – role of
EXIM bank and commercial banks. – Finance for rehabilitation of sick units.

CORPORATE FINANCE
Unit-I
Define corporate finance.
Corporate Finance is the specific area of finance dealing with the financial decisions
corporations make, and the tools and analysis used to make the decisions. The discipline
as a whole may be divided between long term, capital investment decisions, and short
term, working capital management.
Corporate finance has two basic functions:-
Acquisition of Resources
Acquisition of resource means fund generation at lowest possible cost. Resource

generation can be done through:-
 Equity --- It includes proceeds obtained from stock selling, retained earnings, and
investment returns.
 Liability --- It includes bank loans, warranties of products and payable account.
• Allocation of Resources
Investment of funds for profit maximization motive is known as allocation of resources.

Investment can be categorized into two groups:-
 Fixed Asset --- Land, Machinery, buildings, etc.

 Current Asset --- Inventory, cash, receivable accounts, etc.
Corporate or business finance is all about raising and allocation of funds for increasing
profit. Senior management chalks out long-term plan for fulfilling future objectives.
Value of the company's stock is a very important issue for the management because it is
directly related to the wealth of the share-holders of the company.
Functions of Corporate Finance are:-
 Raising of Capital or Financing

 Budgeting of Capital
 Corporate Governance
 Financial management
 Risk Management

All the above functions are interrelated and interdependent. For example, in order to
materialize a project a company needs to raise capital. So, budgeting of capital and
financing are interdependent.
Decisions making of the corporate finance are basically of two types based on the time
period for the same, namely, Long term and Short term.
i . Long term decisions:-
It is basically concerned with the capital investment decisions such as viability

assessment of the project, financing it through equity or debt, pay dividend or reinvest out
of the profit.
Long term corporate finance which is generally related to fixed assets and capital
structure are called Capital Investment Decisions. Senior managements always target to
maximize the value of the firm by investing in positive NPV (Net Present Value) projects.
If such opportunities don't arise then reinvestment of profits should be stalled and the
excess cash should be returned to the shareholders in the form of dividends. Hence,
Capital Investment Decisions constitute three decisions:-
You might get confused to know how to get the best Car Financing Option. However, you
are able to
 Decision on Investment
 Decision on Financing
 Decision on Dividend
ii. Short term decisions:-
These are also known as working capital management which tries to strike a balance
between current assets (cash, inventories, etc.) and current liabilities (a company's debts
or obligations impending for less than one year).
Principle of Corporate Finance
Principles of Corporate Finance constitute the theories and their implementations

by the managers of the companies in the practical field for maximization of profit.
Corporate Finance deals with a company's financial or monetary activity (promotion,

financing, investment, organization, capital budgeting etc.).
All these activities are accomplished with the sole objective of profit maximization.
For meeting the fund requirements for any project of a corporation, a company can get it
from various sources such as internal, external or equities at the lowest cost possible. This
fund is then used for investment purposes for the production of the desirable asset.

Principle of Corporate Finance shows how the different corporate financial theories
help to formulate the policies for the growth of a company.
Finance is a science of managing money and other assets. It is the process of

canalizations of funds in the form of invested capital, credits, or loans to those economic
agents who are in need of funds for productive investments or otherwise. Eg. On one
hand, the consumers, business firms, and governments need funds for making their
expenditures, pay their debts, or complete other transactions. On the other hand, savers
accumulate funds in the form of savings deposits, pensions, insurance claims, savings or
loan shares, etc which becomes a source of investment funds. Here, finance comes to the
fore by channeling these savings into proper channels of investment.
Broadly, finance can be classified into three fields:-
 Public Sector Finance: Financing in the government or public level is known as

public sector finance. Government meets its expenditures mainly through taxes.
Government budget generally don't balance, hence it has to borrow for these deficits
which in turn gives rise to public debt.
 Corporate or Business Finance: It tries to optimize the goals (profit, sales, etc.)
of a corporation or other business organization by estimating future asset requirements
and then allocating funds in accordance to the availability of funds.
 Personal Finance :
It basically deals with the optimization of finances in the individual (single consumer,
family, personal savings, etc.) level subjected to the budget constraint. Eg. A consumer
can finance his/her purchase of a car by taking a loan from any bank or financial
institutions.
Corporate or business finance is all about raising and allocation of funds for increasing
profit. Senior management chalks out long-term plan for fulfilling future objectives.
Value of the company's stock is a very important issue for the management because it is
directly related to the wealth of the share-holders of the company.
Some of the terms important in principle of Corporate finance are:-
Net Present Value (NPV)
Net Present Value = (Present Value of Inflow of Cash) – (Present Value of
Outflow of Cash)
NPV helps to measure the value of a currency today with that of the future, after taking
into consideration returns and inflation.
Positive Net Present Value for a project means that the project is viable because cash
flows will be positive for the same.

Senior managements always target to maximize the value of the firm by investing in
positive NPV (Net Present Value) projects. If such opportunities don't arise then
reinvestment of profits should be stalled and the excess cash should be returned to the
shareholders in the form of dividends.
Financial Risk management
According to Financial Economics, that project which increases the value of the
shareholders wealth should be taken on. Financial Risk Management is the creation of
value of the shareholders of a firm by managing the exposure to risk by the use of
financial instruments (loans, deposits, bonds, equity stocks, future and options, etc.).
Financial risk management involves:-
 Identification of the source of risk

 Risk measurement
 Chalking out of plans to manage the risks
Financial Risk Management always tries to find out viable opportunity to hedge the
costly risk exposures by using financial instruments.
Indian capital market

A market in which individuals and institutions trade financial securities.
Organizations/institutions in the public and private sectors also often sell securities on the
capital markets in order to raise funds. Thus, this type of market is composed of both
the primary and secondary markets.
Indian financial system:
Financial system is the system which consists of variety of institutions, markets
and instruments. It provides means by which savings are transferred in to investments.
Financial Institution
and Intermediaries.
Deficit Units
Surplus Units
Financial Market

Functions of financial system

1. Payment system
2. Pooling of funds
3. Transfer of resources
4. Risk management
5. Price information
Objectives of financial system
1. Speeding up economic growth
2. Rapid industrialization
3. Support to agriculture
4. Support to trade
5. Rural / Backward development
6. Project finance
7. Entrepreneurship development
8. Housing education and health
9. Infrastructure
10. Liquidity
11. Price control
12. Human development.
Financial market
1. Capital market
2. Money market
3. Forex market
Capital market:
Capital market compresses various channels which make the individuals and
community savings available for public trade, business and industry. Capital market is
defined as a market which constitutes all long term lending by banks and financial
institutions, ling term borrowings from foreign markets and rising of capital by new
issue markets.
Therefore capital market is the mechanism which provides long term finance like
shares, debentures and ling term borrowings and not the short term finance.
Elements of capital Market:

Equity share:
Equity share is a share which is not a preference share i.e., no priority given to
share holders. All the share holders are treated alike.
Types
1. Growth Share
2. Income Share
3. defensive share
4. Cyclic Share.

Preference Shares:
Preference share is a share, where the holder of the share will be given preference
in paying dividends and settlement during liquidation.
Types
1. Cumulative preference share
2. Non cumulative preference share
3. Participating preference share
4. Non participating preference share
5. Convertible preference share
6. Non convertible share
7. Redeemable preference share
8. Irredeemable preference share
9. Cumulative convertible preference share
Debenture and Bonds;
Both the instruments are documents acknowledging the debt of the company. The
difference between bond and debenture is bond unsecured where as debenture secured
Types
1. Registered debenture / Bond
2. Bearer/ unregistered debenture /Bond
3. Fully convertible debenture
4. Partly convertible debenture
5. Non convertible debenture
6. Redeemable debenture
7. Sinking fund bonds—Installment
8. Serial bonds – serial 3 to 4 times in a year
9. Collateral bonds – floating charge
10. Secured debenture /bond – fixed charge
11. Non secured debenture/ bond
12. Guaranteed bonds
13. Joint bonds
14. Income bonds—payment of the rest will be made only when there is a profit
Mutual fund:
Mutual fund is collection of funds from small investors and investing large
amounts out of collections in equalities and other securities.
Types
By structure
1. Open ended
2. closed ended
3. Interval schemes.
By investment objective
1. Growth schemes
2. Income schemes
3. Balanced schemes

4. Money market schemes

Other schemes
1. Tax saving schemes (ELSS)
2. Industry specific / sector specific
3. Index schemes
4. Load funds
5. No load fund
6. Theme fund
7. Children fund
Non Tradable Securities
1. Post office / Govt securities
2. term loan from bank and financial institution
3. Feed capture by financial institutions
Capital Market—Types
1. Primary market
2. Secondary market
Primary Market:
It is also called as new issue market. It deals with securities issued for the first
time in the market. Corporate organizations are willing to raise the funds through primary
market only. They raise funds through the issue equity and preference shares and
debentures.
There are two methods of raising funds in primary market they are.
1. Public issue: In this method the company will to the general public and
raises the funds by issue of securities. It involves advertising in
newspapers etc and equity subscription.
2. Rights issue: In this method the funds are raised by the money
contributed by the equity share holders of the company.
Secondary Market:
Secondary Market is a market for trading existing securities of the companies.
Stock market is an organized market through which the securities are bought and sold in
an orderly manner. Since the securities market is called as secondary market it is also
been known as stock exchange.
Money Market:
Money Market is the market deals with short term securities. It is a marker to
provide short term finance for the organizations.
1. Call money market:
Amount borrowed or lent on demand for a very shout period of 1 to 14
days. Interring holidays and Sundays are excluded for the purpose.
2. Bill market:
The documents of bill of exchange will be issued by the passes which can
be negotiable and will mature in a shout period of time.
3. Certificate deposits:

A certificate of deposits is a marketable receipt of fund which is having a

maturity period of up to one year. It is issued by bands in the form of
promissory notes.
4. Commercial paper:
Commercial paper is a short term negotiable instrument issued by the
companies. The maturity period range from 30 to 364 days. Compulsory
credit is also required.
5. Treasury bills:
The lowest risk category instrument is Treasury bill which is issued by
RBI. The maturity period ranges from 14 to 364 days.
6. Money market Mutual fund:
Money market Mutual fund is introduced here to provide additional short
term avenue through which the small investor could actually take part in
the money market.
Forex Market:
Forex market is the market deals with the trading of foreign currencies. It is also
considered as one of the important avenue of investment.
Advantages, Disadvantages of various instruments
Equity shares:
Advantages:
1. Command and control
2. No fixed cost
3. No charge over assets
4. Permanent capital
5. Public issue
Disadvantages:
1. Control /management by equity share holders
2. Market price- If it is low further raising can be possible
3. High dividend
4. Excessive capitalization of equity shares will affect the company’s
profit.
Preference share:
Advantages:
1. Assured return
2. Fixed return
3. Maturity period
4. Chance of convertibility
5. Preference right
Disadvantages:
1. Not a permanent capital
2. Rigid capital structure
Not able to alter the returns
3. Cost of capital higher than debenture

4. No tax benefits
Debenture:
Advantages:
1. Assured return
2. Less risky and secured
3. Tax benefit
4. Flexibility/ convertibility
Disadvantages:
1. Charge on assets
2. Not a permanent capital
3. More of debenture will affect the profit of the organization.
Problems of Industrial finance:
1. High cost
2. Difficulty in information transfer
3. Less response from house hold (10%of investment)
4. Prevalence of unorganized market
5. Inability of the poor to approach organized market
6. No integration between various segments of financial market
7. Pricing and allocation of resources is not efficient
8. Participation is not uniform
9. More amount of brokerage and underwriting exchanges
10. difficulty in attaining minimum subscription
11. Problem of repaying the amount of the minimum subscription is not attained
12. Gap between functional and institutional setup. Merchant banking is absent.
13. Due to risk aversion of investor they prefer less risky securities
14. the cost of flotation is very high
15. the Existing companies with sound track record can raise funds very easily but the
new organization can’t do it very easily.
Problems other View:
1. Applicant submitting window dressed annual report
2. Unrealizable accounting creates non performing assets
3. Difficulty in assessing capital finance
4. Diluting the loan other than original purpose
5. Relevant norms not framed so it leads to failure
6. Poor projects appraisal
7. Double or multiple financing
8. Improper monitoring of borrower by lender
9. Undue delay in sanctioning loans.
"Debt Financing vs. Equity Financing
Financing your new business can be categorized into two different types: debt financing
and equity financing.
Debt Financing:
In basic terms, this is a loan. Money that you borrow from another source with the
understanding that you will pay it back in a fixed amount of time. As the name suggests,
this type of financing means that you have "debt" -- money that you owe to someone.
The person who lends you money does not have any liberties or ownership over your
business. Your relationship continues as long as you owe the money and once it is paid
back, your relationship with the lender ends. Debt financing can be short-term (one year
or less for repayment) or long-term (repayment over more than one year). This type of
financing occurs with banks and the SBA (Small Business Administration).
Advantages to Debt Financing:
 You retain maximum control over your business

 The interest on debt financing is tax deductible
Disadvantages to Debt Financing:
 Too much debt can cause problems if you begin to rely on it and do not have the
revenue to pay it back.
 Too much debt will make you unattractive to investors who will view you as
"high risk."
Equity Financing:
This type of financing is an exchange of money (from a lender) for a piece of ownership
in the business. This appears to be "easy money" because it involves no debt. This type
of financing normally occurs with venture capitalists and angel investors.
Advantages to Equity Financing:
 You don't have to worry about repayment in the traditional way. As long as your
business makes a profit, the lenders will be repaid.
 With the help of investors, your business becomes more credible and may win
new attention from the lenders' networks.
Disadvantages to Equity Financing:
 As the business owner, you lose your complete control and autonomy. Now,
investors have a say in the decisions that are made.
 Too much may indicate to potential funders that you are willing to take the
necessary personal risks, which could signify a lack of belief in your own
business venture.
When a banker, venture capitalist, or angel investor is considering giving you money,
they will look at your debt to equity ratio. This is the amount of debt you have compared
to the amount of equity you have. To lenders, this ratio is important because it tells the
amount of money available for repayment in the case of default. It also shows if your
business is being run in a sensible way, without too much dependence on any one source.

When considering what type of financing you want or need, take some time to think
about your business motives. How much control do you want? What are your long-term
goals? With equity financing, you and your investors may come to disagree on important
business decisions. When this happens, it is often best for you to "cash in" and let your
investors take the business into the future without you. To some entrepreneurs who
believe in their business idea and want to see it through, selling is not an option. If this
describes you, equity financing is not for you. Instead, you should explore debt financing
and retain control over the direction of your business venture.
SEBI Guide Lines

Equity
1. Price band is free for existing companies but at par for fresh issue
2. The prospectus must contain the net asset value.
3. Proper justification of price should be given.
4. Promoter’s contribution 20 to 25 % on the issue.
5. Minimum No of share application and application money
For at par 200 shares face value of 10 each
For premium minimum application money is not less than
Rs.2000
25% on face value of shares and not less than 5% on face value
6. Securities issued should be fully paid up with in 12 months.
7. 12 months elapsed between two issues.
8. Period of subscription
10 working days at least for 3 working says.
Rights issue- 30 days not mare than 60 days.
9. Retention of oversubscription:
10% of the net offer for rounding off to the nearest multiple of 100
10. Underwriting optional but the underwriter has to give commit money for
5% of issue amount or 25 lakh which ever is less.
11. Merchant banker are also responsible for prospectus.
12. Promoters lock in period 5 years
13. For premium 3 years track record is needed and promoters contribution
25%. If not promoters contribution is 50%.
14. If the issue amount goes beyond Rs 500 crores the issuer has to arrange for
monitoring by financial institution.
SEBI Guide lines for debenture:
1. Conversion period not more than 36 months.
2. Compulsory credit rating
3. No restriction on fixing interest
4. Creation of Redemption reserves.
5. Premium can be collected for the company which has 3 years sound track record.
6. Disclose of loan certificate
7. If interest rate is less than bank rate, proper disclosure has to be made about it.
8. After interest dividend has to be paid.
9. Redemption can be made after 5 years.

