Page number-1 FINANCE MANAGEMENT & CORPORATE FINANCE UNIT-1 (KMBN- 204)

Introduction to Finance & Corporate Finance: Corporate Finance & its scope, Corporate Governance and
Agency Problem, Corporate valuation Models: Asset Based Valuation Model, Earning based Valuation Model,
Cash flow-based Model, CAPM Model, APT, EVA Analysis, Introduction to start-up finance, Financial
Decisions, Time Value of Money

INTRODUCTION OF FINANCE
Finance may be defined as the art and science of managing money. It includes financial service and financial
instruments. Finance also is referred as the provision of money at the time when it is needed. Finance function is
the procurement of funds and their effective utilization in business concerns.
The concept of finance includes capital, funds, money, and amount. But each word is having unique meaning.
Studying and understanding the concept of finance become an important part of the business concern.

INTRODUCTION OF FINANCIAL MANAGEMENET

Financial management is that part of managerial process which is concerned with the planning and controlling of
firm‘s financial resources. It is concerned with the procurement of funds from most suitable Sources and making
the most efficient use of such funds. In the earlier stages, financial management was a branch of economics and
as a separate subject it is of recent origin. The subject is of immense importance to the managers because among
the most crucial decisions of the firm are those which relate to finance.

MEANING OF FINANCIAL MANAGEMENT

Financial management is a vital and an integral part of business management. It refers to that part of managerial
activity which is concerned with planning and controlling of financial resources of the enterprise. It deals with
raising finance for the enterprise and the efficient utilization of such finance. It includes:

 Investment decisions
 financing decisions
 dividend decisions
 liquidity decisions
 capital budgeting
 budgetary control
DEFINITIONS OF FINANCIAL MANAGEMENT
According to the Guthumann and Dougall, ―Business finance can broadly be defined as the activity concerned
with planning, raising, controlling, administering of the funds used in the business‖.
According to Joseph L. Massie ―Financial management is the operational activity of a business that is
responsible for obtaining and effectively utilizing the funds necessary for efficient operations.‖
According to Wheeler ―Financial Management is the activity which is concerned with the acquisition and
administration of capital funds in meeting the financial needs and overall objectives of business enterprise.‖
According to Khan and Jain, ―Finance is the art and science of managing money‖.
NATURE OF FINANCIAL MANAGEMENT
1. Financial Management is an essential part of Top Management: – In the modern business management
the financial manager is one of the active members of top management team and day-by-day his role is becoming
more significant in solving the complex management problems. This is because almost all kinds of business
activities such as production, marketing etc. directly or indirectly involve the acquisition and use of finance.
2. Less Descriptive and More Analytical: – Financial management is less descriptive and more analytical. Due
to the development of new statistical and accounting techniques of financial analysis, the financial Management
chooses the best alternative out of the many possible alternatives.
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3. Continuous Function: – Financing is a continuous function. In addition to the raising of finance, there is a
continuous need for planning and controlling the finances of an enterprise. A firm performs finance functions
continuously in the normal course of the business.
4. Different from Accounting Function: – There are key difference between the accounting and finance
function. Accounting generates information or data whereas in the finance function the data re analyzed and used
for the purpose of decision making.
5. Wide Scope: – There is wide scope of financial management. It is concerned not only with the raising of
finance but also with the allocation and efficient use of such finance.
6. Centralized Nature: – Financial management is centralized in nature. It is neither possible nor desirable to
decentralize the financial responsibilities.
7. Measurement of Performance: – Financial management is concerned with the wise use of finance. It fixes
certain norms and standards against which the benefits of an investment decisions are matched.
8. Inseparable Relationship between Finance and other Activities: – There exists an inseparable relationship
between finance on the one hand and production, marketing and other activities on the other. All other activities
are related to finance.
9. Applicable to All Types of Organizations: – It is applicable to all forms of organization whether corporate
or non-corporate such as sole proprietorship and partnership firms etc.

SCOPE OF FINANCIAL MANAGEMENT

Financial management as an academic discipline has undergone notable changes over the years, with regard to
its scope of functions. At the same time, the financial manager‘s role also has undergone fundamental changes
over the years. Study of the changes that have taken place over the years is known as ―Scope of Financial
Management‖. In order to have an easy understanding and better exposition to the changes, it is necessary to
divide the scope into two approaches:
(A) TRADITIONAL APPROACH
(B) MODERN APPROACH
(A) Traditional Approach: – Under this approach the role of financial management was limited to the
procurement of funds on suitable terms. The utilization of funds was considered out of the scope of financial
management. Under this approach, a study of the following three things was made for the procurement of funds.
(1) Arrangement of funds from Financial Institutions.
(2) Arrangement of funds through financial Instruments like share, bonds etc.
(3) Legal and accounting relationship between a business and its source of funds.
The notable feature of the traditional approach was the assumption that the duty of the finance manager was only
to raise funds from external parties and that he was not concerned with taking the internal financial decisions. He
was not responsible for the efficient use of funds.
(B) Modern Approach: – The modern approach considers the term financial management in a broad sense.
According to this approach the finance function covers both acquisitions of funds as well as their efficient
utilization. According to this approach the financial management is concerned with the solution of three major
problems relating finance:
(1) What is the total volume of funds an enterprise should commit?
(2) How should the funds required be raised?
(3) In what specific assets the enterprise should invest its funds?
Thus, in the modern approach, the financial management is responsible for taking three decisions:
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(1) The Investment Decision: – Investment decision also known as ‗Capital Budgeting‘ is related to the
selection of long-term assets or projects in which investments will be made by the business. Long term assets are
the assets which would yield benefits over a period of time in future.
(2) The Financing Decision: – This function is related to rising of finance from different sources. For this
purpose the financial manager is to determine the proportion of debt and equity. In other words there are two
sources of finance:
(I) Debt: – Debt means long term loans and includes:
 Debentures
 Loan from Bank
 Loan from Financial Institutions
 Mortgage Loans
(ii) Equity: Equity refers to shareholder’s funds and includes:
 Equity Share Capital
 Preference Share Capital
 Reserve
 Accumulated Profits
3. The Dividend Policy Decision: – The financial management has to decide as to which portion of the profits is
to be distributed as dividend among shareholders and which portion is to be retained in the Business. For this
purpose the financial management should take into consideration the factors of dividend stability, bonus shares
and cash dividends in practice.
OBJECTIVES OF FINANCIAL MANAGEMENT
Effective procurement and efficient use of finance lead to proper utilization of the finance by the business
concern. It is the essential part of the financial manager. Hence, the financial manager must determine the basic
objectives of the financial management. Objectives of Financial Management may be broadly divided into two
parts such as:
1. Profit maximization
2. Wealth maximization.
1. Profit Maximization
Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for
the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency of the
concern. Profit maximization is also the traditional and narrow approach, which aims at, maximizes the profit of
the concern. Profit maximization consists of the following important features.
1. Profit maximization is also called as cashing per share maximization. It leads to maximize the business
operation for profit maximization.
2. Ultimate aim of the business concern is earning profit; hence, it considers all the possible ways to
increase the profitability of the concern.
3. Profit is the parameter of measuring the efficiency of the business concern. So it shows the entire
position of the business concern.
4. Profit maximization objectives help to reduce the risk of the business.
2. Wealth Maximization
Wealth maximization is one of the modern approaches, which involves latest innovations and improvements in
the field of the business concern. The term wealth means shareholder wealth or the wealth of the persons those
who are involved in the business concern. Wealth maximization is also known as value maximization or net
present worth maximization. This objective is a universally accepted concept in the field of business.
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FUNCTIONS OF FINANCE MANAGER/ FINANCIAL DECISION AREAS