10. Protection of interest of debenture holder.

 Monitor the progress financial institution
 Adjust certificate for utilization of fund
 Appointing trustees for debentures
 Filing of encumbrance certificate with SEBI and NOC from
banks.
 Supervising by trustees.
Commercial banks
An institution which accepts deposits, makes business loans, and offers related services.
Commercial banks also allow for a variety of deposit accounts, such as checking, savings,
and time deposit. These institutions are run to make a profit and owned by a group of
individuals, yet some may be members of the Federal Reserve System. While commercial
banks offer services to individuals, they are primarily concerned with receiving deposits
and lending to businesses.
Functions of Commercial Banks
The functions of commercial banks are divided into two categories:
i) Primary functions, and
ii) Secondary functions including agency functions.
i) Primary functions:
The primary functions of a commercial bank include:
a) Accepting deposits; and
b) Granting loans and advances;
a) Accepting deposits
The most important activity of a commercial bank is to mobilize deposits from the public.
People who have surplus income and savings find it convenient to deposit the amounts
with banks. Depending upon the nature of deposits, funds deposited with bank also earn
interest. Thus, deposits with the bank grow along with the interest earned. If the rate of
interest is higher, public are motivated to deposit more funds with the bank. There is also
safety of funds deposited with the bank.
b) Grant of loans and advances
The second important function of a commercial bank is to grant loans and advances. Such
loans and advances are given to members of the public and to the business community at
a higher rate of interest than allowed by banks on various deposit accounts. The rate of
interest charged on loans and advances varies depending upon the purpose, period and the
mode of repayment. The difference between the rate of interest allowed on deposits and
the rate charged on the Loans is the main source of a bank’s income.
i) Loans
A loan is granted for a specific time period. Generally, commercial banks grant short-
term loans. But term loans, that is, loan for more than a year, may also be granted. The
borrower may withdraw the entire amount in lump sum or in installments. However,
interest is charged on the full amount of loan. Loans are generally granted against the
security of certain assets. A loan may be repaid either in lump sum or in installments.
ii) Advances
An advance is a credit facility provided by the bank to its customers. It differs from loan
in the sense that loans may be granted for longer period, but advances are normally

granted for a short period of time. Further the purpose of granting advances is to meet the
day to day requirements of business. The rate of interest charged on advances varies from
bank to bank. Interest is charged only on the amount withdrawn and not on the sanctioned
amount.
Modes of short-term financial assistance
Banks grant short-term financial assistance by way of cash credit, overdraft and bill
discounting.
a) Cash Credit
Cash credit is an arrangement whereby the bank allows the borrower to draw amounts up
to a specified limit. The amount is credited to the account of the customer. The customer
can withdraw this amount as and when he requires. Interest is charged on the amount
actually withdrawn. Cash Credit is granted as per agreed terms and conditions with the
customers.
b) Overdraft
Overdraft is also a credit facility granted by bank. A customer who has a current account
with the bank is allowed to withdraw more than the amount of credit balance in his
account. It is a temporary arrangement. Overdraft facility with a specified limit is allowed
either on the security of assets, or on personal security, or both.
c) Discounting of Bills
Banks provide short-term finance by discounting bills that is, making payment of the
amount before the due date of the bills after deducting a certain rate of discount. The
party gets the funds without waiting for the date of maturity of the bills. In case any bill is
dishonored on the due date, the bank can recover the amount from the customer.
ii) Secondary functions
Besides the primary functions of accepting deposits and lending money, banks perform a
number of other functions which are called secondary functions. These are as follows:-
a) Issuing letters of credit, travellers cheques, circular notes etc.
b) Undertaking safe custody of valuables, important documents, and Securities by
providing safe deposit vaults or lockers;
c) Providing customers with facilities of foreign exchange.
d) Transferring money from one place to another; and from one branch to another branch
of the bank.
e) Standing guarantee on behalf of its customers, for making payments for purchase of
goods, machinery, vehicles etc.
f) Collecting and supplying business information;
g) Issuing demand drafts and pay orders; and,
h) Providing reports on the credit worthiness of customers.
Difference between Primary and Secondary Functions of Commercial Banks
Primary Functions Secondary Functions
1. These are the main activities of the bank. 1. These are the secondary activities of the
bank.
2.These are the main sources of 2. These are not the main sources of
Income of the bank. income of the banks.
3. These are obligatory on the part of bank 3. These are not obligatory on the part of
to perform. bank to perform. But generally all
commercial banks perform these activities.

Different modes of Acceptance of Deposits

Banks receive money from the public by way of deposits. The following types of deposits
are usually received by banks:
i) Current deposit
ii) Saving deposit
iii) Fixed deposit
iv) Recurring deposit
v) Miscellaneous deposits
i) Current Deposit
Also called ‘demand deposit’, current deposit can be withdrawn by the depositor at any
time by cheques. Businessmen generally open current accounts with banks. Current
accounts do not carry any interest as the amount deposited in these accounts is repayable
on demand without any restriction.
The Reserve bank of India prohibits payment of interest on current accounts or on
deposits up to 14 Days or less except where prior sanction has been obtained. Banks
usually charge a small amount known as incidental charges on current deposit accounts
depending on the number of transaction.
ii) Savings deposit/Savings Bank Accounts
Savings deposit account is meant for individuals who wish to deposit small amounts out
of their current income. It helps in safe guarding their future and also earning interest on
the savings. A saving account can be opened with or without cheque book facility. There
are restrictions on the withdrawals from this account. Savings account holders are also
allowed to deposit cheques, drafts, dividend warrants, etc. drawn in their favour for
collection by the bank. To open a savings account, it is necessary for the depositor to be
introduced by a person having a current or savings account with the same bank.
iii) Fixed deposit
The term ‘Fixed deposit’ means deposit repayable after the expiry of a specified period.
Since it is repayable only after a fixed period of time, which is to be determined at the
time of opening of the account, it is also known as time deposit. Fixed deposits are most
useful for a commercial bank. Since they are repayable only after a fixed period, the bank
may invest these funds more profitably by lending at higher rates of interest and for
relatively longer periods. The rate of interest on fixed deposits depends upon the period
of deposits. The longer the period, the higher is the rate of interest offered. The rate of
interest to be allowed on fixed deposits is governed by rules laid down by the Reserve
Bank of India.
iv).Recurring Deposits
Recurring Deposits are gaining wide popularity these days. Under this type of deposit,
the depositor is required to deposit a fixed amount of money every month for a specific
period of time. Each installment may vary from Rs.5/- to Rs.500/- or more per month and
the period of account may vary from 12 months to 10 years. After the completion of the
specified period, the customer gets back all his deposits along with the cumulative
interest accrued on the deposits.

v).Miscellaneous Deposits
Banks have introduced several deposit schemes to attract deposits from different types of
people, like Home Construction deposit scheme, sickness Benefit deposit scheme,
Children Gift plan, Old age pension scheme, Mini deposit scheme, etc.
Different methods of Granting Loans by Bank
The basic function of a commercial bank is to make loans and advances out of the money
which is received from the public by way of deposits. The loans are particularly granted
to businessmen and members of the public against personal security, gold and silver and
other movable and immovable assets. Commercial bank generally lends money in the
following form:
i) Cash credit
ii) Loans
iii) Bank overdraft, and
iv) Discounting of Bills
i) Cash Credit:
A cash credit is an arrangement whereby the bank agrees to lend money to the borrower
up to a certain limit. The bank puts this amount of money to the credit of the borrower.
The borrower draws the money as and when he needs. Interest is charged only on the
amount actually drawn and not on the amount placed to the credit of borrower’s account.
Cash credit is generally granted on a bond of credit or certain other securities. This very
popular method of lending in our country.
ii) Loans:
A specified amount sanctioned by a bank to the customer is called a ‘loan’. It is granted
for a fixed period, say six months, or a year. The specified amount is put on the credit of
the borrower’s account. He can withdraw this amount in lump sum or can draw cheques
against this sum for any amount. Interest is charged on the full amount even if the
borrower does not utilize it. The rate of interest is lower on loans in comparison to cash
credit. A loan is generally granted against the security of property or personal security.
The loan may be repaid in lump sum or in installments. Every bank has its own procedure
of granting loans. Hence a bank is at liberty to grant loan depending on its own resources.
The loan can be granted as:
a) Demand loan, or
b) Term loan
a) Demand loan
Demand loan is repayable on demand. In other words it is repayable at short notice. The
entire amount of demand loan is disbursed at one time and the borrower has to pay
interest on it. The borrower can repay the loan either in lump sum (one time) or as agreed
with the bank. Loans are normally granted by the bank against tangible securities
including securities like N.S.C., Kisan Vikas Patra, Life Insurance policies and U.T.I.
certificates.
b) Term loans
Medium and long term loans are called ‘Term loans’. Term loans are granted for more
than one year and repayment of such loans is spread over a longer period. The repayment
is generally made in suitable installments of fixed amount. These loans are repayable
over a period of 5 years and maximum up to 15 years.

Term loan is required for the purpose of setting up of new business activity, renovation,
modernization, expansion/extension of existing units, purchase of plant and machinery,
vehicles, land for setting up a factory, construction of factory building or purchase of
other immovable assets. These loans are generally secured against the mortgage of land,
plant and machinery, building and other securities. The normal rate of interest charged for
such loans is generally quite high.
iii) Bank Overdraft
Overdraft facility is more or less similar to cash credit facility. Overdraft facility is the
result of an agreement with the bank by which a current account holder is allowed to
withdraw a specified amount over and above the credit balance in his/her account. It is a
short term facility. This facility is made available to current account holders who operate
their account through cheques. The customer is permitted to withdraw the amount as and
when he/she needs it and to repay it through deposits in his account as and when it is
convenient to him/her. Overdraft facility is generally granted by bank on the basis of a
written request by the customer. Some times, banks also insist on either a promissory note
from the borrower or personal security to ensure safety of funds. Interest is charged on
actual amount withdrawn by the customer. The interest rate on overdraft is higher than
that of the rate on loan.
iv) Discounting of Bills
Apart from granting cash credit, loans and overdraft, banks also grant financial assistance
to customers by discounting bills of exchange. Banks purchase the bills at face value
minus interest at current rate of interest for the period of the bill. This is known as
‘discounting of bills’. Bills of exchange are negotiable instruments and enable the debtors
to discharge their obligations towards their creditors. Such bills of exchange arise out of
commercial transactions both in internal trade and external trade. By discounting these
bills before they are due for a nominal amount, the banks help the business community.
Of course, the banks recover the full amount of these bills from the persons liable to
make payment.
Agency and General Utility Services provided by Modern Commercial
Banks:-
You have already learnt that the primary activities of commercial banks include
acceptance of deposits from the public and lending money to businessmen and other
members of society. Besides these two main activities, commercial banks also render a
number of ancillary services.
These services supplement the main activities of the banks. They are essentially non-
banking in nature and broadly fall under two categories:
i) Agency services, and
ii) General utility services.
i) Agency Services
Agency services are those services which are rendered by commercial banks as agents of
their customers. They include:
a) Collection and payment of cheques and bills on behalf of the customers;
b) Collection of dividends, interest and rent, etc. on behalf of customers, if so instructed
by them;
c) Purchase and sale of shares and securities on behalf of customers;

d) Payment of rent, interest, insurance premium, subscriptions etc. on behalf of

customers, if so instructed;
e) Acting as a trustee or executor;
f) Acting as agents or correspondents on behalf of customers for other banks and financial
institutions at home and abroad.
ii) General utility services
General utility services are those services which are rendered by Commercial banks not
only to the customers but also to the general public. These are available to the public on
payment of a fee or charge. They include:
a) Issuing letters of credit and travellers’ cheques;
b) Underwriting of shares, debentures, etc.;
c) Safe-keeping of valuables in safe deposit locker;
d) Underwriting loans floated by government and public bodies.
e) Supplying trade information and statistical data useful to customers;
f) Acting as a referee regarding the financial status of customers;
g) Undertaking foreign exchange business.
Various sources of finances

A company needs finance to meet its various types of requirements. Some funds are
required for a fairly long time for the purpose of acquiring fixed assets and some others
are required for day to day working.
Sources of long term finance

The main sources of long term finance are as follows:
1. Shares:
These are issued to the general public. These may be of two types:
(i) Equity and (ii) Preference. The holders of shares are the owners of the business.
2. Debentures:
These are also issued to the general public. The holders of debentures are the creditors of
the company.
3. Public Deposits:
General public also like to deposit their savings with a popular and well established
company which can pay interest periodically and pay-back the deposit when due.
4. Retained earnings:
The company may not distribute the whole of its profits among its Shareholders. It may
retain a part of the profits and utilize it as capital.
5. Term loans from banks:
Many industrial development banks, cooperative banks and commercial banks grant
medium term loans for a period of three to five years.
6. Loan from financial institutions:
There are many specialized financial institutions established by the Central and State
governments which give long term loans at reasonable rate of interest. Some of these
institutions are: Industrial Finance Corporation of India (IFCI), Industrial Development
Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Unit
Trust of India (UTI), and State Finance Corporations etc. These sources of long term
finance will be discussed in the next lesson..

The short-term sources are:

1. Trade credit,
Trade credit refers to credit granted to manufactures and traders by the suppliers of raw
material, finished goods, components, etc. Usually business enterprises buy supplies on a
30 to 90 days credit. This means that the goods are delivered but payments are not made
until the expiry of period of credit. This type of credit does not make the funds available
in cash but it facilitates purchases without making immediate payment. This is quite a
popular source of finance.
2. Bank Credit
Commercial banks grant short-term finance to business firms which are known as bank
credit. When bank credit is granted, the borrower gets a right to draw the amount of credit
at one time or in installments as and when needed. Bank credit may be granted by way of
loans, cash credit, overdraft and discounted bills.
(i) Loans
When a certain amount is advanced by a bank repayable after a specified period, it is
known as bank loan. Such advance is credited to a separate loan account and the
borrower has to pay interest on the whole amount of loan irrespective of the amount of
loan actually drawn. Usually loans are granted against security of assets.
(ii) Cash Credit
It is an arrangement whereby banks allow the borrower to withdraw money up to a
specified limit. This limit is known as cash credit limit. Initially this limit is granted for
one year. This limit can be extended after review for another year. However, if the
borrower still desires to continue the limit, it must be renewed after three years. Rate of
interest varies depending upon the amount of limit. Banks ask for collateral security for
the grant of cash credit. In this arrangement, the borrower can draw, repay and again draw
the amount within the sanctioned limit. Interest is charged only on the amount actually
withdrawn and not on the amount of entire limit.
(iii) Overdraft
When a bank allows its depositors or account holders to withdraw money in excess of the
balance in his account up to a specified limit, it is known as overdraft facility. This limit
is granted purely on the basis of credit-worthiness of the borrower. Banks generally give
the limit up to Rs.20,000. In this system, the borrower has to show a positive balance in
his account on the last Friday of every month. Interest is charged only on the overdrawn
money. Rate of interest in case of overdraft is less than the rate charged under cash credit.
(iv) Discounting of Bill
Banks also advance money by discounting bills of exchange, promissory notes and
undies. When these documents are presented before the bank for discounting, banks
credit the amount to customer’s account after deducting discount. The amount of discount
is equal to the amount of interest for the period of bill.
3. Customers’ Advances
Sometimes businessmen insist on their customers to make some advance payment. It is
generally asked when the value of order is quite large or things ordered are very costly.
Customers’ advance represents a part of the payment towards price on the product (s)

which will be delivered at a later date. Customers generally agree to make advances when
such goods are not easily available in the market or there is an urgent need of goods. A
firm can meet its short-term requirements with the help of customers’ advances.
4. Installment credit
Installment credit is now-a-days a popular source of finance for consumer goods like
television, refrigerators as well as for industrial goods. You might be aware of this
system. Only a small amount of money is paid at the time of delivery of such articles. The
balance is paid in a number of installments. The supplier charges interest for extending
credit. The amount of interest is included while deciding on the amount of installment.
Another comparable system is the hire purchase system under which the purchaser
becomes owner of the goods after the payment of last installment. Sometimes
commercial banks also grant installment credit if they have suitable arrangements with
the suppliers.
5. Loans from Co-operative Banks
Co-operative banks are a good source to procure short-term finance. Such banks have
been established at local, district and state levels. District Cooperative Banks are the
federation of primary credit societies. The State Cooperative Bank finances and controls
the District Cooperative Banks in the state. They are also governed by Reserve Bank of
India regulations. Some of these banks like the Vaish Co-operative Bank was initially
established as a co-operative society and later converted into a bank. These banks grant
loans for personal as well as business purposes. Membership is the primary condition for
securing loan. The functions of these banks are largely comparable to the functions of
commercial banks.
Merits of short-term finance
a) Economical : Finance for short-term purposes can be arranged at a short notice and
does not involve any cost of raising. The amount of interest payable is also affordable. It
is, thus, relatively more economical to raise short-term finance.
b) Flexibility: Loans to meet short-term financial need can be raised as and when
required. These can be paid back if not required. This provides flexibility.
c) No interference in management: The lenders of short-term finance cannot interfere
with the management of the borrowing concern. The management retains their freedom in
decision making.
d) May also serve long-term purposes : Generally business firms keep on renewing
short-term credit, e.g., cash credit is granted for one year but it can be extended upto 3
years with annual review. After three years it can be renewed. Thus, sources of short-term
finance may sometimes provide funds for long-term purposes.
Demerits of short-term finance
Short-term finance suffers from a few demerits which are listed below:
a) Fixed Burden: Like all borrowings interest has to be paid on short-term loans
irrespective of profit or loss earned by the organization. That is why business firms use
short-term finance only for temporary purposes.
b) Charge on assets: Generally short-term finance is raised on the concern cannot raise
further loans against the security of these assets nor can these be sold until the loan is
cleared (repaid).
c) Difficulty of raising finance: When business firms suffer intermittent losses of huge
amount or market demand is declining or industry is in recession, it loses its

creditworthiness. In such circumstances they find it difficult to borrow from banks or

other sources of short-term financed) Uncertainty: In cases of crisis business firms
always face the uncertainty of securing funds from sources of short-term finance. If the
amount of finance required is large, it is also more uncertain to get the finance.
e) Legal formalities: Sometimes certain legal formalities are to be complied with for
raising finance from short-term sources. If shares are to be deposited as security, then
transfer deed must be prepared. Such formalities take lot of time and create lot of
complications.
Export import bank (EXIM bank)

Meaning of EXIM bank
Government or semi-government agency which commonly provides insurance cover to
exporters against losses from non-payment by the importers, as a means to promote the
country's foreign trade. Other services offered by EXIM banks may include (1) marine
insurance, (2) post-shipment discounting of invoices, (3) pre-shipment advances against
confirmed orders, and (4) help in finding new markets.
Objectives:
The objectives and functions of the Exim Bank include the following:
1. Grant of loans and advances in India solely or jointly with commercial banks to
persons exporting or intending to export India goods which may include the export of
turnkey projects and civil consultancy services.
2. Grant of lines credit to Governments, financial institutions and other suitable
organizations in foreign countries to enable person outside India to import from India,
goods including turnkey projects, civil construction contracts and other services including
consultancy services.
3. Handling transaction where a mix of government credit and commercial credit for
exports is involved.
4. Purchasing, discounting and negotiating export bills.
5. Selling or discounting export bills in international markets.
6. Discounting of export bills negotiated or purchased by a scheduled bank or financial
institution notified by government, or granting loans and advances against such bills.
7. Providing refinance facilities to specified financial institutions against credits extended
by them for specified exports or imports.
8. Granting loans and advances or issuing guarantees solely or jointly with a commercial
bank for the import of goods and services from abroad.
9. Issuing confirmation/endorsing letters of credit on behalf of exporters in India,
negotiating, collecting bills under letters of credit, opening letters of credit on behalf of
importers of goods is services and negotiating documents received there under.
10. Buying and selling foreign exchange and performing such other functions of an
authorized dealer as may necessary for the functions of an export- import bank.
11. Undertaking and financing research, surveys and techno-economic studies bearing on
the promotion and development of international trade.
12. Providing technical, administrative and financial assistance to any exporter in India or
any other person who intends to export goods from India for the promotion, management
or expansion of any industry with a view to developing international trade.
Functions

Planning, promoting, developing and financing export oriented units.

Underwriting the issue of shares for the export oriented companies
Financing export or import of machinery or lease basis.
Granting loans and advances for joint ventures.
Accepting, discounting bills of exchange relating to export or import.
Subscribing the shares / securities of EXIM Bank of other countries.
Providing technical, administrative, financial assistance for the export / import units.
Creating data base about exporters.
Providing re-finance facilities to the commercial banks.
Providing agency services like
Advice on exchange control practices in other countries.
Advice and design financial packages for export oriented industries in India.
Exposing Indian exporting companies to Euro Financing
Guarding Indian companies on contracts abroad.
EXPORT FINANCING
Import LC
Applicant/importer --->Issuing Bank---> Advising Bank--->Beneficiary/exporter.
Payment
Applicant--->Issuing Bank--->Negotiating bank--->Beneficiary.
Modes
1. letter of credit
2. Payment in advance
3. Documentary collection
Payment in Advance.
Exporter risk is low
Importer risk is high
Exporter may dispatch goods not in accordance with specification
Exporter may not dispatch goods or dispatch late.
Loss of profit
Documentary collection
The collectin by banks of a sum of money ofn behalf of an exporters (the
principal) due from an importer (the Drawee).
Letters of credit:
A conditional undertaking given by a bank (issuing bank) at the request of the
customer (applicant) to pay a seller (beneficiary) against stipulated documents, provided
all terms of conditions are compiled.
Parties to a letter of Credit.
Applicant – Buyer importer
Beneficiary – seller / exporter
Issuing Bank – Applicant Bank
Advising Bank – Issuing banks agent in Beneficiary’s country
Reimbursing Bank – Bank authorized by issuing bank to reimburse in bank making
payment.
International sources of finance

Following are the international sources of finance:

1. Foreign Direct Investment
Foreign direct investment is one of the most important sources of foreign investment in
developing countries like India. It is seen as a means to supplement domestic investment
for achieving a higher level of growth and development. FDI is permitted under the forms
of investments.
1. Through financial collaborations / capital / equity participation;
2. Through Joint ventures and technical collaborations;
3. Through capital markets (Euro Issues);
4. Through private placements or preferential allotment.
2. GDR/ADR
Depository Receipts (DRs): A DR means any instrument in the form of depository
receipt or certificate created by the overseas depository bank outside India and issued to
non-resident investors against the issue of ordinary shares. In depository receipt,
negotiable instrument evidencing a fixed number of equity shares of the issuing company
generally denominated in U.S. $. DRs are commonly used by the company which sells
their securities in international market and expanding their share holdings abroad. These
securities are listed and traded in international stock exchanges. These can be either
American depository receipt (ADR) or global depositary receipt (GDR). ADRs are issued
in case the funds are raised through retail market in United States. In case of GDR issue,
the invitation to participate in the issue cannot be extended to retail US investors.
3. FII
Institutional investors are organizations which pool large sums of money and invest
those sums in securities, real property and other investment assets. They can also include
operating companies which decide to invest its profits to some degree in these types of
assets.
Types of typical investors include banks, insurance companies, retirement or pension
funds, hedge funds, investment advisors and mutual funds. Their role in the economy is
to act as highly specialized investors on behalf of others. For instance, an ordinary person
will have a pension from his employer. The employer gives that person's pension
contributions to a fund. The fund will buy shares in a company, or some other financial
product. Funds are useful because they will hold a broad portfolio of investments in many
companies. This spreads risk, so if one company fails, it will be only a small part of the
whole fund's investment.
4. International Monetary fund
The International Monetary Fund (IMF) is an intergovernmental organization that
oversees the global financial system by taking part in the macroeconomic policies of its
established members, in particular those with an impact on exchange rate and the balance
of payments. The objectives are to stabilize international exchange rates and facilitate
development through the influence of neoliberal economic policies in other countries as a
condition of loans, debt relief, and aid. It also offers loans with varying levels of
conditionality, mainly to poorer countries. Its headquarters is in Washington, D.C. The
IMF’s relatively high influence in world affairs and development has drawn heavy
criticism from some sources.
Functions:
 Helping in international trade, that is, business between countries

 Looking after exchange rates

 Looking after balance of payments
 Helping member countries in economic development
DEFINITION OF SICKNESS
Symptoms of sick units
1. Financial symptoms
1. irregularity in bank accounts unable to provide security

2. Non payment of interest on borrowings
3. Non payment of installments dues on loans.
4. inability to pay the creditors on tine
5. adverse reaction in the stock exchange to the shares of the company
2. Non-financial symptoms
1. Incapacity to produce according to schedule

2. in ability to market the goods produced
3. Fast turnover of labor.
4. Generally poor reputation in the market
Causes
Internal causes
1. Low productivity of labour.
2. High cost of labour.
3. Obsolete plant and machinery
4. Obsolete technology
5. A weak marketing department
6. Inefficient and dishonest management.
7. Poor financial panning.
External causes
1. Non availability of raw material
2. High cost of raw material.
3. Non availabity of infrastructure facilities
4. Marketing difficulties because of government interference.
5. Non availability of finance due to governmental measures.
General and personnel administration: The problem areas are summarized as under:
 Dispute/difference of opinion among the promoters/directors.
 Poor industrial relations leading to labour unrest.
 Lack of motivation and co-ordination.
 Lack of manpower planning.
 Lack of assigning equal importance to all areas of business. It is generally
observed that the

 main promoter takes more interest in the area of his specialization and ignores
other aspects of
 The business. For example, technocrat entrepreneurs, by their nature are more
inclined to improving the technical aspects of the product. The result may be that
the product will not be a commercial success though it may have technical
excellence.
 Projects that solely depend upon the skills of a key promoter may find it difficult
to sail
 Through in the event of death or ill-health of the key person.
BOARD OF INDUSTRIAL AND FINANCIAL RECONSTRUCTION (BIFR)
Board of industrial and Financial Reconstruction (BIFR) was established by the Central
Government, under section 3 of the Sick Industrial Companies (Special provisions) Act,
1985 and it became fully operational in May, 1987. BIFR deals with issues like revival
and rehabilitation on sick companies, winding up of sick companies, institutional finance
to sick companies, amalgamation of companies etc. BIFR is a quasi judicial body.
The role of BIFR as envisaged in the SICA (Sick Industrial Companies Act) is:
(a) Securing the timely detection of sick and potentially sick companies
(b) Speedy determination by a group of experts of the various measures to be taken in
respect of the sick company
(c) Expeditious enforcement of such measures
BIFR has a chairman and may have a maximum of 14 members, drawn from various
fields including banking, labour, accountancy, economics etc. It functions like a court and
has constituted four benches.
Course of Action by BIFR
1. Allowing the company time on its own to make its net worth positive with in a
reasonable period.
2. Having a scheme through the operating agency in respect of the company.
3. Deciding of the winding up of the company.
The scheme may be of the following

1. Financial assistance.
2. Merger.
3. Sale or lease of a part of the company.
4. Suspension of existing contracts
Course of Action by BIFR
4. Allowing the company time on its own to make its net worth positive with in a
reasonable period.
5. Having a scheme through the operating agency in respect of the company.
6. Deciding of the winding up of the company.
The scheme may be of the following

6. Merger.
7. Sale or lease of a part of the company.
8. Suspension of existing contracts

IRCI (Industrial Reconstruction Corporation of India )

The central Government in the year 1971 has established IRCI with the specific
objective of dealing with the problem of industrial sickness.
IRBI
1. The IRCI ceased to exist when the industrial Reconstruction Bank of India
was established in 1985.
2. The assets and liabilities were taken over by IRBI.
3. The IRBI identifies the sick units in the initial stage and corrects the
imbalances of the long term and shout term funds, replacement of balancing
equipment and modernization of obsolete plant and machinery.
4. IRBI also provides finance for expansion, diversification, Modernization etc.
Reporting to the BIFR
The Board of Directors of a sick industrial company is required, by law, to report the
sickness to the BIFR within 60 days of finalization of audited accounts, for the financial
year at the end of which the company has become sick. BIFR has prescribed a format for
this report. While reporting by a company of its sickness to the BIFR is mandatory as per
the provisions of law, any other interested person/party can also report the fact of
sickness of a company to the BIFR. Such interested parties may be the financial
institution/bank that has lent loan to the company, the RBI, the Central/State
Governments. The BIFR has prescribed a different format for the report to be submitted
by such interested parties. When a company has been financed by a consortium of banks,
it is the Lead Bank that should report to the BIFR about the sickness under advice to
other participating banks in the consortium.
Viability study for rehabilitation proposal: Once bitten, twice shy! - Before attempting
to rehabilitate a sick unit, a detailed and thorough viability study is to be undertaken to
ensure that the revival programme will really bear fruits. It is not advisable to venture
upon any revival programme if there are gray areas that need further study.
The viability study shall enquire into the technical, commercial, managerial and financial
aspects.
Technical Appraisal
(a) Study the manufacturing process used by the unit. Ascertain if any new process has
since been developed. Explore the necessity of switching over to the latest manufacturing
process and study the cost, benefit aspects of such switchover.
(b) Study the production capacity of different production sections and checkup if the
production capacities of different sections are perfectly balanced. If there is any
production section, which has a lower capacity than that required for perfect balancing,
the overall capacity of the plant can be significantly increased without huge investments,
by adding the required balancing machinery.
(c) Explore the possibilities of adding additional/special features to the products that will
add competitive edge to the product. Also examine the need for changing the product-mix
that is in tune with the market requirement.
(d) Find out if any plant/equipment need major repair/overhauling to improve its
operating efficiency.
(e) If the locational disadvantages outweigh all other factors, the scope for shifting the
location to an advantageous place may be examined and the consequent cost-benefit

analysis studied. This may be possible if the firm is functioning in a leased premise and
owns only the plant and machinery. If the unit is located in own building, the proposal for
shifting the plant and machinery to a leased building in an advantages location may also
be studied. The building owned by the firm can be leased out to some other firms. The
long-term cost benefit analysis will give lead to the acceptability or otherwise of such a
proposal.
(f) Study the modifications required, if any in the plant layout so that the material
handling output.
(g) Examine if any of the manufacturing operations that are done in house can be
entrusted to outside agencies, which may result in cost reduction.
Commercial Appraisal
(a) Commercial failure of a project will be mainly due to problems relating to the product
itself viz., defects/imperfections in product design which may lead to consumer
resistance. Such situations indicate that the products offered by competitors have better
features that attract consumers. Hence, the scope for product improvement and the cost
involved are to be studied.
(b) In spite of consumer acceptance of the product, if the project has gone sick, it is likely
that the profit margins might be low. Minor modifications in designing and packing the
product with upward revision in price may be accepted by the market which may bring
better returns to the company. This aspect may be studied by carrying out test marketing
for the improved product.
(c) Every product follows a life cycle which passes through four stages viz.,
-Introduction.
-Rapid expansion.
-Maturity.
- Decline.
Profit margins shrink and signs of sickness appear when the product is in its ‘decline’
stage. Product innovation can only sustain the product at this stage. The decline once
started can not be contained for long in spite of product innovations. Product
diversification may prove to be a feasible solution. Hence for rehabilitating a unit whose
product has already reached its ‘decline’ stage, the feasibility of witching over to
diversify products making use of the existing production facilities is to be studied. The
cost-benefit analyses of additional investments needed for product diversification and
additional benefits that may accrue are to be analyzed.
Management Appraisal: A good project in the hands of an ineffective management
turns the project bad. Similarly a good management is capable making a not-so-good
project, a success.
Hence the first thing under management appraisal is to study whether the sickness is due
to reasons beyond the control of the present management or due to ineffective
management.
If the sickness is due to reasons beyond the control of the management, for any revival
package to come out successful, it should be first ascertained if the management is still
committed to the project and is serious about reviving the unit. The management’s
commitment and seriousness may be indicated by,
 Its readiness to inject additional funds to revive the unit.