Finance function is one of the major parts of business organization, which involves the permanent and
continuous process of the business concern. Finance is one of the interrelated functions which deal with personal
function, marketing function, production function and research and development activities of the business
concern. At present, every business concern concentrates more on the field of finance because, it is a very
emerging part which reflects the entire operational and profit ability position of the concern. Deciding the proper
financial function is the essential and ultimate goal of the business organization.

Finance manager is one of the important role players in the field of finance function. He must have entire
knowledge in the area of accounting, finance, economics and management. His position is highly critical and
analytical to solve various problems related to finance. A person who deals finance related activities may be
called finance manager. Finance manager performs the following major functions:

Functions of Financial Manager

1) Forecasting Financial Requirements:-It is the primary function of the Finance Manager. He is responsible
to estimate the financial requirement of the business concern. He should estimate, how much finances
required to acquire fixed assets and forecast the amount needed to meet the working capital requirements in
future.
2) Acquiring Necessary Capital:-After deciding the financial requirement, the finance manager should
concentrate how the finance is mobilized and where it will be available. It is also highly critical in nature.
3) Investment Decision:-The finance manager must carefully select best investment alternatives and consider
the reasonable and stable return from the investment. He must be well versed in the field of capital budgeting
techniques to determine the effective utilization of investment. The finance manager must concentrate to
principles of safety, liquidity and profitability while investing capital. Cash Management: - Present day‘s
cash management plays a major role in the area of finance because proper cash management is not only
essential for effective utilization of cash but it also helps to meet the short-term liquidity position of the
concern.
4) Interrelation with Other Departments:-Finance manager deals with various functional departments such as
marketing, production, personal, system, research, development, etc. Finance manager should have sound
knowledge not only in finance related area but also well versed in other areas. He must maintain a good
relationship with all the functional departments of the business organization.
IMPORTANCE OF FINANCIAL MANAGEMENT
Finance is the lifeblood of business organization. It needs to meet the requirement of the business concern. Each
and every business concern must maintain adequate amount of finance for their smooth running of the business
concern and also maintain the business carefully to achieve the goal of the business concern. The business goal
can be achieved only with the help of effective management of finance. We can‘t neglect the importance of
finance at any time at and at any situation. Some of the importance of the financial management is as follows:
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1. Financial Planning
Financial management helps to determine the financial requirement of the business concern and leads to take
financial planning of the concern. Financial planning is an important part of the business concern, which helps to
promotion of an enterprise.
2. Acquisition of Funds
Financial management involves the acquisition of required finance to the business concern. Acquiring needed
funds play a major part of the financial management, which involve possible source of finance at minimum cost.
3. Proper Use of Funds
Proper use and allocation of funds leads to improve the operational efficiency of the business concern. When the
finance manager uses the funds properly, they can reduce the cost of capital and increase the value of the firm.
4. Financial Decision
Financial management helps to take sound financial decision in the business concern. Financial decision will
affect the entire business operation of the concern. Because there is a direct relationship with various department
functions such as marketing, production personnel, etc.
5. Improve Profitability
Profitability of the concern purely depends on the effectiveness and proper utilization of funds by the business
concern. Financial management helps to improve the profitability position of the concern with the help of strong
financial control devices such as budgetary control, ratio analysis and cost volume profit analysis.
6. Increase the Value of the Firm
Financial management is very important in the field of increasing the wealth of the investors and the business
concern. Ultimate aim of any business concern will achieve the maximum profit and higher profitability leads to
maximize the wealth of the investors as well as the nation.
7. Promoting Savings
Savings are possible only when the business concern earns higher profitability and maximizing wealth. Effective
financial management helps to promoting and mobilizing individual and corporate savings.
Nowadays financial management is also popularly known as business finance or corporate finances. The
business concern or corporate sectors cannot function without the importance of the financial management.

SOURCES OF FINANCE
Sources of finance mean the ways for mobilizing various terms of finance to the industrial concern. Sources of
finance state that, how the companies are mobilizing finance for their requirements. The companies belong to the
existing or the new which need sum amount of finance to meet the long-term and short-term requirements such
as purchasing of fixed assets, construction of office building, purchase of raw materials and day-to-day expenses.
Sources of finance may be classified under various categories according to the following important heads:
1. Based on the Period of time: - According to period of time the source of finance can be categories in two categories
these are:
a) Long-term sources
b) Short-term sources

(a) Long-term sources: Finance may be mobilized by long-term or short-term. When the finance mobilized
with large amount and the repayable over the period will be more than five years, it may be considered as long-
term sources. Share capital, issue of debenture, long-term loans from financial institutions and commercial banks
come under this kind of source of finance. Long-term source of finance needs to meet the capital expenditure of
the firms such as purchase of fixed assets, land and buildings, etc.
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Long-term sources of finance include:

● Equity Shares
● Preference Shares
● Debenture
● Long-term Loans
● Fixed Deposits

(b) Short-term sources: Apart from the long-term source of finance, firms can generate finance with the help of
short-term sources like loans and advances from commercial banks, moneylenders, etc. Short-term source of
finance needs to meet the operational expenditure of the business concern.
Short-term source of finance include:
● Bank Credit
● Customer Advances
● Trade Credit
● Factoring
● Public Deposits
● Money Market Instruments

2. Based on Ownership: - Sources of Finance may be classified under various categories based on the
ownership:
a) An ownership source of finance include
 Shares capital, earnings
 Retained earnings
 Surplus and Profits
b) Borrowed capital include
 Debenture
 Bonds
 Public deposits
 Loans from Bank and Financial Institutions.