  Its readiness to strengthen the existing management by agreeing to induct

professionals as directors at various functional areas like
technical/finance/marketing/research and development etc.
The managerial appraisal shall suggest the required changes in the existing organisational
set up of the unit and also shall study the possible reduction in the man power that can be
achieved without affecting the organisiational efficiency, the likely compensation payable
for retrenchment etc.
Financial appraisal: Since appraisal of all other areas have a financial commitment in
one form or the other, financial appraisal assumes greater importance. All aspects of
financial reconstruction need to be considered and analysed.
When a project that has long term debt component in its capital structure becomes sick, it
becomes necessary to ease the burden of debt to enable the sick unit to recover from its
sickness. This necessitates restructuring of the debts. In general, banks and financial
institutions offer the following concessions in their package of rehabilitation assistance.
(a) Reduction in interest rate of existing loans.
(b) Conversion of short-term loans in to long-term loans.
(This gives the unit under revival the much-needed leeway to repay short term
borrowings.)
(c) Conversion of part of long term loans into equity.
(d) Funding of the overdue interest (un-paid interest) and making it repayable in easy
installments.
The funded interest component may carry concessional rate of interest or even at times
bears no interest.
(e) Offering a revised schedule of repayment for the principal components of term loan.
(f) Sanction of additional loan to meet the additional capital expenditure.
(g) Enhancement of working capital limits and regularizing the irregular portion of
working capital finance already availed.
If any asset is found not useful, the wise choice would be to dispose off the asset and use
the amount realized to support the rehabilitation programme.

CORPORATE FINANCE
II Unit
Short term working capital
Estimating working capital requirements – Approach adopted by Commercial banks,
Commercial paper- Public deposits and inter corporate investments.

WORKING CAPITAL MANAGEMENT

INTRODUCTION
The term working capital is commonly used for the capital required for day-to-day
working in a business concern, such as for purchasing raw material, for meeting day-to-
day expenditure on salaries, wages, rents rates, advertising etc. But there are much
disagreement among various financial authorities (Financiers, accountants, businessmen
and economists) as to the exact meaning of the term working capital.
Working capital refers to the capital required for day-to-day operations of a business
enterprise. There are two concepts of Working Capital – Gross Working capital and Net
Working capital.
1. Gross Working Capital
Gross Working capital refers to the firm’s investment in current assets (Cash, Short Term
Securities, Debtors, Bills Receivable and Inventory). Current assets are those assets,
which can be converted into cash within a period of one year.
2. Net Working Capital
Net Working capital refers to the difference between current assets and current liabilities.
It may be positive or negative.
TYPES OF WORKING CAPITAL
Working capital can be divided into two categories on the basis of time. They are –
Permanent Working Capital and Temporary or Variable Working capital.
Permanent Working Capital refers to that minimum amount of investment in current
assets, which is required at all times to carry on minimum level of business activities. It
represents the current assets required on a continuing basis over the entire year, and hence
should be financed out of long term funds.
Temporary Working capital represents the additional current assets required at different
times during the operating year.
Need for Working Capital
Working capital is needed till a firm gets cash on sale of finished products. It depends on
two factors:
i. Manufacturing cycle i.e. time required for converting the raw material into finished
product; and
ii. Credit policy i.e. credit period given to Customers and credit period allowed by
creditors.
Thus, the sum total of these times is called an “Operating cycle” and it consists of the
following six steps:
i. Conversion of cash into raw materials.
ii. Conversion of raw materials into work-in-process.
iii. Conversion of work-in-process into finished products.
iv. Time for sale of finished goods—cash sales and credit sales.
v. Time for realization from debtors and Bills receivables into cash.

vi. Credit period allowed by creditors for credit purchase of raw materials, inventory and
creditors for wages and overheads.
Importance or Advantages of Adequate Working Capital
Working capital is the life blood and nerve centre of a business. Just as circulation of
blood is essential in the human body for maintaining life, working capital is very
essential to maintain the smooth running of a business. No business can run successfully
without an adequate amount of working capital. The main advantages of maintaining
adequate amount of working capital are as follows:
1. Solvency of the business: Adequate working capital helps in maintaining solvency of
the business by providing uninterrupted flow of production.
2. Goodwill: Sufficient working capital enables a business concern to make prompt
payments and hence helps in creating and maintaining goodwill.
3. Easy loans: A concern having adequate working capital, high solvency and good credit
standing can arrange loans from banks and other on easy and favourable terms.
4. Cash Discounts: Adequate working capital also enables a concern to avail cash
discounts on the purchases and hence it reduces costs.
5. Regular supply of raw materials: Sufficient working capital ensures regular supply
of raw materials and continuous production.
6. Regular payment of salaries, wages and other day-to-day commitments:
A company which has ample working capital can make regular payment of salaries,
wages and other day-to-day commitments which raises the morale of its employees,
increases their efficiency, reduces wastages and costs and enhances production and
profits.
7. Exploitation of favourable market conditions: Only concerns with adequate working
capital can exploit favourable market conditions such as purchasing its requirements in
bulk when the prices are lower and by holding its inventories for higher prices.
8. Ability to face Crisis: Adequate working capital enables a concern to face business
crisis in emergencies such as depression because during such periods, generally, there is
much pressure on working capital.
9. Quick and Regular return on Investments: Every Investor wants a quick and regular
return on his investments. Sufficiency of working capital enables a concern to pay quick
and regular dividends to its investors as there may not be much pressure to plough back
profits. This gains the confidence of its investors and creates a favourable market to raise
additional funds i.e., the future.
10. High morale: Adequacy of working capital creates an environment of security,
confidence, and high morale and creates overall efficiency in a business.
Excess or Inadequate Working Capital
Every business concern should have adequate working capital to run its business
operations. It should have either redundant or excess working neither capital nor
inadequate or shortage of working capital. Both excess as well as short working capital
positions are bad for any business. However, out of the two, it is the inadequacy of
working capital which is more dangerous from the point of view of the firm.
Disadvantages of Redundant or Excessive Working Capital
1. Excessive Working Capital means ideal funds which earn no profits for the business
and hence the business cannot earn a proper rate of return on its investments.

2. When there is a redundant working capital, it may lead to unnecessary purchasing and
accumulation of inventories causing more chances of theft, waste and losses.
3. Excessive working capital implies excessive debtors and defective credit policy which
may cause higher incidence of bad debts.
4. It may result into overall inefficiency in the organization.
5. When there is excessive working capital, relations with banks and other financial
institutions may not be maintained.
6. Due to low rate of return on investments, the value of shares may also fall.
7. The redundant working capital gives rise to speculative transactions.
FACTORS EFFECTING WORKING CAPITAL NEEDS OF FIRMS

1. Nature of business:
In the case of public utility concern like railways, electricity etc most of the transactions
are on cash basis. Further they do not require large inventories. Hence working capital
requirements are low. On the hand, manufacturing and trading concerns require more
working capital since they have to invest heavily in inventories and debtors. Example
cotton or sugar mil
2. Size of business
Generally large business concerns are required to maintain huge inventories are required.
Hence bigger the size, the large will be the working capital requirements.
3. Time consumed in manufacture
To run a long production process more inventories is required. Hence the longer the
period of manufacture, the higher will the requirements of working capital and vice-
versa.
4. Seasonal fluctuations
A number of industries manufacture and sell goods only during certain seasons. For
example the sugar industry produces practically all sugar between December and April.
Their working capital requirements will be higher during this session. It is reduced as the
sales are made and cash is realized.
5. Fluctuations in supply
If the supply of raw materials is irregular companies, are forced to maintain huge stocks
to avoid stoppage of production. In such case, working capital requirement will be high.
6. Speed of turnover
A concern say hotel which effects sales quickly needs comparatively low working capital.
This is because of the quick conversion of stock into cash. But if the sales are slow, more
working capital will be required.
7. Terms of sales
Liberal credit sales will result in locking up of funds in sundry debtors. Hence a
company, which allows liberal credit, will need more working capital than companies,
which observe strict credit norms.
8. Terms of purchase
Working capital requirements are also affected by the credit facilities enjoyed by the
company. A company enjoying liberal credit facilities from its suppliers will need lower
amount working capital. (For example book shops). But a company that has to purchase
only for cash will need more working capital.

9. Labour intensive Vs. Capital intensive industries

In labour intensive industries, large working capital is required because of heavy wage
bill and more time taken for production. But the capital intensive industries require lesser
amount of working capital because of have investment in fixed assets and shorter time
taken for production.
10. Growth and expansion of business

A growing concern needs more working capital to finance its increasing activities and
expansion. But working capital requirements are low in the case static concerns.
11. Price level changes
Changes in price level also affect the working capital requirements. Generally the rising
prices will require the firm to maintain large amount of working capital. This is because
more funds will be required to maintain the same amount of working capital to maintain
the same level of activity.
Working capital advance by commercial banks
Working capital advance by commercial banks represents the most important source for
financing current assets.
Forms of Bank Finance: Working capital advance is provided by commercial banks in
three primary ways: (i) cash credits / overdrafts, (ii) loans, and (iii) purchase / discount of
bills. In addition to these forms of direct finance, commercials banks help their customers
in obtaining credit from other sources through the letter of credit arrangement.
i. Cash Credit / Overdrafts: Under a cash credit or overdraft arrangement, a pre-
determined limit for borrowing is specified by the bank. The borrower can draw as often
as required provided the out standings do not exceed the cash credit / overdraft limit.
ii. Loans: These are advances of fixed amounts which are credited to the current account
of the borrower or released to him in cash. The borrower is charged with interest on the
entire loan amount, irrespective of how much he draws.
iii. Purchase / Discount of Bills: A bill arises out of a trade transaction. The seller of
goods draws the bill on the purchaser. The bill may be either clean or documentary (a
documentary bill is supported by a document of title to goods like a railway receipt or a
bill of lading) and may be payable on demand or after a usual period which does not
exceed 90 days. On acceptance of the bill by the purchaser, the seller offers it to the bank
for discount / purchase. When the bank discounts / purchases the bill it releases the funds
to the seller. The bank presents the bill to the purchaser (the acceptor of the bill) on the
due date and gets its payment.
iv. Letter of Credit: A letter of credit is an arrangement whereby a bank helps its customer
to obtain credit from its (customer’s) suppliers. When a bank opens a letter of credit in
favour of its customer for some specific purchases, the bank undertakes the responsibility
to honour the obligation of its customer, should the customer fail to do so.
Commercial Paper
Commercial paper can be defined as a short term, unsecured promissory notes which are
issued at discount to face value by well known companies that are financially strong and
enjoy a high credit rating. Here are some of the features of commercial paper –
1. They are negotiable by endorsement and delivery and hence they are flexible as well as
liquid instruments. Commercial paper can be issued with varying maturities as required
by the issuing company.
2. They are unsecured instruments as they are not backed by any assets of the company
which is issuing the commercial paper.
3. They can be sold either directly by the issuing company to the investors or else issuer
can sell it to the dealer who in turn will sell it into the market.
4. It helps the highly rated company in the sense they can get cheaper funds from
commercial paper rather than borrowing from the banks.
However use of commercial paper is limited to only blue chip companies and from the
point of view of investors though commercial paper provides higher returns for him they
are unsecured and hence investor should invest in commercial paper according to his risk
-return profile.
Eligibility for issuance of CP

Presently, companies, which satisfy the following requirements, shall be eligible
to issue commercial paper:
 The tangible net worth of the company is not less than Rupees four crore
 Working capital (fund-based) limit of the company is not less than four crore
 The minimum credit rating of the company shall be P-2 from CRISIL or
equivalent from other Rating agencies
The borrowed account of the company is classified as a Standard Asset.
Besides companies, Primary Dealers (PDs) and Satellite Dealers are also
permitted to issue CP.
Public Deposits
Public Deposits
Many firms, large and small, have solicited unsecured deposits from the public in recent
years, mainly to finance their working capital requirements.
Inter-corporate Deposits
A deposit made by one company with another, normally for a period up to six months, is
referred to as an inter-corporate deposit. Such deposits are usually of three types.
a. Call Deposits: In theory, a call deposit is withdrawal by the lender on giving a day’s
notice. In practice, however, the lender has to wait for at least three days. The interest rate
on such deposits may be around 10 percent per annum.
b. Three-months Deposits: More popular in practice, these deposits are taken by
borrowers to tide over a short-term cash inadequacy that may be caused by one or more
of the following factors: disruption in production, excessive imports of raw material, tax
payment, and delay in collection, dividend payment, and unplanned capital expenditure.
The interest rate on such deposits is around 12 percent per annum.

c. Six-months Deposits: Normally, lending companies do not extend deposits beyond this
time frame. Such deposits usually made with first-class borrowers, carry and interest rate
of around 15 percent per annum.
The various advantages of public deposits enjoyed by the companies are:
1. There is no involvement of restrictive agreement

2. The process involved in gaining public deposit is simple and easy
3. The cost incurred after tax is reasonable
4. Since there is no need to pledge security for public deposits, the assets of firm that
can be mortgaged can be preserved
The disadvantages of public deposits from the company's point of view are:
1. The maturity period is short enough

2. Limited fund can be obtained from the public deposits
Who accepts public Deposits?

1. Public and private limited non banking non financial companies of
varying sizes.
2. Public and private limited non banking financial companies
3. Government companies since 1980.
4. Branches of foreign companies.
5. Partnership terms.
6. Proprietary concerns.
Inter corporate investments

Inter corporate investment occurs when one corporation purchases the shares of another.
There are four types of long term inter corporate investments: portfolio, significant
influence, controlling and joint controlling.
Portfolio investments
Portfolio investments are long-term investments whereby the investor is unable to
exercise significant influence or control over the invitee’s strategic, operating, financing
and investing policies. This is presumed to be the case when the investor owns less than
20% share ownership. However, this presumption may be overturned by evidence to the
contrary. Portfolio investments are accounted for using the cost method.
Significant influence investments
Significant influence investments are long-term investments whereby the investor is able
to exercise significant influence over the invitee’s strategic, operating, financing and
investing policies, but does not unilaterally control the investee. Significant influence is
presumed to be the case when the investor owns between 20% 49% of the shares of the
investee. Again, this presumption may be overturned by evidence to the contrary. For
example, the presence of a controlling investor with a large equity interest might preclude
any other investors from exercising significant influence. Evidence that an investor
exercises significant influence includes representation on the board of directors, dictating

the terms of related party transactions, interchange of management personnel, etc.

Significant influence investments are accounted for using the equity method.
Difference between cost and equity method
The cost and equity method differ in terms of how they record the change in the value of
the investment over time. Because investors with significant influence are able to
determine the investee's policies, the income earned by the investee is treated as if it was
earned by the investor itself. As a result, in the equity method, the investor accrues the
income earned by the investee. Inter company profits are eliminated because the investor
and investee are considered to be part of the same economic entity. Also, significant
influence investors control the dividend policy of the investee, so dividends are treated as
a liquidation of the investment rather than income.
In terms of a portfolio investment, the investor cannot impact the management policies of
the investee and so, does not accrue income. Also, the investor does determine the
dividend policy, so dividends are recognized as income. Inter company profits are
recognized because the investor and investee are considered separate economic entities.
The change in the value of the investee is recognized when the investor sells the
investment.

CORPORATE FINANCE
UNIT – III ADVANCED FINANCIAL MANAGEMENT

Appraisal of Risky Investments, certainty equivalent of cash flows and risk adjusted
discount rate, risk analysis in the context of DCF methods using Probability
information, nature of cash flows, Sensitivity analysis; Simulation and investment
decision, Decision tree approach in investment decisions.

CORPORATE FINANCE
Unit-III
Risk Analysis in Capital Budgeting

Introduction
In discussing the capital budgeting techniques, we have so far assumed that the proposed
investment projects do not involve any risk. This assumption was made simply to
facilitate the understanding of the capital budgeting techniques. In real world situation,
however, the firm in general and its investment projects in particular are exposed to
different of risk. What is risk? How can risk be measured and analyzed in the investment
decisions?
Nature of risk
Risk exists because of the inability of the decision maker to make perfect forecasts.
Forecasts cannot be made with perfection or certainty since the future events on which
they depend are uncertain. An investment is not risky if, we can specify a unique
sequence of cash flows for it. But whole trouble is that cash flows cannot be forecast
accurately, and alternative sequences of cash flows can occur depending on the future
events. Thus, risk arises in investment evaluation because we cannot anticipate the
occurrence of the possible future events with certainty and consequently, cannot, make
are correct prediction about the cash flow sequence. To illustrate, let us suppose that a
firm is considering a proposal to commit its funds in a machine, which will help to
produce a new product. The demand for this product may be very sensitive to the general
economic conditions. It may be very high under favorable economic conditions and very
low under unfavorable economic conditions. Thus, the investment would be profitable in
the former situation and unprofitable in the later case. But, it is quite difficult to predict
the future state of economic conditions, uncertainty about the cash flows associated with
the investment derives
A large number of events influence forecasts. These events can be grouped in different
ways. However, no particular grouping of events will be useful for all purposes. We may,
for example, consider three broad categories of the events influencing the investment
forecasts.
 General economic conditions
This category includes events which influence general level of business activity. The
level of business activity might be affected by such events as internal and external
economic and political situations, monetary and fiscal policies, social conditions etc.
Industry factors
This category of events may affect all companies in an industry. For example, companies
in an industry would be affected by the industrial relations in the industry, by innovations,
by change in material cost etc.

 Company factors
This category of events may affect only a company. The change in management, strike in
the company, a natural disaster such as flood or fire may affect directly a particular
company.
Investment Decisions under Capital Rationing

Firms may have to choose among profitable investment opportunities because of the
limited financial resources. In this article we shall discuss the methods of solving the
capital budgeting problems under capital rationing. We shall show that the net present
value (NPV) is the most valid section rule even under the capital rationing situations.
A firm should accept all investment projects with positive net present value (NPV) in
order to maximize the wealth of shareholders. The net present value (NPV) rule tells us to
spend funds in the projects until the net present value (NPV) of the last project is zero.
Capital rationing refers to a situation where the firm is constrained for external, or self
imposed, reasons to obtain necessary funds to invest in all investment projects with
positive net present value (NPV). Under capital rationing, the management has not
simply to determine the profitable investment opportunities, but it has also to decide to
obtain that combination of the profitable projects which yields highest net present value
(NPV) within the available funds.
Why capital rationing?

Capital rationing may rise due to external factors or internal constraints imposed by the
management. Thus there are two types of capital rationing.
 External capital rationing
 Internal capital rationing
External capital rationing
External capital rationing mainly occurs on account of the imperfections in capital

markets. Imperfections may be caused by deficiencies in market information, or by
rigidities of attitude that hamper the free flow of capital. The net present value (NPV)
rule will not work if shareholders do not have access to the capital markets. Imperfections
in capital markets alone do not invalidate use of the net present value (NPV) rule. In
reality, we will have very few situations where capital markets do not exist for
shareholders.
Internal capital rationing
Internal capital rationing is caused by self imposed restrictions by the management.
Various types of constraints may be imposed. For example, it may be decide not to obtain
additional funds by incurring debt. This may be a part of the firm’s conservative financial
policy.
Management may fix an arbitrary limit to the amount of funds to be invested by the
divisional managers. Sometimes management may resort to capital rationing by requiring
a minimum rate of return higher than the cost of capital. Whatever, may be the type of
restrictions, the implication is that some of the profitable projects will have to be forgone

because of the lack of funds. However, the net present value (NPV) rule will work since
shareholders can borrow or lend in the capital markets.
It is quite difficult sometimes justify the internal capital rationing. But generally it is used
as a means of financial controls. In a divisional set up, the divisional managers may
overstate their investment requirements. One way of forcing them to carefully assess their
investment opportunities and set priorities is to put upper limits to their capital
expenditures. Similarly, a company may put investment limits if it finds itself incapable
of coping with the strains and organizational problems of a fast growth.
Risk analysis
Risk exists because of the inability of the decision maker to make perfect
forecasts. Forecasts can be made perfectly since the future events are uncertain.
An investment is not risky if he can specify a unique sequence of cash flow. But
the trouble is that cash flows can not be forecasted accurately. Thus risk arises in
investment decisions.
Factors causing/ influencing investment forecasts:
1. General economic conditions
2. Industry factors
3. Company factors
Risk associated with an investment may be defines as variability that is
likely to accrue in the future returns from the investment.
The greater the variability of the expected returns higher the risk. The
common measures of risks are standard deviation and co-efficient of
variation.
Eg. Investment in Govt securities
Standard rate of return less risk.
Investment in share
Variable rate of return, high risk.
It is quite obvious that one of the limitations of DCF techniques is the difficulty in
estimating cash flows with certain degree of certainty. Certain projects when taken up by
the firm will change the business risk complexion of the firm.
This business risk complexion of the firm influences the required rate of return of the
investors. Suppliers of capital to the firm tend to be risk averse and the acceptance of a
project that changes the risk profile of the firm may change their perception of required
rates of return for investing in firm’s project.
Generally the projects that generate high returns are risky. This will naturally alter the
business risk of the firm. Because of this high risk perception associated with the new
project a firm is forced to asses the impact of the risk on the firm’s cash flows and the
discount factor to be employed in the process of evaluation.
Definition of Risk: Risk may be defined as the variation of actual cash flows from the
expected cash flows. The term risk in capital budgeting decisions may be defined as the
variability that is likely to occur in future between the estimated and the actual returns.
Risk exists on account of the inability of the firm to make perfect forecasts of cash flows.
Risk arises in project evaluation because the firm cannot predict the occurrence of
possible future events with certainty and hence, cannot make any correct forecast about

the cash flows. The uncertain economic conditions are the sources of uncertainty in the
cash flows.
For example, a company wants to produce and market a new product to their prospective
customers. The demand is affected by the general economic conditions. Demand may be
very high if the country experiences higher economic growth. On the other hand
economic events like weakening of US dollar, sub prime crises may trigger economic
slow down. This may create a pessimistic demand drastically bringing down the estimate
of cash flows.
Risk is associated with the variability of future returns of a project. The greater the
variability of the expected returns, the riskier the project.
Every business decision involves risk. Risk arises out of the uncertain conditions under
which a firm has to operate its activities. Because of the inability of firms to forecast
accurately cash flows of future operations the firms face the risks of operations. The
capital budgeting proposals are not based on perfect forecast of costs and revenues
because the assumptions about the future behaviour of costs and revenue may change.
Decisions have to be made in advance assuming certain future economic conditions.
There are many factors that affect forecasts of investment, cost and revenue.
1) The business is affected by changes in political situations, monetary policies, taxation,
interest rates, policies of the central bank of the country on lending by banks etc.
2) Industry specific factors influence the demand for the products of the industry to which
the firm belongs.
3) Company specific factors like change in management, wage negotiations with the
workers, strikes or lockouts affect company’s cost and revenue positions.
Therefore, risk analysis in capital budgeting is part and parcel of enterprise risk
management. The best business decisions may not yield the desired results because the
uncertain conditions likely to emerge in future can materially alter the fortunes of the
company.
Every change gives birth to new challenges. New challenges are the source of new
opportunities. A proactive firm will convert every problem into successful enterprise
opportunities. A firm which avoids new opportunities for the inherent risk associated with
it, will stagnate and degenerate. Successful firms have empirical history of successful
management of risks.
Therefore, analyzing the risks of the project to reduce the element of uncertainty in
execution has become an essential aspect of today’s corporate project management.
Types and sources of Risk in capital Budgeting
Risks in a project are many. It is possible to identify three separate and distinct types of
risk in any project.
1) Stand – alone risk: it is measured by the variability of expected returns of the project.
2) Portfolio risk: A firm can be viewed as portfolio of projects having as certain degree
of risk. When new project added to the existing portfolio of project the risk profile the
firm will alter. The degrees of the change in the risk depend on the covariance of return
from the new project and the return from the existing portfolio of the projects. If the
return from the new project is negatively correlated with the return from portfolio, the
risk of the firm will be further diversified away.
3) Market or beta risk: It is measured by the effect of the project on the beta of the firm.
The market risk for a project is difficult to estimate.

Stand alone risk is the risk of a project when the project is considered in isolation.
Corporate risk is the projects risks to the risk of the firm. Market risk is systematic risk.
The market risk is the most important risk because of the direct influence it has on stock
prices.
Sources of risk: The sources of risks are
1. Project – specific risk
2. Competitive or Competition risk
3. Industry – specific risk
4. International risk
5. Market risk
1. Project – specific risk: The sources of this risk could be traced to something quite
specific to the project. Managerial deficiencies or error in estimation of cash flows or
discount rate may lead to a situation of actual cash flows realized being less than that
projected.
2. Competitive risk or Competition risk: unanticipated actions of a firm’s competitors
will materially affect the cash flows expected from a project. Because of this the actual
cash flows from a project will be less than that of the forecast.
3. Industry – specific: industry – specific risks are those that affect all the firms in the
industry. It could be again grouped into technological risk, commodity risk and legal risk.
All these risks will affect the earnings and cash flows of the project. The changes in
technology affect all the firms not capable of adapting themselves to emerging new
technology.
The best example is the case of firms manufacturing motor cycles with two strokes
engines. When technological innovations replaced the two stroke engines by the four
stroke engines those firms which could not adapt to new technology had to shut down
their operations. Commodity risk is the risk arising from the effect of price – changes on
goods produced and marketed.
Legal risk arises from changes in laws and regulations applicable to the industry to which
the firm belongs. The best example is the imposition of service tax on apartments by the
Government of India when the total number of apartments built by a firm engaged in that
industry exceeds a prescribed limit. Similarly changes in Import – Export policy of the
Government of India have led to the closure of some firms or sickness of some firms.
4. International Risk: these types of risks are faced by firms whose business consists
mainly of exports or those who procure their main raw material from international
markets. For example, rupee – dollar crisis affected the software and BPOs because it
drastically reduced their profitability. Another best example is that of the textile units in
Tirupur in Tamilnadu, exporting their major part of the garments produced. Rupee
gaining and dollar Weakening reduced their competitiveness in the global markets. The
surging Crude oil prices coupled with the governments delay in taking decision on
pricing of petrol products eroded the profitability of oil marketing Companies in public
sector like Hindustan Petroleum Corporation Limited. Another example is the impact of
US sub prime crisis on certain segments of Indian economy.
The changes in international political scenario also affect the operations of certain firms.
5. Market Risk: Factors like inflation, changes in interest rates, and changing general
economic conditions affect all firms and all industries. Firms cannot diversify this risk in
the normal course of business. Techniques used for incorporation of risk factor in capital

budgeting decisions there are many techniques of incorporation of risk perceived in the
evaluation of capital budgeting proposals. They differ in their approach and methodology
so far as incorporation of risk in the evaluation process is concerned.
Statistical tools for Risk analysis

Statistical techniques are analytical tools for handling risky investments. These
techniques, drawing from the fields of mathematics, logic, economics and psychology,
enable the decision-maker to make decisions under risk or uncertainty.
The concept of probability is fundamental to the use of the risk analysis techniques. How
is probability defined? How are probabilities estimated? How are they used in the risk
analysis techniques? How do statistical techniques help in resolving the complex problem
of analyzing risk in capital budgeting? We attempt to answer these questions in our posts
1. Probability:
The most crucial information for the capital budgeting decision is a forecast of
future cash flows. A typical forecast is single figure for a period. This referred to as “best
estimate” or “most likely” forecast. But the questions are: To what extent can one rely
this single figure? How is this figure arrived at? Does it reflect risk? In fact, the decision
analysis is limited in two ways by this single figure forecast. Firstly, we do not know the
changes of this figure actually occurring, i.e. the uncertainty surrounding this figure. In
other words, we do not know the range of the forecast and the chance or the probability
estimates associated with figures within the range. Secondly, the meaning of best
estimates or most likely is not very clear. It is not known whether it is mean, median or
mode. For these reasons, a forecaster should not give just one estimate, but a range of
associate probability- a probability distribution.
Probability may be described as a measure of someone’s option about the likelihood that
an event will occur. If an event is certain to occur, we say that it has a probability of one
of occurring. If an event is certain not to occur, we say that its probability of occurring is
zero. Thus, probability of all events to occur lies between zero and one. A probability
distribution may consist of a number of estimates. But in the simple form it may consist
of only a few estimates. One commonly used form employs only the high, low and best
guess estimates, or the optimistic, most likely and pessimistic estimates.
Assigning probability
The classical probability theory assumes that no statement whatsoever can be made about
the probability of any single event. In fact, the classical view holds that one can talk
about probability in a very long run sense, given that the occurrence or non-occurrence of
the event can be repeatedly observed over a very large number of times under
independent identical situations. Thus, the probability estimate, which is based on a very
large number of observations, is known as an objective probability.
The classical concept of objective probability is of little use in analyzing investment

decision because these decisions are non-respective and hardly made under independent

identical conditions over time. As a result, some people opine that it is not very useful to
express the forecaster’s estimates in terms of probability. However, in recent years
another view of probability has revived, that is, the personal view, which holds that it
makes a great deal of sense to talk about the probability of a single event, without
reference to the repeatability, long run frequency concept. Such probability assignments
that reflect the state of belief of a person rather than the objective evidence of a large
number of trials are called personal or subjective probabilities.
Risk:
Risk is referred to a situation where the probability distribution of the cash flow of
an investment proposal is known on the other hand if the probability distribution proposal
is not the cash flow of an investment proposal is not known then it is uncertainty.
Expected Net Present Values:

Once the probability assignments are made the expected net present value can be
found out of multiplying the monetary values of possible cash flows b their probabilities.
n ENCFt
ENPV = ∑ ----------
t=0
( 1+K ) t
ENCFt = NCFjt X Pjt
NCF = Net cash flow
Pjt = Probability of net cash flow
J = Event
T = Period
K = Discount rate.
Possible event cash flow probability

A 4000 0.10
B 5000 0.20
C 6000 0.40
D 7000 0.20
E 8000 0.10
Solution
Possible event cash flow probability ENCF

A 4000 0.10 400
B 5000 0.20 1000
C 6000 0.40 2400
D 7000 0.20 1400
E 8000 0.10 800
------------
6000

-------------
6000
ENCF = ---------- - Co
(1 + 0.1)1
= 5454.5 – 5000 = 454.5
This project can be accepted, since the value is positive.
2. Variance or standard deviation
Dispersion is the right measure of calculating risk. Dispersion of cash flow means
difference between the possible cash Flows that can occur and their expected value. It
indicates the degree of risk. A commonly used measure of risk is standard deviation or
variance. Variance measure the deviation about expected cash flow of each of the
possible cash flows. Standard deviation is the square root of variance.
3. Risk Adjusted Discount Rate (RADR)

The basis of this approach is that there should be adequate reward in the form of return to
firms which decide to execute risky business projects. Man by nature is risk averse and
tries to avoid risk. To motivate firms to take up risky projects returns expected from the
project shall have to be adequate, keeping in view the expectations of the investors.
Therefore risk premium need to be incorporated in discount rate in the evaluation of risky
project proposals. Therefore the discount rate for appraisal of projects has two
components.
Those components are
1. Risk – free rate and risk premium
Risk Adjusted Discount rate = Risk free rate + Risk premium
Risk free rate is computed based on the return on government securities.
Risk premium is the additional return that investors require as compensation for assuming
the additional risk associated with the project to be taken up for execution. The more
uncertain the returns of the project the higher the risk. Higher the risk greater the
premium. Therefore, risk adjusted Discount rate is a composite rate of risk free rate and
risk premium of the project.
Advantages:
1. It is simple and easy to understand.
2. Risk premium takes care of the risk element in future cash flows.
3. It satisfies the businessmen who are risk – averse.
Limitations:
1. There are no objective bases of arriving at the risk premium. In this process the
premium rates computed become arbitrary.
2. The assumption that investors are risk – averse may not be true in respect of certain
investors who are willing to take risks. To such investors, as the level of risk increases,
the discount rate would be reduced.
3. Cash flows are not adapted to incorporate the risk adjustment for net cash in flows.
Under this method the risking uncertain, expected future cash flows are converted into
cash flows with certainty. Here we multiply uncertain future cash flows by the certainty –
equivalent coefficient to convert uncertain cash flows into certain cash flows. The
certainty equivalent coefficient is also known as the risk – adjustment factor. Risk

adjustment factor is normally denoted by at (Alpha). It is the ratio of certain net cash flow
to risky net cash flow
= Certainty Equivalent = Certain Cash flow / Risky Cash flow
The discount factor to be used is the risk free rate of interest. Certainty equivalent
coefficient is between 0 and 1. This risk – adjustment factor varies inversely with risk. If
risk is high a lower value is used for risk adjustment. If risk is low a higher coefficient of
certainty equivalent is used.
In formal way, the certainty equivalent approach may be expressed as:

Net present value = (the risk adjusted factor X the forecasts of net cash flow) / (1 +
Risk free rate)
The certainty equivalent coefficient, the risk adjustment factor assumes a value between
zero and one, and varies inversely with risk. A lower risk adjustment rate will be used if
lower risk is anticipated. The decision maker subjectively or objectively establishes the
coefficients. These coefficients reflect the decision makers’ confidence in obtaining a
particular cash flow in period. For example, a cash flow of 20000$ may be estimated in
the next year, but if the investor feels that only 80% of it is a certain amount, then the
certainty-equivalent coefficient will be 0.8. That is, he consider only 16000$ as the
certain cash flow. Thus, to obtain certain cash flows, we will multiply estimated cash
flows by the certainty-equivalent coefficients.
The certainty-equivalent coefficient can be determined as a relationship between the
certain cash flows and the risky cash flows. That is:
Risk adjustment factor = certain net cash flow / Risky net cash flow
For example, if one expected a risky cash flow of 80000$ in period and certain cash flow
of 60000$ equally desirable, then risk adjustment factor will be 0.75 = 60000/80000.
If the internal rate of return method is used, we will calculate that rate of discount, which
equates the present value of certainty equivalent cash outflows. The rate so found will be
compared with the minimum required risk free rate. Project will be accepted if the
internal rate is higher than the minimum rate; otherwise it will be unacceptable.
Evaluation of certainty equivalent
The certainty equivalent approach explicitly recognizes risk, but the procedure for
reducing the forecasts of cash flows is implicit and is likely to be inconsistent from one
investment to another. Further, this method suffers from many dangers in a large
enterprise. First, the forecaster, expecting the reduction that will be made in his forecasts,
may inflate them in anticipation. This will no longer give forecasts according to “best
estimate”. Second, if forecasts have to pass through several layers of management, the
effect may be to greatly exaggerate the original forecast or to make it ultra conservative.
Third, by focusing explicit attention only on the gloomy outcomes, chances are increased
for passing by some good investments.
4. Sensitivity Analysis:
In the methods discussed so far we have considered only one figure of cash lows
for each year. However, there are chances of making some estimation errors. The
sensitivity analysis approach takes care of this aspect by providing more than one
estimate of future return of a project. It is superior to one figure forecast since it gives a
more precise idea about the variability of the return.

Usually sensitivity analysis provides information about cash flows under three
assumptions.
i. Pessimistic
ii. Most likely
iii. Optimistic.
Outcomes associated with the project. It explains how sensitive the cash flows are under
these three difference between the pessimistic and optimistic cash flows the more risky is
the project and vice versa.
5. Variance or standard deviation
Dispersion is the right measure of calculating risk. Dispersion of cash flow means
difference between the possible cash lows that can occur and their expected value. It
indicates the degree of risk. A commonly used measure of risk is standard deviation or
variance. Variance measure the deviation about expected cash flow of each of the
possible cash flows. Standard deviation is the square root of variance.
6. Decision tree analysis
Decision tree analysis is another technique which is helpful in tracking risky
capital investment. Decision tree is a graphic display of relationship between a present
decision and possible future events, future events and their consequences. The sequence
of event is mapped out time in format resembling branches of a tree.
In other words it is practical representation in tree from which indicates the
magnititude, probability and inter relationship of all possible outcomes.
An out standing feature of decision tree analysis is that it links events
chronologically with forecasted probabilities and thus gives a systematic appearance of
decisions and their forecasted events.
Constructing a decision tree
1. Defining the proposal:
We have to define what is exactly required under the proposal
E.g. New product
2. Identifying of alternative:
Every proposal will have two alternatives i.e, accept or reject. However there may
be more than two alternative for the projects
3. Graphing to decision tree:
The decision tree is than laid down showing decision point( cash outlay), decision
branches (alternative)
4. Forecasting cash flows:
The forecast regarding each decision branch are also shown along with the
branch. Probabilities are also designed to each cash flow. Expected values for future
return are calculated and the total expected value for the decision is determined.
5. Evaluating results:
Having determined the expected value for each decision, the results are analyzed.
Some alternatives may look to be acceptable while others may be weak or unacceptable.
The firm may proceed with the profitable alternative.

CORPORATE FINANCE
UNIT – IV FINANCING DECISION

Simulation and financing decision - cash inadequacy and cash insolvency- determining
the probability of cash insolvency- Financing decision in the Context of option pricing
model and agency costs- Inter-dependence of investment- financing and Dividend
decisions.

Simulation and financing decision:

Simulation is a quantitative technique developed for studying alternative courses
of action by building a model of that system and then conducting a series of repeated trial
and error experiments to forecast the behavior of the system over a period of time. It is a
technique for decision making under uncertainty. This is known as Monte Carlo
simulation.
There are two types of simulation

1. Process/ system simulation (Small scale model of sign or buildings)
2. Digital simulation (special case is Montecarlo)
Simulation can be defined as replacement of unknown actual environment
by its theoretical counterpart using an assumed probability distribution and
the samples are drawn from the theoretical population using random
number table.
Reasons for applying simulation techniques
1. it is not possible to develop a mathematical model and solution without some
basic assumptions.
2. It may be too costly to actually observe a system.
3. Sufficient time may not be available to allow the system for a very long time.
4. Actual operation and observation of a real system may be too disruptive.
Methodology of simulation:
1. Clearly define the problem.
2. Construct an appropriate mathematical model of the problem (ie flow carts,
formulae etc.)
3. Ensure that the model represents the real situation involving probabilistic
elements.
4. Supply values for input parameters and observe the output values.
5. Analyze the results of simulation activity.
6. Make changes in the model or parameters and repeat the process.
Simulation in financing:
1. Many business organizations invest large amount of investment for expanding
their capacity, reducing production cost.
2. They often go for investment in new product development.
3. There is enough risk associated with each investment plan and this risk can be
reduced if they have the knowledge about the effects of the various factors by
evaluation the alternative courses of action.
4. The profitability of the investment will depend upon pricing policy, market share.
5. If the alternative involve many parameters and interrelation with large may be
very difficult for human minds.
6. Monte Carlo simulation used for risk analysis which uses the probability
estimates for each uncertain factor.

7. The simulation method enables the evaluation without actual investment and
waiting for a long time.
8. It also gives the decision maker and ides regarding the important of one or more
parameters over others on the rate of return.
9. Simulation makes approximately 1000 iterations.
10. Flexible budgets, profit planning are the areas of application of simulation.
Cash inadequacy:
Meaning: shortage of cash / non availability of cash to meet out immediate cash
payment due to improper cash reserve or cash management though the firm having lot
of assets, stocks etc.,
Circumstances that create cash inadequacy:
1. Improper payment schedule.
2. Making cash disbursement on non priority basis.
3. Miscalculation in holding cash.
4. More credit sales or more credit period.
5. Purchasing goods for cash but selling for credit.
6. Not preparing cash budget.
7. Not forecasting the cash requirement.
8. Poor debt collections.
9. Hasty decision to invest.
10. Lesser control of inflow of cash.
Cash insolvency:
It is a situation where no prevailing / availability of cash for a small period or a
longer period that leads to financial crisis in spite of having considerable value of fixed
assets.
Circumstances lead to cash insolvency:
1. Unable to pay wages, salary for the current month lag.
2. Accumulation of non performing assets
3. Cash invested in long term securities.
4. Cash locked in non moving items.
5. No centralized system of cash disbursement.
6. Payments not made from single controlled account.
7. Poor cash collection process.
8. More difference of time between cheque receiving and collection/ realization.
9. Bank process time is more.
10. Time interval between billing and dispatch of goods is more.
11. Not following lock box system.
12. Failure to meet obligation, hence creditor may file a case, reputation cost.
13. Poor management of working capital (estimation).
14. Improper investment policy.
15. Poor control of cash in flows /out flows.
16. No provision for unpredicted expenses.
17. Conflict between finance manager and sales manager.
18. Non availability of other sources of cash.
Motives of holdings:

1. Transportation motive.
2. Precautionary motive.
3. Speculative motive.
4. Compensation (wages) motive.
Cash Management techniques:

1. Playing on the float.
2. Lock box system.
3. Concentration Banking.
4. Internet Banking.
Objectives of cash Management:
1. Planning and managing cash flows.
2. Maintenance of optimum cash flows.
3. Productive utilization of excess funds.
Options
Definition
An option is type of contract between two parties wherein one person grants the other
person the right to buy a specific asset at a specific price within the specific time period.
In other words, an option is contract between two parities to buy or sell a specified
number of shares at a later date for an agreed price.
An option is a contract conveying the right but not the obligation to buy or sell specified
financial instruments.
Types of option:
As the option provides a right to buy or sell there are two types of options:
(i)Call option
A call option provides to the holder a right to buy specified assets at specified price on or
before a specified data. In case of call option he has a right to call from the market the
specified assets.
(ii)Put option
A put option provides to the holder a right to sell specified assets at specified price on or
before a specified date. In case of put option he has a right to put the specified assets in
the market.
For example an investor A enters into a contract with B whereby A has the right to buy
100 shares of XYZ Ltd @ Rs.95 each on or before a specified date. This is a call option.
In the same case if A has the right to sell instead of buying it is called put option. Further
A may or may not exercise his right. If he does not exercise his right it will lapse after the
specified date. In order to acquire this right A has to pay a price to B.
(iii) American options

In the American option, the option holder can exercise the right to buy or sell, at any time
before the expiration or on the expiration date.
(iv)European option
This option can be exercised only on the expiration date by the holder of the option. The
expiry and the exercise date coincide with each other.