TIME VALUE OF MONEY

―Time value of money‖ means that the value of a unit of money is different in different time periods. The value
of a sum of money received today is more than its value received after some time. Conversely, the sum of money
received in future is less valuable than it is today. In other words, the present worth of a rupee received after
some time will be less than a rupee received today. The time value of money can also be referred to as time
preference for money.
Three reasons may be attributed to the individual‘s time preference for money.
 Risk
 Preference for consumption
 Investment opportunities.
We live under risk or uncertainty. As an individual is not certain about future cash receipts, he or she prefers
receiving cash now. Most people have subjective preference consumption over future consumption of goods and
service either because of the urgency of their present wants or because of the risk is not being in a position to
enjoy future consumption that may be caused by illness or death, Or because of inflation.
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TIME VALUE OF
COMPOUNDING MONEY DISCOUNTING
FUTURE VALUE PRENSE VALUE

1. Compounding or Future Value Concept: – Under this method of compounding, the future values of all cash
inflows at the end of the time horizon at a particular rate of interest are found. Interest is compounded when the
amount earned on an initial deposit becomes part of the principal at the end of the first compounding period.
Example: – If Mr. A invests Rs. 1,000 in a bank which offers him 10% interest compounded annually, he as Rs.
1,100 in his account at the end of the first year. The total of the interest and principal Rs. 1,100 constitutes the
principal for the next year. He thus earns Rs, 1,210 for the second year. This becomes the principal for the third
year and so on.

(A) Compound Value of a Single Flow (Lump Sum):- The process of calculating future value becomes very
cumbersome if they have to be calculated over long maturity periods 10 to 20 years. A generalized procedure for
calculating the future value of a single cash flow compounded annually is as follows:

FV = PV (1 + i)n
Where:-
FV = Future value of the initial flow in n years
PV = Initial Cash flow
i = Annual rate of interest
n = No. of years for which compounding is done.
Example: – Mr. X invests Rs. 1,000 at 10% is compounded annually for three years. Calculate value after three
years.
FV = PV (1 + i)n
FV = 1000 1 + 0.10 3
𝐹𝑣 = 1331
(B) Multi-period Compounding or Future Value :– If the company will compounding interest half-yearly
(semi-annually) instead of annually then investors will gain as he will get interest on half-yearly interest. Since
interest will be compounded half-yearly, for finding out the compound value.

FV = PV (1 + i/m)n x m

Where,
FV = Future value of the initial flow in n years
PV = Initial Cash flow
I = Annual rate of interest
n = No. of years for which compounding is done.
M = No. of times compounding is done during a year.
Example: – Mr. X invests Rs. 10,000 at 10% p.a. compounded semiannually. Calculate value after three years.

FV = PV (1 + i/m)n x m
FV = 10,000 (1 + .10/2)2 x 2
FV = 11,025
(C) Compounded Value of a Series of Cash Flows: – We have considered only single payment made once and
its accumulation effect. An investor may be interested in investing money in installments and wish to know the
value of its savings after n years
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Where,
FV = Future value of the initial flow in n years
PV = Initial Cash flow
I = Annual rate of interest
n = No. of years for which compounding is done.
A = Amount deposit or invested.

Example: – Mr. X invests Rs.500, Rs.1000, Rs.1500, Rs. 2000 and Rs. 2500 at the end of each year for 5 years.
Calculate the value at the end of 5 years compounded annually if the rate of interest is 5% p.a.

(D) Compound Value of an Annuity: – Annuity refers to the periodic flows of equal amounts.

FV = A {(1+i) n – 1}/i

Example: – Mr. X invests Rs. 2,000 at the end of each year for 5 years into his account, interest being 5%
compounded annually. Determine the amount of money he will have at the end of the 5 year.

(2) Discounting or Present Value Concept: – As per this concept, rupee one of today is more valuable than
rupee one a year later. The reason for more value of rupee today than a rupee of future is interest. Discounting is
the process of determining present values of a series of future cash flows.

Example: – If Mr. X, depositor expects to get Rs. 100 after one year at the rate of 10%, the amount he will have
to forgo at present is Rs. 90.90 at present. Thus, it is present value of Rs. 100.

(A) Discounting or Present Value of a Single Flow (Lump Sum):– We can determine the PV of a future cash
flow using the formula:
PV = FV (1 + i)n
Example :– Mr. X expects to have an amount of Rs. 1000 after one year what should be the amount he has to
invest today if the bank if offering 10% interest rate?

PV = 1000 (1 + .10)1
PV = 909.09
(B) Present Value of a Series of Cash Flows: – In a business situation, it is very natural that returns received by
a firm are spread over a number of years. To estimate the present value of future series of returns, the present
value of each expected inflow will be calculated.

Where
PV = Sum of individual present values of each cash flow
C1, C2, C3 = Cash flows after periods 1, 2——————n
I = Discounting Rate
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Example: – Given the time value of money as 10% (i.e. the discounting factor). You are required to find out the
present value of future cash inflows that will be received over next four years.

INTRODUCTION TO CORPORATE FINANCE

Corporate finance is the division of a company that deals with financial and investment decisions. Corporate
finance is primarily concerned with maximizing shareholder value through long-term and short-term financial
planning and the implementation of various strategies. Corporate finance activities range from capital investment
decisions to investment banking.
In other words, how should businesses allocate scarce resources to minimize expenses and maximize revenues?
How should companies acquire these resources - through stock or bonds, owner capital or bank loans? Finally,
what should a company do with its profits? How much
should it reinvest into the company, and how much should
it pay out to the business's owners?

CHARACTERISTICS OR FEATURES OF
CORPORATE FINANCE
The points below discuss the characteristics or features
of corporate finance.
1) Financial Activity: Corporate finance is a financial
activity. It includes planning, raising, investing and
monitoring the finance of the company. In short, it
includes all the financial aspects of the company. This
work is done by the financial department headed by the
finance manager.
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2) Raising the finance: Corporate finance includes raising (collecting) finance for the company. Finance can be
collected through shares, debentures, bank loans, etc. It is very difficult for new companies to collect finance
because the investors do not have confidence in new companies. However, it is very easy for reputed
companies to collect finance due to their well-established goodwill in the market.

3) Investing the finance: Corporate finance also includes investing (using) the finance. The finance is used to
achieve the objectives of the company. It is used to purchase fixed assets. It is also used for running the
company. The finance must be used profitably.
4) Objective oriented: Corporate finance is objective oriented. That is, it is used to achieve the objectives of
the company. The main objectives are, viz., (i) To earn maximum profits, (ii) To give a proper dividend to
the shareholders, and (iii) To create a proper reserve for future growth and expansion, etc.
5) Types of finance: There are two types of corporate Finance, viz., fixed capital and working capital. Fixed
capital is also called long-term finance. It is used to meet the long-term needs of the company. It is used to
purchase fixed assets. Working capital is also called short-term finance. It is used to meet the short-term
needs of the company. It is used to pay the day-to-day expenses of the company. Medium term finance is
also used to meet the medium term needs of the company.
6) Relationship with other departments: Corporate finance has a close relationship with all other departments
in the company, i.e. Production Department, Marketing Department, etc. This is because all departments
need finance continuously.
7) Dynamic in nature: Corporate finance is dynamic in nature. It goes on changing according to the changes in
environment, circumstances, times, etc. So, the finance manager must use new and innovative ideas for
collecting and investing money. He must use creativity while doing his job.
8) Requires proper planning and control: Corporate finance requires proper planning and control. Planning is
required to collect finance from the investors. It is also required for investing the finance. Control is required
to find out whether the finance is invested properly or not. If the finance is not invested properly, then
corrective measures must be taken.
9) Managing finance is an art and science: Managing finance is an Art because it requires human skills and
judgment. It is a Science because it follows a systematic approach.
10) Legal requirements: There are many legal requirements for corporate finance. The company has to take
permission, from the Controller of Capital Issues, for collecting finance from the public. The company also
has to follow all the rules of SEBI. A Sole Trader and Partnership Firm need not follow these rules.
11) Important part of business management: Corporate finance is an important part of business finance.
"Finance is the life blood of business." Finance is required for all business activities. It is required for
promoting business. It is required for conducting the business smoothly. It is required for expansion,
diversification, modernization, replacement of assets, etc. Finance is also required for paying taxes, dividend,
and interest and for meeting contingencies.

SCOPE OF CORPORATE FINANCE:

Corporate finance understands the financial problems of the organization beforehand and prevents them. Capital
investments become an important part of corporate finance decisions such as, if dividends should be offered to
shareholders or not, if the proposed investment option should be rejected or accepted, managing short term
investment and liabilities.
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a) Finance Planning:- In the planning phase, corporate finance needs to get a clear perspective on certain
aspects, essentially the finance of the company has to be decided on questions like, what are the sources of
finance, how much finance is required by the company and will it be profitable?
b) Raising Capital: - Making capital investments is perhaps one of the most important tasks of corporate
finance, which has serious business implications. To raise the finance, the corporate finance has to raise
money from the company with the assistance of sources like shares, debentures, banks, financial institutions,
creditors etc
c) Investing Capital: - There are two types of corporate finance, fixed capital and working capital. As the
name suggests fixed capital is used to purchase fixed assets like land, building, property, machinery, etc..,
while working capital is generally used to purchase raw material and manage day to day fixed expenses like
overheads, salaries etc.
d) Monitoring the Finance / Managing Risks:- Monitoring finance is a science, there is a method to it, it is a
very complex job. It requires many tools and techniques. Corporate finance has to control and manage the
finance of the company, they have to minimize the risk of investment and at the same time assure maximum
returns on the invested capital.
NATURE OF CORPORATE FINANCE:
Financing as well as investing choices are always termed as two sides of a same coin. Features of corporate
finance and characteristics of corporate finance offer different technology and also strategies what allow
managers to evaluate financing and also investing choices. Here are some of the guidelines below discussing the
characteristics, features and nature of corporate finance.
1) Financial Planning: Corporate finance is a financial planning for a company. The characteristics of
corporate finance include preparation, raising funds, investing plus tracking each finance of organization. At
short, it offers all financial aspects for the firm. This research, techniques and strategies are defined by each
financial department lead through that finance supervisor.
2) Fund Raising: An important feature of corporate finance is to raise funds for the company. Finance can be
accumulated through shares, bank loans, debentures, bonds, etc. Its most hard for newer service providers in
order to collect finance as their investors do not have confident and vision towards new businesses.
Nevertheless, it is quite easy for respected companies to gather finance considering goodwill, reputation in
the market.
3) Goal Oriented: One of the features of corporate finance is goal oriented. That means, it is important to
regularly achieve each objectives associated with the company. The main goal of corporate finance are to
maximize profits, giving good dividends to shareholders, as well as creating fund reserves for future
expansion activities and so forth.
4) Investing Objective: The nature of corporate finance notes for every company is to optimize investing needs
for maximizing profits. Your finance can be used to quickly attain your investing objectives of the company.
For example: it can be used to invest in machines or fixed assets. It‘s can also be used for day to day
company operations. That finance needs to be optimized for profitably.
5) Finance Options: There are two main options in the nature of corporate finance, i.e. working capital and
fixed capital. Working-capital normally called as short-term finance. It‘s mainly used to meet the short-term
financial requirements for your business. For example: It can be used to cover your day-to-day expenses or
operational cost of a company. Fixed capital normally called as long-term finance. It is always used to fulfill
your very long-term financial requirements for your business. For example: buying a new manufacturing unit
or fixed assets.
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6) Legal Requirements: There are definitely various legal criteria to corporate finance. The company needs to
take the appropriate permission, from the finance regulatory board of the country for the rising finance from
public. For example: In India SEBI (Securities and Exchange Board of India) and SEC (Securities Exchange
Commission) in United States also offers to follow all of the guidelines to a company. This features of
corporate finance need to be taken utmost care when raising funds.
7) Dynamic in Nature: A dynamic in nature of corporate finance is a distinct feature of finance. That it goes on
changing based on the change in planning, environment, circumstances, times, project delays etc. Your
finance supervisor must suggestions new and innovative ideas to utilize savings, invested money and
corporate finance. He must be a creativity when doing his task.

8) Connecting with Other Divisions: A nature of corporate finance has a near relationship with different
divisions within a company. For example: marketing and promotional department, manufacturing
department, advertising division, accounting department, etc. That is mainly because all the divisions require
finance to perform their operation constantly and smoothly.

Profit Maximization v/s Wealth Maximization

Basis Wealth Maximization Profit Maximization

It is defined as the management of financial It is defined as the management of

Definition resources aimed at increasing the value of the financial resources aimed at increasing
stakeholders of the company the profit of the company

Focuses on increasing the value of the Focuses on increasing the profit of the
Focus stakeholders of the company in the long term company in the short term

It does not consider the risks and

It considers the risks and uncertainty inherent in
Risk the business model of the company
uncertainty inherent in the business
model of the company

It helps in achieving a larger value of a It helps in achieving efficiency in the

Usage company‘s worth, which may reflect in the company‘s day-to-day operations to
increased market share of the company make the business profitable
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CORPORATE GOVERNANCE
Corporate Governance refers to the way a corporation is governed. It is the technique by which companies are
directed and managed. It means carrying the business as per the stakeholders‘ desires. It is actually conducted by
the board of Directors and the concerned committees for the company‘s stakeholder‘s benefit. It is all about
balancing individual and societal goals, as well as, economic and social goals.

Corporate Governance deals with determining ways to take effective strategic decisions. It gives ultimate
authority and complete responsibility to the Board of Directors. In today‘s market- oriented economy, the need
for corporate governance arises. Also, efficiency as well as globalization is significant factors urging corporate
governance. Corporate Governance is essential to develop added value to the stakeholders.

BENEFITS OF CORPORATE GOVERNANCE

1. Good corporate governance ensures corporate success and economic growth.
2. Strong corporate governance maintains investors‘ confidence, as a result of which, company can raise capital
efficiently and effectively.
3. It lowers the capital cost.
4. There is a positive impact on the share price.
5. It provides proper inducement to the owners as well as managers to achieve objectives that are in interests of
the shareholders and the organization.
6. Good corporate governance also minimizes wastages, corruption, risks and mismanagement.
7. It helps in brand formation and development.
8. It ensures organization in managed in a manner that fits the best interests of all.

MEANING OF AGENCY PROBLEM

The agency problem can be defined as a conflict taking place when the agents entrusted with the responsibility of
looking after the interests of the principals choose to use the power or authority for their benefits and in
corporate finance. It can be explained as a conflict of interest between its management and its stockholders.

It is a common problem observed in almost every organization, whether a church, club, company, government
institution. A conflict of interest occurs when responsible people misuse their authority and power for personal
benefits. However, it can be resolved if only the organizations are willing to fix it
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TYPES OF AGENCY PROBLEMS

The management of an organization may have goals that are most likely derived to maximize their benefits. On
the other hand, an organization‘s stockholders are most likely interested in their wealth maximization. This
contrast between the goals and objectives of the management and stockholders of an organization may often
become a basis for agency problems. Precisely speaking, there are three types which are discussed below: –

1) Stockholders vs. Management – Large companies may have many equity holders. It is always crucial for an
organization to separate management from ownership since there is no reason to form a management part.
Segregating rights from management has endless advantages as it does not affect regular business operations.
The company will hire professionals to manage the key functions of the same. But hiring outsiders may
become troublesome for stakeholders. The managers hired may make unjust decisions and might even
misuse the shareholders‘ money, which can be a reason for the conflict of interests between the two and
hence, agency problems.
2) Stockholders vs. Creditors – The stockholders might pick up risky projects for making more profits. This
increased risk might elevate the required ROR on the company‘s debt. Hence, the overall value of the
pending debts might fall. If the project sinks, the bondholders will supposedly have to participate in losses,
resulting in agency problems with the stockholders and the creditors.
3) Stockholders vs. other Stakeholders – The stakeholders of a company may have a conflict of interests
with other stakeholders like customers, employees, society, and communities. For example, the employees
might be asking for a hike in their salaries which, if rejected by the stakeholders, there are probabilities of
agency problems occurring.

HOW AGENCY PROBLEM CAN BE SOLVED?

Conflicts of interest among stockholders, bondholders and managers are called agency problem. It is assumed
that the managers and the shareholder if left alone will each attempt to act in his or her own self- interest. Which
creates the conflicts of interest can be termed as agency conflicts.
Resolving the problem:
Most firms today use a package of economic incentives, along with some monitoring, to influence a manager‘s
performance and thus reduce the agency problem. The following incentives or factors that motivate managers are
discussed below:
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a) Performance-based compensation plans: Managers compensation usually depends on the company‘s

performance. If any organization is performing better the manages can be compensated and the compensation
can be in the form of
 A specified annual salary designed to cover living expenses,
 A bonus paid at the end of the year which depends on the company‘s profitability during the year and,
 Options to buy stock, or actual shares of stock, which reward the executives for the firm‘s long- term
performance
(b) Direct intervention by shareholders: Although a great deal of stock is owned by individuals, an increasing
percentage is owned by institutional investors such as insurance companies, pension funds, and mutual funds.
These institutional investors can enforce a firm‘s managers for improving their performance and sometimes give
suggestions regarding how the business should be run.

(c) The threat of firing: The CEOs or other top executives can be forced out of office due to the company‘s
poor performance.

(d) The threat of takeover: Hostile takeover is most likely to occur when a firm‘s stock is undervalued relative
to it‘s potentially a hostile takeover; the managers of the acquired firm are generally fixed. Thus, managers have
a strong incentive to take, actions which maximize stock prices and possible to avoid taking over.

AGENCY RELATIONSHIP
The relationship existing between the stockholders and the management of company is that of 'principal' and
'agent' thus it is known as 'agency relationship'. Agency relationship comes into existence when any person
appoints another person to act on his behalf and to represent his interests.

For example, Arun may appoint Atul to sell his goods on his behalf. In this case, the goods are basically owned
by Arun, but Atul is selling them on behalf of Arun therefore both are engaged in agency relationship.
Consequently, the likelihood of existence of conflicts in their interest is known as agency problem.

A relationship is said to be an agency relationship wherein a person employs another person to do some work on
his behalf. The person, who employs another person, is known as 'principal' and the person, who got employed,
is known as 'agent'.
In context of finance, the primary agency relationship exists between the following persons:
1) Shareholders and Managers, and
2) Creditors and Shareholders.

AGENCY COST
Agency costs are regarded as the costs incurred on the conflict of interest among the stockholders (principals)
and management (agents). Normally, such costs are categorized into two types, namely the indirect costs and
direct costs. Explanations of both types are as follows:
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1) Direct Agency: - Cost Agency expenses that can be directly attributed to a specific agent-principal contact
are known as direct agency costs.
 Monitoring Costs: When the activities of the company‘s management are aligned to the benefits of the
shareholders and these restrict the activities of the administration. The cost of maintaining the board of
directors therefore to a certain extent is also a part of the monitoring costs. Other examples of the
monitoring costs are the employee stock options plan available for the employees of a company.
 Bonding Costs: Contractual obligations are entered between the company and the agent. A manager
stays with a company even after it is acquired, who might forgo the employment opportunities.
 Residual Losses: If the monitoring bonding costs are not enough to diverge the principal and agent
interests, additional costs are incurred, called the residual costs.

2) Indirect Agency Cost: The indirect agency costs refer to the expenses incurred due to the opportunity lost.
For example, there is a project that the management can undertake which might result in the termination of
their jobs. However, the company‘s shareholders believe that if the company undertakes the project, it will
improve its values. If, however, the project is rejected, it will have to face a huge loss in terms of
shareholders‘ stake. Since this expense is not directly quantifiable but affects the interests of the management
and shareholders, it becomes a part of the indirect agency costs.

CORPORATE VALUATION MODELS

A corporate valuation is a general process of determining the economic value of a whole business or company
unit. Business valuation can be used to determine the fair value of a business for a variety of reasons, including
sale value, establishing partner ownership, taxation, and even divorce proceedings. Owners will often turn to
professional business evaluators for an objective estimate of the value of the business.
There are a number of methodologies that may be used for the valuation of a business; some of the popular ones
are as following:

1. Assets Based Valuation Model

Under the asset-based approach of business valuation, the emphasis is on net asset value of the company. Net asset
value is arrived at by deducting outside liabilities from the assets of the company. However, the disputable point is
on what basis the assets need to be valued - whether at book, market, replacement, or liquidation value.
Generally, the assets are valued at their book value, i.e. the original acquisition cost minus accumulated
depreciation. The simple logic behind such an approach is that under the normal situations, assets are purchased
by a business organization for the purpose of using them in business and not for resale. In other words, the assets
are valued on the presumption that the business organization is a going concern concept. However, there may be
certain circumstances, which necessitate use of other valuation measures, e.g.
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 If the plants and machineries of a manufacturing unit have lived beyond their useful economic life (earlier
than their initial estimated period), and are no more useful for production, it is perfectly alright to value them
at liquidation value;

 Intangible assets (such as goodwill, patents, trademark, brands, technical knowhow, etc.) should also be
valued properly, some of which may be valued using super profit method.
Net Asset/Intrinsic Value Method
The literal meaning of "Intrinsic value" is the worth of an object or enterprise, which is derived in and of itself or
in simpler terms independent of superfluous factors. This philosophical concept is equally applicable to the value
of a company's stock, which is perceived to have an intrinsic value. It is an important element to be taken into
consideration by a prudent investor before deciding in favor of investing in a company. For the calculation of the
net asset or intrinsic value of a company, total outside liabilities (including preference share capital) need to be
subtracted from the total assets (excluding fictitious assets) by applying following formula:
Net Assets = Total Assets - Total Outside/External Liabilities
The value of a company's net assets is also referred to as its net worth or equity shareholders' funds. A positive
figure of a company's net assets represents the value available for the equity shareholders after meeting all the
external liabilities. Net assets per share may be calculated by dividing net assets with the number of equity shares
issued and outstanding.
Net Assets per Share = Net Assets/Number of Equity Shares Issued and Outstanding
Example: On the basis of following information of XYZ Ltd. you are required to calculate net asset value per
share as per book value, market value, and liquidation value bases.
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Assets-based approach has the following benefits:

1) This is a simple and single-dimensional approach;

2) It facilitates reckoning the assets and liabilities to be
taken for the valuation purpose;
3) A measuring standard for the assets, viz. book value,
market value, or liquidation value is required to be
decided;
4) Once a measuring standard is finalized, the value of
each asset and liability is determined; and
5) In cases where a controlling interest over a business is
being dealt with, the asset-based approach is, by and
large, considered the most suitable approach.

Disadvantages of Asset Based Approach

The shortcomings associated with assets-based approach
are as follows:
1) The book value of certain assets may be altogether
unrelated to their actual market value.
2) The realizable/replacement value of certain assets (on
a going concern basis), in some cases, may be much more
than their accounting book value.
3) Asset-Based approach is associated with calculation of
realizable value of assets, which is a complex and time-
taking process.
4) There is a possibility of some significant revenue
generating assets being excluded.
5) This approach is rusticated to focusing on reported
asset values only.
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2. Earning/Income Based Valuation Model

Under the income based approach, a company's fair market value is ascertained by multiplying the benefit stream
generated by it with a discount rate or capitalization rate. The stream of benefits gets converted into the present
value by discount/capitalization rate.
Income-based approaches may be of several categories, e.g. capitalization of earnings or cash-flows, discounted
cash-flows (DCF), the excess earnings method (a combination of income-based approach and asset-based
approach), etc.
Majority of income-based approaches uses the adjusted past financial data of the subject company, with the
exception of DCF method, which uses the projected financial data of the subject company. Further, the above
data are required for a single period only in most of the cases, with the exception of DCF method, for which data
for multiple future periods are required. The discount rate or the capitalization rate should be in synchronization
with the applicable type of benefit stream. Under the income-based approach, the subject company's valuation is
normally the fair market value of a controlling marketable interest in that company. This is due to the reason that
the entire benefit stream of the company is taken into consideration for valuation purpose. The capitalization and
discount rates are generally taken from the available data of public companies.

Advantages of Earning/Income Based Valuation Model

Income-based approaches of valuation have following benefits to their credit:
 This is a well acknowledged and a popular approach of valuation;
 Due to its flexibility, it is capable of resolving varieties of issues faced by companies at various stages.
 It acts as a catalyst to boost market price, even in a scenario of inactive market.

Disadvantages of Earning/Income Based Valuation Model.

 It depends upon projections, which are rather theoretical, and not pragmatic in nature; and
 This approach provides application of discount rate with numerous variables in arriving at a suitable
 It not considers an inflation factor that‘s by we are not able to correct valuation of assets.

3. Cash Flow Based Valuation Model

One of the common methods used for valuation of a company is to determine the amount of cash flows what a
firm can generate in future. While making the analysis of investment or financing projects, the cash flow based
valuation model is used for finding out the financial flows of company, which can be generated in future and are
available to all persons contributing to the capital of company. The cash flow based valuation can be done
through many different methods. Some of them are as follows:
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4. Capital asset pricing model or CAPM

Capital asset pricing model or CAPM is a specialized model used in business finance to determine the
relationship between the expected dividends and the risk associated with investing in particular equity. When
assessing CAPM, one can understand that expected returns on specific security are equal to the risk-free returns
plus the addition of a beta factor.
Assessing the capital asset pricing model requires a proper understanding of systematic and unsystematic risks.
Systematic risks are general dangers, which are associated with the investment of any form. Wars, inflation rates,
recessions, etc. are some of the examples of systematic risks.
The investor which does not want to bear risk can invest in risk-free securities. The small investor having less
number of security has more risk. The investor can reduce unsystematic risk by having a well-diversified
security in the portfolio. The diversified and balanced portfolio of all securities will make the investor's
unsystematic risk equal to the systematic risk in the stock market.

Formula for CAPM

This entire formula considers the returns, which an investor is liable to receive due to their risk-taking ability and
extended time of investment. The beta factor is determined as a risk in conjunction with current market
conditions
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Assumptions of Capital Asset Pricing Model

The CAPM is based on the following assumptions.

a) Risk-averse investors: - The investors are basically risk averse and diversification is necessary to reduce
their risks.
b) Maximizing the utility of terminal wealth: - An investor aims at maximizing the utility of his wealth rather
than the wealth or return. The term ‗Utility‘ describes the differences in individual preferences. Each
increment of wealth is enjoyed less than the last as each increment is less important in satisfying the basic
needs of the individual. Thus, the diminishing marginal utility is most applicable to wealth.
c) Choice on the basis of risk and return: - Investors make investment decisions on the basis of risk and
return. Risk and return are measured by the variance and the mean of the portfolio returns. CAPM assumes
that the rational investors put away their diversifiable risk, namely, unsystematic risk. But only the
systematic risk remains which varies with the Beta of the security.
d) Similar expectations of risk and return: - All investors have similar expectations of risk and return. In
other words, all investors‘ estimates of risk and return are the same. When the expectations of the investors
differ, the estimates of mean and variance lead to different forecasts.
e) Identical time horizon: - The CAPM is based on the assumption that all investors have identical time
horizon. The core of this assumption is that investors buy all the assets in their portfolios at one point of time
and sell them at some undefined but common point in future. This assumption further implies that investors
form portfolios to achieve wealth at a single common terminal rate.

f) There is risk-free asset and there is no restriction on borrowing and lending at the risk free rate: - This
is a very important assumption of the CAPM. The risk free asset is essential to simplify the complex pair
wise covariance of Markowitz‘s theory. The risk free asset makes the curved efficient frontier of MPT to the
linear efficient frontier of the CAPM simple.
g) There are no taxes and transaction costs: - According to Roll, there must be either a risk free asset or a
portfolio of short sold securities. Then only the capital Market Line (CML) will be straight. When there are
no risk free assets, the investor could not create a proxy risk free asset. As a result, the capital market line
would not be linear and the direct linear relationship between risk and return would not exist.
h) Total availability of assets is fixed and assets are marketable and divisible: - This assumption holds the
view that the total asset quantity is fixed and all assets are marketable. However, models have been
developed to include unmarketable assets which are more complex than the basic CAPM.
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ARBITRAGE PRICING THEORY (APT)

The Arbitrage pricing theory (APT) was first formulated by Stephen Ross in 1970s. It is used to estimate the
price of a financial asset and determine if it is .Undervalued or overvalued in the market. This theory assumes
that security returns are related to an unknown number of unknown factors known as risk factors.
The asset returns are generated by stochastic or random process which can be represented as linear function of
various economic risk factors. Linear function implies that return on an asset depends upon various economic
independent variable factors like inflation, interest rate, etc. The degree of the factor affects the return of an asset
which depends on the sensitivity of return to that particular factor.

The APT was developed to overcome the deficiencies of Capital Asset Pricing Model (CAPM). Where CAPM
assumed that the stock returns were affected by a single parameter that had one beta, APT overcomes this
limitation and proposes that there are multiple parameters that affect the return and each factor has a specific
beta. These specific beta factors measure the impact of a factor on an asset's return.

Assumptions of APT
The assumptions of APT are as follows:
a) The APT assumes that the investors have same expectations and make the same choices given in a particular
set of market circumstances.
b) The APT assumes that the investors are risk averse and profit maximizes.
c) The APT assumes that the perfect competition is present in the market and there is no transaction cost. Unlike
CAPM, the APT theory does not assume following:
d) There is single-period investment horizon.
e) There are no taxes.
f) The investors can borrow and lend at risk-free rate of interest.
g) The selection of the portfolio is based on the mean and variance analysis.
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Advantages of Arbitrage Pricing Theory

1) It has fewer restrictions:- The APT does not have the same requirements about individual portfolios as
other predictive theories. It also has fewer restrictions regarding the types of information allowed to perform
predictions. Because there is more information available, with fewer overall restrictions, the results tend to be
more reliable with the arbitrage pricing theory than with competitive models.

2) It allows for more sources of risk: - The APT allows for multiple risk factors to be included within the data
set being examined instead of excluding them. This makes it possible for individual investors to see more
information about why certain stock returns are moving in specific ways. It eliminates many of the questions
on movement that other theories leave behind because there are more sources of risks included within the
data set.

3) It does not specify specific factors:- Although APT does not offer specific factors like other pricing
models, there are four important factors that are taken into account by the theory. APT looks at changes in
inflation, changes in industrial production, shifts in risk premiums, and shifts in the structure of interest rates
when creating long-term predictive factors.

4) It allows for unanticipated changes: - APT is based on the idea that no surprises are going to happen. That
is an unrealistic expectation, so Ross included an equation to support the presence of an unanticipated
change. That makes it easier for investors to identify assets which have the strongest potential for growth or
the strongest potential for failure, based on the information that is provided by the opportunity itself.

5) It allows investors to find arbitrage opportunities: - The goal of APT is to help investors find securities in
the market that are mispriced in some way. Once these can be identified, it becomes possible to build a
portfolio based on them to generate returns that are better than what the indexes are offering. If a portfolio is
then undervalued, the opportunities can be exploited to generate profits because of the changes in the pricing
theory.

Disadvantages of Arbitrage Pricing Theory

1) It generates a large amount of data: - For someone unfamiliar with the arbitrage pricing theory, the
amount of data that needs to be sorted through can feel overwhelming.
2) It requires risk sources to be accurate: - Every portfolio encounters some level of risk. For APT to be
useful, it requires investors to have a clear perception of the risk, as well as the source of that risk. Only then,
will this theory be able to factor in reasonable estimates with factoring sensitivities with a higher level of
accuracy
3) It requires the portfolio to be examined singularly: - The APT is only useful when examining a single
item for risk. Because of that feature, trying to examine an entire portfolio with diverse investments is
virtually impossible to do. That is why the entire portfolio is examined using the arbitrage pricing theory
instead.
4) It is not a guarantee of results. - The arbitrage pricing theory does not guarantee that profits will happen.
There are securities which are undervalued on the market today for reasons that fall outside of the scope of
what APT considers. Some risks are not ―real‖ risks, as they are built into the pricing mechanisms by the
investors themselves, who have a certain fear of specific securities in certain market conditions.
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START-UP FINANCE

Introduction to Start-up Finance

Initial investment is important for every businessman to convert an idea of starting a venture into reality. In the
beginning, neither of large financial institutions is interested in lending money to such ventures because the
chances of being successful business are very less. In absence of availability of funds from financial institutions,
the businessman is then only available with one option, i.e., arrangement of funds through personal resources.

The personal sources through which the funds can be arranged includes sale proceeds from some assets,
arranging loan by mortgaging the residential home, requesting friends and family members to provide loans and
so on. However, there are very rare chances that the funds required for the purpose are arranged adequately.
Besides this, the person being investing in business through personal resources may lose everything invested in
the business along with good relationship with lender (relatives), if the business is not successful as per the
expectations.

Every businessman is required to prepare a strong business plan, for making his business successful, and for
attracting the prospective investors to make investment. Besides this, he should take advice from the experienced
entrepreneurs and expert persons.

Sources of Finance/Funding for Start-Up

The 'capital' is the blood of every business. Without capital, a business cannot run successfully because it is used
for funding product development, purchasing machinery and stock, paying wages and salary, and for various
other purposes.
The most usual method of arranging funds is borrowing from banks, but the banks are less interested in financing
the start-ups because there are more chances of failure of such businesses. Thus, the other sources of financing
the start-ups are as follows:
1) Personal Savings: The very first source of equity financing is personal savings. This means the
entrepreneurs should first check their own pocket for investing into the new venture. It is also the cheapest
mode of financing.
2) Friends and Family Members: Not many entrepreneurs have enough availability of funds for self-financing
their business. In such case, the next feasible option available to them after spending their savings is sourcing
funds from friends and family members who are interested in making an investment in the business.
3) Business Angels: Even after using personal savings and funds from friends and family members, the
entrepreneur may still lack some amount of funds which can be procured through business angels. Business
angels are generally an association of private investors or business who are interested in investing into new
business ventures.

4) Crowd Funding: A mechanism through which small amount of funds collected from a large number of
persons to finance a start-up is known as crowd funding. Crowd funding is carried through a vast networks
of people like the significant use of social media, it has enable the businessmen to find the prospective
investors at a single platform, while there are many crowd funding websites that provide lending facilities at
a single platform.
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5) Micro Loans: The loans of lesser amount are known as micro loans. Usually, the start-ups are raising such
loans from individuals at lower rate of interest. Micro loans can be provided by a single individual or a group
of individuals collectively.

6) Venture Capital Firms: Generally, these companies are private firms working for profit generation as main
motive and employing these profits further into emerging business ventures. According to them, such
investments have high growth and profit prospects and can bring about 300 to 500 per cent return on
investment within initial years of investment. In past few years, venture capital firms have invested a huge
amount of money in the small-scale and start-up business having high growth and profit potential. Some of
these venture capital firms are Google, Microsoft, Apple Computer, Starbucks, Genentech, FedEx, Intel,
Home Depot, etc.

ECONOMIC VALUE ADDED (EVA) ANALYSIS METHOD

Economic Value Added (EVA) is a value-based financial performance evaluation technique, which is used to
evaluate the performance of a company. It may also be used as an investment decision tool, which reflects the
absolute value created for shareholders. Almost all companies have embraced EVA as an indicator of their
performance, as an analytical device for creating, selecting and management of a portfolio.

Economic value added (EVA) is a measure of a company's financial performance, which is based on the residual
wealth calculated by deducting its cost of capital (both equity and debt deployed in the business) from its
operating profit after taxes. EVA can also be referred to as economic profit, as it makes an attempt to capture the
true economic profit of a company. It reveals the value addition to the shareholders' wealth by computing
operating profit in excess to the cost of capital invested in the business.

The concept of EVA was first conceived by the management consulting firm Stern Value Management,
originally incorporated as Stern Stewart & Co.

According to Stern Stewart, "EVA is an estimate of a company's true "economic" profit, or the amount by
which earnings exceed or fall short of the required minimum rate of return, investors could get by investing in
other securities of comparable risk".
Calculation of EVA
Basic Format for Calculating EVA
Particulars Rs.
Net Sales
Less: Operating Expenses
Operating Profit (EBIT)
Less: Taxes
Net Operating Profit after Tax (NOPAT)
Less: Capital Charges (Invested Capital x Cost of Capital)
Economic Value Added (EVA)