For example the price of PQR Ltd, share is Rs.80 and one month put option is available
at Rs.76.Midway during the month the rate comes down to Rs.74 and on the last date the
rate is Rs.77. in case of American option the investor can exercise his right and can gain
Rs.2 per share. But in case of European option he will have to wait till the end and he will
incur a loss of Re.1 per share.
(v)Naked options and covered options
A call option is called a covered option if it is covered / written against the assets owned
by the option writer. In case of exercise of the call option by the option holder the option
writer can deliver the asset or the price differential. On other hand if the option is not
covered by the physical asset it is known as naked option. In India all option at the BSE
and NSE are cash settled and delivery of shares is not allowed even in stock options.
(vi) Stock, interest and index options
Options may also be classified with reference to the underlying asset. Options on the
individual shares are known as stock options or equity options. In India, SEBI has
allowed stock options at NSE as well as on BSE in selected shares. An index option is the
option on the index of securities. In India SEBI has allowed options on NIFTY and
Senex. Besides there may be interest rate options and currency options. In India these
options are not popular. It may be noted that the stock options and index options are
exchange traded options whereas the interest rate and currency options are over the
counter.
Features of options
1. Only the buyer or the owner has the right to exercise the option.
2. The buyer has limited liability
3. An option is created only when two parties i.e. a buyer and a writer/ seller, strike a
deal.
4. Option holders do not carry any voting right and are not entitled to receive any
dividend or interest payment.
5. Options have high degree of risk to the option writers / sellers.
6. Options involve buying counter positions by the option writers.
7. Options allow the buyer to earn profit from favorable market conditions. That’s
why options have gained popularity.
8. Options provide flexibility to the investors (buyers) who have every right to either
purchase or sell before or at a certain future date.
9. No certificates are issued by the company.
Players in the options Market
-Development institutions
-Mutual funds
-Domestic and foreign institutional investors
-Brokers
-Retail investors
Factors affecting option prices
The value of a put or call depends on the market behavior of the equity. Investors and
option traders are very much interested in the expected future value of a put or call. So it
becomes necessary for them to know the various factors that affect the option value.
1. Stock volatility

Buyers of option view volatile stocks favorably because their chances of getting profit are
more. If at all there is a loss it can be limited to the amount of premium. On the other
hand the seller (the owner of stock) dislikes volatility as it can work against him. The
probability of rise and fall in prices affects the owner of the stock to great extent. As a
result option sellers demand higher prices for writing options on volatile stocks. Thus
volatility of stocks prices reflects a combined effect of the reluctance of the option sellers
to write them and the willingness of the buyers to pay a higher premium on volatile
stocks. Thus the value of the call option is high in case of volatile stocks.
2. Expiration date or option period
The expiration date of the option considerably affects the premium. If the period of
option is longer the buyer will have better chances of making a profit. Buyers benefit
from extended periods of time which sellers suffer. So buyers are prepared to pay high
premiums for options lasting longer. In other words longer the option period higher will
be the option price.
3. Striking prices
The price at which the stock may be put or called is the contract price. It is also referred
to as the strike price. During the life of the contract the strike price remains fixed. As an
exception to this general rule the amount of any dividend paid during the option period
will reduce the strike price. When the strike price is nearer to the market price of the
stock under option the buyer has the greater chances of making money on the option.
4. Dividends
Dividends are one of the important factors which affect option value. Generally stocks
paying higher dividends do not increase very much in price. So the prudent stock buyers
avoid options on these stocks.
Naturally options writers prefer to write options on high dividend stocks as they collect
dividends in addition to their premium income. So buyers and sellers agree to lower
premiums for high dividend paying stocks.
5. Interest rates
When the interest rates are higher the value of the striking price would be lower and at
the same time the call price would be higher. At higher interest rates holding bonds would
fetch higher income in the form of interest. Options writers sacrifice considerable income
by holding stocks instead of bonds when the rates interests are higher. As a result an
option writer demands a higher premium for writing at a time when interest rates are
higher.
Option Pricing Model:

While making a decision regarding finance of a project we may have general
options. Option pricing is a technique which values the option at present and future level.
Purpose of option pricing:

1. To value the option at present and future level.
2. To draw a condition that is required to have significant value.
3. To apply and embed with investment including expansion, delay and abandoning
of a project.
4. To examine the option in firms valuation.
5. To consider option in financing dividend decisions.

6. To use option in the design and customize securities to reduce cost and risk.
7. It gives insights about financial flexibility.
8. Holding of large amount of cash is also option method.
Data required for option pricing:
1. Current value of underlying assets – S
2. Strike price of the option – K
3. Life of the option – t
4. Risk less interest rate corresponding life of the option – r
5. Variance in the value of underlying asset –
6. Dividend payment – d
Types of pricing Model
1. Binomial Model.
2. Black scholes Model.
3. Jump process option pricing Model.
Binomial Model:
It is base on a simple formulation for the assets price process in which the asset,
in any time period moves to one of possible prices.
In the figure S is the current stock price the price process up to Su with probability P and
moves down to Sd probability 1-P in any time period.
Value form value of call
Stock price at Su ΔSu - $B (1+r) Cu
Sd ΔSd - $B (1+R) Cd
Δ is change in the price of security.
Value of call = current value of underlying asset x option Δ – Borrowing needed to

replace the option.
Black Scholes Model:
It is named after the creation of the model, Fischer Black and Myron Scholes. This
model allows estimating the value of any option using a smaller number of inputs and it
has been used value to many listed options.
The value of the call option of this model is given below.
S- Current value of underlying asset.
K- Strictly price of the option.
t – Life to experience of the option
r – Risk less interest to the corresponding period.
- Variance.
Value of a call = SN (d1) – ke-nt N (d2)
Nd1- Probability of option 1

Nd2 – Probability of option 2
ert - Present value of the option.
The black scholes model was designed to value options that can be exercised only at
maturity and on underlying assets that do not pay dividends. In addition options are

valued bases on the assumption that option exercise does not affect the value of the
underlying asset.
Jump process option pricing model:
If the price changes remain large as the time periods in the binomial are shortened.
Cox and Ross (1976) valued options where prices follow a pure jump process, where the
jumps can only positive. Thus in the next interval the stock will have a large positive
jump with a probability.
The rate at which jump owns is λ
The average jump size is k. as a percentage of stock prices.
This model is known as jump diffusion model.
Agency Cost:
The core problem is that stock holders, managers, bond holders and society have less
different increases and incentives. Hence conflict may arise amongst the groups which
results in agency costs.
Categories of Agency cost:
1. Managers act as agents for shareholders.
2. Differing incentives between stock holders and money lender.
3. Revealing of information about financial markets.
Dividends
A dividend refers to that part of the earnings (profit) of a company, which is distributed to
shareholders. Shareholders would like to receive a higher dividend as it increases their
current wealth.
Forms of Dividend
1. Cash dividend
The dividend is paid to shareholders in cash. Cash dividend is the usual method of paying
dividends. It results in outflow of cash. Hence the company should arrange adequate cash
resources for payment of dividend.
2. Bond dividend
If the company does not have sufficient cash resources, it may issue bonds in lieu of
dividend. The shareholders get bonds instead of dividends. The company generally pays
interest on theses bonds and repays the bonds on maturity. Bond dividend enables the
company to postpone payment of dividend. But it is not popular.
3. Property dividend
It refers to the payment in the form of some assets other than cash. This type of dividend
is also not popular.
4. Stock dividend
Stock dividend refers to the issue of bonus shares to shareholders. Bonus shares are
issued free of cost to shareholders out of accumulated profits. Usually they are issued
when a company has substantial reserves but needs to retain cash for expansion
/diversification.
Determination for dividend policy

1. Expectations of shareholders
Shareholders are the owners of the company. So the company should consider the
dividend expectations of shareholders. They may be interested in dividend or capital
gains. The preference for dividend or capital gains depends on the economic status or
attitude of an individual. For example a retired person who wants a regular income may
prefer to receive dividends.
2. New investments
Availability of investment opportunities (such as expansion and diversification) is an
important factor, which influence the dividend decision. If the company has profitable
investment opportunities it may retain a substantial part of the earnings and pay out a
small dividend. It the company does not have good investment opportunities; it is better
to distribute the earnings as dividends. In other words a high payout is desirable for such
companies.
3. Taxation
Taxation policy also affects the dividend policy of a firm. In India dividends are tax free
in the hands of the shareholders. Long term capital gain on listed shares sold on or after
1st October 2004 is also not taxable if securities transitions tax has been paid. But short-
term capital gain is taxable. The shareholders may prefer dividends or capital gains
depending on the effect of tax on their incomes.
4. Liquidity
The liquidity position is an important factor which influences the dividend decision.
Some times a company, which has good earnings, may not have sufficient liquidity. In
such case it is advisable to restrict the dividend to the available liquid resources.
5. Access to capital markets
A company which is confident of raising resources from the capital market (for expansion
and diversification) may pay higher dividends. On the hand if the company is unable to
raise resources due to its poor image or the depressed state of the capital markets, it has to
content with a low payout.
6. Restrictions by lenders
The lenders particularly financial institutions impose restrictions on the payment of
dividends to safeguard their own interests. For example, a lender may stipulate that only
up to 30 percent of the profits may be paid as dividends. Because of these restrictions, a
company may be forced to retain earnings and have a low payout.
7. Control
The objective of maintains control by the present mang3ement may also affect the
dividend policy. Suppose a company’s is quite liberal in paying dividends, it may have to
raise funds for expansion or diversification by the issue of new shares, its control will be
diluted. Hence the management may opt for a low payout and retain earnings to maintain
control over the company.
8. Legal Restrictions
The provisions of the companies act are to be adhered in the formulation of dividends
policy. According to these provisions, dividends can be paid only out of current profits or
past profits, only after providing for depreciation. There are also stipulations regarding

transfer of profits to reserve before declarations of dividends. Further dividends cannot be

paid out of capital.
Stability of Dividends
Stability of dividends is the consistency in the stream of dividend payments. It is the
payment of certain amount of minimum dividend to the shareholders. The steadiness is a
sign of good health of the firm and may take any of the following forms – (a) constant
dividend per share, (b) constant DP ratio and (c) constant dividend per share plus extra
dividend.
Constant dividend per share: As per this form of dividend policy, a firm pays a fixed
amount of dividend per share year after year. For example, a firm may have a policy of
paying 25% dividend per share on its paidup capital of Rs. 10 per share. It implies that
Rs. 2.50 is paid out every year irrespective of its earnings. Generally, a firm following
such a policy will continue payments even if it incurs losses. In such years when there is
a loss, the amount accumulated in the dividend equalization reserve is utilized. As and
when the firm starts earning a higher amount of revenue it will consider payment of
higher dividends and in future it is expected to maintain the higher level.
Constant DP ratio: With this type of DP policy, the firm pays a constant percentage of
net earnings to the shareholders. For example, if the firm fixes its DP ratio as 25% of its
earnings, it implies that shareholders get 25% of earnings as dividend year after year. In
such years where profits are high, they get higher amount.
Constant dividend per share plus extra dividend: Under this policy, a firm usually
pays a fixed dividend ordinarily and in years of good profits, additional or extra dividend
is paid over and above the regular dividend.
The stability of dividends is desirable because of the following advantages:
Build confidence amongst investors: A stable dividend policy helps to build confidence
and remove uncertainty in the minds of investors. A constant dividend policy will not
have any fluctuations suggesting to the investors that the firm’s future is bright. In
contrast, shareholders of a firm having an unstable DP will not be certain about their
future in such a firm.
Investors’ desire for current income: A firm has different categories of investors – old
and retired persons, pensioners, youngsters, salaried class, housewives, etc. Of these,
people like retired persons prefer current income. Their living expenses are fairly stable
from one period to another. Sharp changes in current income, that is, dividends, may
necessitate sale of shares.
Stable dividend policy avoids sale of securities and inconvenience to investors.
Information about firm’s profitability: Investors use dividend policy as a measure of
evaluating the firm’s profitability. Dividend decision is a sign of firm’s prosperity and
hence firm should have a stable DP.
Institutional investors’ requirements: Institutional investors like LIC, GIC and MF
prefer to invest in companies which have a record of stable DP. A company having erratic
DP is not preferred by these institutions. Thus to attract these organizations having large
quantities of investible funds, firms follow a stable DP.
Raise additional finance: Shares of a company with stable and regular dividend
payments appear as quality investment rather than a speculation. Investors of such
companies are known for their loyalty and whenever the firm comes with new issues,
they are more responsive and receptive. Thus raising additional funds becomes easy.

Stability in market price of shares: The market price of shares varies with the stability
in dividend rates. Such shares will not have wide fluctuations in the market prices which
is good for investors.
CORPORATE FINANCE
UNIT – V CORPORATE GOVERNANCE

Corporate Governance - SEBI Guidelines- Corporate Disasters and Ethics- Corporate
Social Responsibility- Stakeholders and Ethics- Ethics, Managers and Professionalism.

Corporate Governance
Corporate governance is the set of processes, customs, policies, laws, and

institutions affecting the way a corporation (or company) is directed, administered or
controlled. An important theme of corporate governance is the nature and extent of
accountability of particular individuals in the organization, and mechanisms that try to
reduce or eliminate the principal-agent problem.
Corporate governance also includes the relationships among the many stakeholders
involved and the goals for which the corporation is governed.[4][5] In contemporary
business corporations, the main external stakeholder groups are shareholders, debt
holders, trade creditors, suppliers, customers and communities affected by the
corporation's activities. Internal stakeholders are the board of directors, executives, and
other employees.
Principles of corporate governance
Rights and equitable treatment of shareholders: Organizations should respect the

rights of shareholders and help shareholders to exercise those rights. They can help
shareholders exercise their rights by openly and effectively communicating information
and by encouraging shareholders to participate in general meetings.
Interests of other stakeholders]Organizations should recognize that they have legal,
contractual, social, and market driven obligations to non-shareholder stakeholders,
including employees, investors, creditors, suppliers, local communities, customers, and
policy makers.
Role and responsibilities of the board he board needs sufficient relevant skills and
understanding to review and challenge management performance. It also needs adequate
size and appropriate levels of independence and commitment to fulfill its responsibilities
and duties.
Integrity and ethical behavior Integrity should be a fundamental requirement in
choosing corporate officers and board members. Organizations should develop a code of
conduct for their directors and executives that promotes ethical and responsible decision
making.
Disclosure and transparency: Organizations should clarify and make publicly known
the roles and responsibilities of board and management to provide stakeholders with a
level of accountability. They should also implement procedures to independently verify
and safeguard the integrity of the company's financial reporting. Disclosure of material
matters concerning the organization should be timely and balanced to ensure that all
investors have access to clear, factual information.
Corporate governance controls
Internal corporate governance controls monitor activities and then take corrective action
to accomplish organizational goals. Examples include:

Monitoring by the board of directors: The board of directors, with its legal authority to
hire, fire and compensate top management, safeguards invested capital. Regular board
meetings allow potential problems to be identified, discussed and avoided. Whilst non-
executive directors are thought to be more independent, they may not always result in
more effective corporate governance and may not increase performance. [30] Different
board structures are optimal for different firms. Moreover, the ability of the board to
monitor the firm's executives is a function of its access to information. Executive
directors possess superior knowledge of the decision-making process and therefore
evaluate top management on the basis of the quality of its decisions that lead to financial
performance outcomes, ex ante. It could be argued, therefore, that executive directors
look beyond the financial criteria.
Internal control procedures and internal auditors: Internal control procedures are
policies implemented by an entity's board of directors, audit committee, management, and
other personnel to provide reasonable assurance of the entity achieving its objectives
related to reliable financial reporting, operating efficiency, and compliance with laws and
regulations. Internal auditors are personnel within an organization who test the design and
implementation of the entity's internal control procedures and the reliability of its
financial reporting
Balance of power: The simplest balance of power is very common; require that the
President be a different person from the Treasurer. This application of separation of
power is further developed in companies where separate divisions check and balance
each other's actions. One group may propose company-wide administrative changes,
another group review and can veto the changes, and a third group check that the interests
of people (customers, shareholders, employees) outside the three groups are being met.
Remuneration: Performance-based remuneration is designed to relate some proportion
of salary to individual performance. It may be in the form of cash or non-cash payments
such as shares and share options, superannuation or other benefits. Such incentive
schemes, however, are reactive in the sense that they provide no mechanism for
preventing mistakes or opportunistic behavior, and can elicit myopic behavior.
External corporate governance controls
External corporate governance controls encompass the controls external stakeholders
exercise over the organization. Examples include:
Competition
Debt covenants
Demand for and assessment of performance information (especially financial statements)
Government regulations
Managerial labour market
Media pressure
Takeovers
Different Reform of Corporate Governance
Corporate finance view

The suppliers of finance to the company i.e. Debt holders and equity holders
exercise control and ensure accountability of company management to assure themselves
of getting the best possible return of their investment.
Law point of view

It refers to protection of shareholders interest by implementing an inter related

mechanism relating to Board of Directors ownership structure, institutional and
individual investors and Government and Shareholders that influence the decision of the
organization.
Elements / Scope of Corporate Governance

1. Serving shareholders and protection of their interest.
2. Extending Corporate Governance for non investing stake holders like employees,
customers, suppliers, society.
3. Corporate Governance is not only protecting share holders interest but also to
promote social interest.
4. Secure employment.
SEBI Guidelines on Corporate Governance Clause 49 (Listed Companies)

1. Submitting quarterly compliance report to Stock Exchange Signed by CEO.
2. Company must setup board and constitute a committee for investor’s grievances.
3. Setting up of monitoring cell.
4. Committee / Cell shall meet 4 times in a year with a gap of 3 months.
5. Provisions regarding constitution of board, remuneration, nature of directorship
has to be followed.
6. An executive earlier of the company cannot become a director of the company.
7. Disclosure of non-executives directors’ compensation has to be made.
8. Directors can’t borrow loan from the companies.
9. Disclosure Clause.
- Details of material contracts.
- Disclosure of Accounting treatment
- Proceeds from public, rights issue
- Management discussion and analysis
- Auditors report or certificate Corporate Governance.
Corporate Disaster
When the company not complying various clauses of SEBI time to time, it may
face disaster in future by insolvency or ultra virus activities where will finally resulting in
winding up of the organization.
Whistle blower policy may protect the organization from the problem of corporate
disaster.
Whistle blower policy is establishing a mechanism for employees to report the top
management on unethical behavior, suspected and fraud behavior.
Circumstances causes’ corporate disaster
1. Non compliance of various SEBI Guidelines on CG.

2. Mismanagement and ultra virus activities.
3. Non-adhering the institution of company law board.
4. Unethical / Unlawful activity of BOD’s.

5. Not able to control employee strike and no interest in protecting the interest of
share holders, employees, general public.
6. Cheating the Govt. by white collar criminal activities like tax evasion,
adulteration, pollution, etc.
7. Not performing the activities of directors.
- Trustee, loyalty, supervision, etc.
8. No coordination between people like CEO, BODs, etc.
9. Not addressing the social responsibility.
10. Not conducting periodical meeting’s of BODs.
What is corporate social responsibility?
Corporate social responsibility (CSR) is also known by a number of other names:
corporate responsibility, corporate accountability, corporate ethics, corporate citizenship,
sustainability, stewardship, triple bottom line and responsible business, to name just a
few.
CSR is an evolving concept that currently does not have a universally accepted definition.
Generally, CSR is understood to be the way firms integrate social, environmental and
economic concerns into their values, culture, decision making, strategy and operations in
a transparent and accountable manner and thereby establish better practices within the
firm, create wealth and improve society.
The World Business Council for Sustainable Development has described CSR as the
business contribution to sustainable economic development. Building on a base of
compliance with legislation and regulations, CSR typically includes "beyond law"
commitments and activities pertaining to:
Corporate governance and ethics
Health and safety
Environmental stewardship
Human rights (including core labour rights)
Human resource management
Community involvement, development and investment
Involvement of and respect for Aboriginal peoples
Corporate philanthropy and employee volunteering
Customer satisfaction and adherence to principles of fair competition
Anti-bribery and anti-corruption measures
Accountability, transparency and performance reporting
Supplier relations, for both domestic and international supply chains.
There are four dimensions of corporate responsibility
 Economic - responsibility to earn profit for owners

 Legal - responsibility to comply with the law (society’s codification of right and
wrong)
 Ethical - not acting just for profit but doing what is right, just and fair
 Voluntary and philanthropic - promoting human welfare and goodwill
 Being a good corporate citizen contributing to the community and the quality of
life.

Why has CSR become important?
Many factors and influences, including the following, have led to increasing attention
being devoted to CSR:
 Globalization -- with its attendant focus on cross-border trade, multinational

enterprises and global supply chains -- is increasingly raising CSR concerns
related to human resource management practices, environmental protection, and
health and safety, among other things.
 Governments and intergovernmental bodies, such as the United Nations, the
Organization for Economic Co-operation and Development and the International
Labour Organization have developed compacts, declarations, guidelines,
principles and other instruments that outline social norms for acceptable conduct.
 Advances in communications technology, such as the Internet, cellular phones and
personal digital assistants, are making it easier to track corporate activities and
disseminate information about them. Non-governmental organizations now
regularly draw attention through their websites to business practices they view as
problematic.
 Consumers and investors are showing increasing interest in supporting
responsible business practices and are demanding more information on how
companies are addressing risks and opportunities related to social and
environmental issues.
 Numerous serious and high-profile breaches of corporate ethics have contributed
to elevated public mistrust of corporations and highlighted the need for improved
corporate governance, transparency, accountability and ethical standards.
 Citizens in many countries are making it clear that corporations should meet
standards of social and environmental care, no matter where they operate.
 There is increasing awareness of the limits of government legislative and
regulatory initiatives to effectively capture all the issues that corporate social
responsibility addresses.
 Businesses are recognizing that adopting an effective approach to CSR can reduce
risk of business disruptions, open up new opportunities, and enhance brand and
company reputation.
Potential benefits of implementing a CSR approach
Key potential benefits for firms implementing CSR include:
 Better anticipation and management of an ever-expanding spectrum of risk.

Effectively managing social, environmental, legal, economic and other risks in an
increasingly complex market environment, with greater oversight and stakeholder
scrutiny of corporate activities, can improve the security of supply and overall
market stability. Considering the interests of parties concerned about a firm's
impact is one way of anticipating and managing risk.
 Improved reputation management. Organizations that perform well with regard
to CSR can build reputation, while those that perform poorly can damage brand
and company value when exposed. This is particularly important for organizations

with high-value retail brands, which are often the focus of media, activist and
consumer pressure. Reputation, or brand equity, is founded on values such as
trust, credibility, reliability, quality and consistency. Even for companies that do
not have direct retail exposure through brands, their reputation as a supply chain
partner -- both good and bad -- for addressing CSR issues can make the difference
between a business opportunity positively realized and an uphill climb to
respectability.
 Enhanced ability to recruit, develop and retain staff. This can be the direct
result of pride in the company's products and practices, or of introducing
improved human resources practices, such as “family-friendly” policies. It can
also be the indirect result of programs and activities that improve employee
morale and loyalty. Employees become champions of a company for which they
are proud to work.
 Improved competitiveness and market positioning. This can result from
organizational, process and product differentiation and innovation. Good CSR
practices can also lead to better access to new markets. For example, a firm may
become certified to environmental and social standards so it can become a
supplier to particular retailers.
 Enhanced operational efficiencies and cost savings. These flow in particular
from improved efficiencies identified through a systematic approach to
management that includes continuous improvement. For example, assessing the
environmental and energy aspects of an operation can reveal opportunities for
turning waste streams into revenue streams (wood chips into particle board, for
example) and for system-wide reductions in energy use.
Corporate Social Responsibility
Socially responsible practices of the organization such as protection of investor

interest, social commitment and giving more importance for ethical and social
responsible business is known as CSR.
CSR to Share Holders.

1. Dissemination of information.
2. Declaration of dividend, bonus shares and rights issue.
3. Wealth maximization.
4. Conduct of AGM – notice.
5. Confidence building among shareholders.
6. Following legal rules relating to CSR.
7. Redressal of problems/Grievances of stake holders
- Redemption of shares
- Allotment letter/Transfer letter
- Non receipt of dividend
- Adopting corporate Governance.
- Disclosure of information.
- Setup of grievance committee.

CSR to employees:
1. Payment of wages/ salary
2. Conducting appraisal.
3. Payment of allowances.
4. Providing welfare benefits.
5. Providing insurance.
CSR to society:
1. Avoiding pollution.
2. Backward development.
3. Organizing health and awareness camps.
4. Disclosure of information.
CSR to Government:
1. Paying tax.
2. Pollution control.
3. Backward area development.
Managerial Ethics
Ethics: ‘Ethos’ is a Greek word which means customs and traditions.
Ethical decision - making
When making a decision in management the following criteria of ethical decision -
making should be considered:
Legality - will the decision somehow affect the legal status?
Fairness - how will the decision affect those involved in it?
Self - respect - does the decision - maker feel good about the decision and its
consequences?
Long - term effects" - how do the predicted long - term effects relate to the above
parameters?
"Ethics in Management" Management ethics are the ethical treatment of employees,

stockholders, owners, and the public by a company. A company, while needing to make a
profit, should have good ethics. Employees should be treated well, whether they are
employed here or overseas. By being respectful of the environment in the community a
company shows good ethics, and good, honest records also show respect to stockholders
and owners.
Managerial corporate Ethics:

This subject deals with a specialized part of ethical and moral values that engage
the corporate people in their day to day work. It is not enough when the managers are
legally correct but also morally correct.
Ethics for Managers:

The following figure shows that managerial ethics is the intersection of technical
and administrative aspect and purely moral and ethical values of individual and society.
It includes a set of beliefs attitudes and habit that an engineer or

manager is required to adopt and display in his work.
Variety of Ethical issues:

1. Organization related
2. Environment related.
3. society related
4. Product related
5. Finance / cost related.
6. Customer related.
7. Supplier related.
8. Employee related.
9. Competitor related
10. Government related.
Moral aspect of Ethics:

1. Not offending customs and sentiments.
2. Not to violate intellectual property rights.
3. Not to deplete environmental resources.
4. Running unsafe plants.
5. Pollution / Effluents.
Various types of ethics for corporate Authority:

1. Sentiment centered ethics – respecting others.
2. Bio centric ethics – Respect living organisms, saving biological life.
3. Eco-centric ethics – Environment / pollution control.
4. Human centered ethics – for well being of the population.
5. Accounting ethics following accounting standards.

Frequently Asked questions (FAQs)

BA 9260 - CORPORATE FINANCE
UNIT- I
1. Explain the structure and functioning of Indian capital market. November/December
2006, April/May 2010,
2. Explain the role of SEBI in regulating Indian capital market.
November/December2009, April/May 2010
3. Disuses the functions of BIFR in the rehabilitation of sick units.
November/December2009, April/May 2010, November/December 2010
4. Explain the various sources of finance to large scale industries. November/December
2006, November/December2009
5. What are the various problems based by the industrial finance?
UNIT- II
1. Explain the provisions relating to inter corporate investments. May/June2012
2. Commercial paper as a source of financing working capital requirement of a firm –
Discuss. May/June 2012
3. Explain the various sources of finance, which is provided by EXIM Banks to Exporters
in India. November/December 2006, November/December2008, November/December
2010, May/June 2012
4. What are factors affecting working capital requirements explain in detail?
November/December 2010
5. Discuss the role of commercial banks as financial intermediaries. November/December
2006, November/December2008, November/December2009,
UNIT-III
1. Explain the merits and demerits of decision tree approach in investment decisions.
November/December2009, April/May 2010, November/December 2010
2. Discuss the various risk associated with the investment of funds.
November/December2008,
3. Explain the nature of business risk, interest rate risk and market risk.
November/December 2006, November/December2009, November/December 2010
4. Evaluate sensitivity analysis as method of for assessing risk. November/December
2006, November/December2008, April/May 2010,
UNIT-IV
1. Define dividend. Explain various forms of dividend.
2. What are the various factors influencing dividend policy? November/December 2006,
November/December2008,
3. Explain the factors that determine the option pricing. November/December 2006
4. Discuss the relationship between the financing decision and dividend decision in a
firm. November/December2009, April/May 2010

UNIT-V
1. Discuss the importance of social responsibility of present day business.
November/December 2006, November/December2008, November/December2009,
April/May 2010, November/December 2010, May/June 2012
2. Explain the guidelines issued by the SEBI towards corporate governance.

November/December2009, April/May 2010,
3. Explain the key elements of organizational design and corporate governance.
November/December 2006,
4. Explain ethics in business and explain points to be kept in mind by a businessman.
November/December 2010, May/June 2012
5. Briefly mention the arguments against the social responsibility of business.
November/December2008

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Jeppiaar Engineering College Department of Management Studies

JEPPIAAR ENGINEERING COLLEGE

DEPARTMENT OF MANAGEMENT STUDIES

II YEAR MBA / III SEMESTER / FINANCE ELECTIVE

BA 9260 – CORPORATE FINANCE

III Semester Elective: BA9260, Corporate Finance Page 1

JEPPIAAR ENGINEERING COLLEGE

TITLE PAGE NO.

III Semester Elective: BA9260, Corporate Finance Page 2

BA 9260 CORPORATE FINANCE LT P C

UNIT – I INDUSTRIAL FINANCE 9

UNIT – II SHORT TERM-WORKING CAPITAL FINANCE 6

UNIT – III ADVANCED FINANCIAL MANAGEMENT 12

UNIT – IV FINANCING DECISION 10

UNIT – V CORPORATE GOVERNANCE 8

III Semester Elective: BA9260, Corporate Finance Page 3

1. Richard A.Brealey, Stewat C.Myers and Mohanthy, Principles of Corporate

1. Brigham and Ehrhardt, Corporate Finance - A focused Approach, Cengage

II Year / III Semester Elective: BA9260, Corporate Finance Page 4

UNIT – I INDUSTRIAL FINANCE

II Year / III Semester Elective: BA9260, Corporate Finance Page 5

Corporate finance has two basic functions:-

Acquisition of resource means fund generation at lowest possible cost. Resource

Investment of funds for profit maximization motive is known as allocation of resources.

 Fixed Asset --- Land, Machinery, buildings, etc.

Functions of Corporate Finance are:-

 Raising of Capital or Financing

II Year / III Semester Elective: BA9260, Corporate Finance Page 6

i . Long term decisions:-

It is basically concerned with the capital investment decisions such as viability

ii. Short term decisions:-

Principle of Corporate Finance

Principles of Corporate Finance constitute the theories and their implementations

Corporate Finance deals with a company's financial or monetary activity (promotion,

II Year / III Semester Elective: BA9260, Corporate Finance Page 7

Finance is a science of managing money and other assets. It is the process of

Broadly, finance can be classified into three fields:-

 Public Sector Finance: Financing in the government or public level is known as

Some of the terms important in principle of Corporate finance are:-

Net Present Value (NPV)

Net Present Value = (Present Value of Inflow of Cash) – (Present Value of

II Year / III Semester Elective: BA9260, Corporate Finance Page 8

Financial Risk management

 Identification of the source of risk

Indian capital market

II Year / III Semester Elective: BA9260, Corporate Finance Page 9

Functions of financial system

Elements of capital Market:

II Year / III Semester Elective: BA9260, Corporate Finance Page 10

II Year / III Semester Elective: BA9260, Corporate Finance Page 11

4. Money market schemes

II Year / III Semester Elective: BA9260, Corporate Finance Page 12

A certificate of deposits is a marketable receipt of fund which is having a

II Year / III Semester Elective: BA9260, Corporate Finance Page 13

"Debt Financing vs. Equity Financing

Advantages to Debt Financing:

 You retain maximum control over your business

Disadvantages to Debt Financing:

Advantages to Equity Financing: