Prepared by:Arvind singh Shivani babbar

Corporate finance

Corporate finance is the area of finance dealing

with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize shareholder value while managing the firm's financial risks.

Different forms of organization

Sole proprietorship

Partnership Corporation Cooperative

The Role of Finance Manager

The routine working capital . cash management decisions. Dividend decisions. Investment decisions. Financial forecasting. International financial decisions. Portfolio management. Risk management.

Time Value of Money (TVM)

Time Value of Money (TVM)

The idea that money available at the present time is

worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.

Future value
How much what you got now grows to when

compounded at a given rate

FV = Future Value

PV = Present Value i = the interest rate per period n= the number of compounding periods

Discounting
It is a process of finding the present value of a future

cash flows It is a reciprocal of compounding

'Present Value (PV)'

The current worth of a future sum of money or

stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows

 PV is the value at time=0

FV is the value at time=n I= is the discount rate, or the interest rate at which the amount will be compounded each period n= is the number of periods

The cost of capital

The cost of capital

The cost of capital determines how a company can raise

money (through a stock issue, borrowing, or a mix of the two). This is the rate of return that a firm would receive if it invested in a different vehicle with similar risk. as the cost of capital is the appropriate discount rate to apply to the future cash flows that security will pay

1)The capital asset pricing model (CAPM) is a method of valuing not just securities, but any investment, using a DCF with a risk adjusted discount rate.The method used to calculate an appropriate discount rate uses the investment's beta. r = rf + ( (rm - rf)) 2) Arbitrage pricing theory (APT)

valuation models.

'Cost Of Equity'
the return that stockholders require for a company. The

traditional formula for cost of equity (COE) is the dividend capitalization model:

A firm's cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership..

Cost of equity = Risk free rate of return + Premium expected for risk
Cost of equity = Risk free rate of return + Beta x (market rate of return- risk free rate of return)
Where Beta= sensitivity to movements in the relevant market: Es -The expected return for a security Rf -The expected risk-free return in that market (government bond yield s- The sensitivity to market risk for the security RM- The historical return of the stock market/ equity market(RMRf )

The risk premium of market assets over risk free assets

'Cost Of Debt
The effective rate that a company pays on its

current debt. This can be measured in either before- or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often.

Rf + credit risk rate)(1-T),

where T is the corporate tax rate and

Rf is the risk free rate.

Weighted average cost of capital

a companys assets are financed by either debt or equity.

WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances.

Where: Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate

Capital structure
Capital structure refers to the way a corporation finances

its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities For example, a firm that sells $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of debt to total financing, 80% in this example, is referred to as the firm's leverage.

 tax advantages on debt issuance, it will be cheaper to issue debt

rather than new equity the cost of issuing new debt will be greater than the cost of issuing new equity. This is because adding debt increases the default risk - and thus the interest rate that the company must pay in order to borrow money By utilizing too much debt in its capital structure, this increased default risk can also drive up the costs for other sources (such as retained earnings and preferred stock) as well. Management must identify the "optimal mix" of financing the capital structure where the cost of capital is minimized so that the firm's value can be maximized.

 The basic theorem states that, under a certain market price

ModiglianiMiller theorem

process in the absence of taxes bankruptcy costs, agency costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. It does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Therefore, the ModiglianiMiller theorem is also often called the capital structure irrelevance principle.

CAPITAL BUDGETING

CAPITAL BUDGETING BUDGETING

The process in which a business determines whether

projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target benchmark. Also known as "investment appraisal".

Project
A project is a series of activities aimed at bringing about

clearly specified objectives within a defined time-period and within a defined budget

PROJECT CYCLE-Refers to a logical sequence of activities to accomplish the projects goals or objectives. Project Cycle ensures that: Problem analysis is thorough. Objectives are clearly stated. Stakeholders are clearly identified and monitored. Assessment of the project results against objectives.

Stages of Project Cycle

Project Appraisal:
Project Appraisal process involves following activities: Technical Analysis. Social Profitability Analysis. Financial Analysis. Commercial Analysis.

Appraisal Techniques
Simple Rate of Return.
Payback Period. Net Present Value.

Internal Rate of Return.

Simple Rate of Return:

Expresses the average net profits (Net Cash Flows) generated each year by an investment as a percentage of investment over the investments expected life. Simple Rate of Return = Y/I Where, Y = the average annual net profit after allowing depreciation from the investment. I = the initial investment.

Payback Period:
The length of time required to recover the cost of an

investment.
PBP = I/E Where, I = the initial investment. E = the projected net cash flows per year from the investment. PBP = Pay Back Period expressed in number of years.
All other things being equal, the better investment is the one

with the shorter payback period.

Internal Rate of Return:

Internal Rate of Return (IRR) is a discount rate which makes

the net present value (NVP) of the cash flow equals to zero. Represents the average earning power of the money used in the project over the project life. IRR is that discount rate i such that, =0 Where, Bn = Benefits in each year of the project. Cn = Costs in each year of the project. n = number of years in the project.

Internal Rate of Return:

Internal Rate of Return (IRR) is a discount rate which makes

the net present value (NVP) of the cash flow equals to zero. Represents the average earning power of the money used in the project over the project life. IRR is that discount rate i such that, =0 Where, Bn = Benefits in each year of the project. Cn = Costs in each year of the project. n = number of years in the project.

Use of appraisal techniques:

Calculating Simple Return Rate
Assume, Investment cost=Rs. 100000 Planning horizon=6 years Yearly cash inflow=25000 Total net cash flow=Rs.150000 SRR= average annual profit/initial investment Therefore, SRR=(25000/100000) =25%

Contd:
Payback Period Assume, Investment cost=Rs. 100000 Planning horizon=6 years Yearly cash inflow=25000 PBP = I/E

Therefore, PBP=100000/25000 = 4 years.

Contd.
Net Present Value
Time period (years) 0 Cash flow(Rs.) PV factor 12% Present value (Rs.) -100000 Cumulati ve present value -100000

-100000

1.000

1
2 3 4 5 6

25000
25000 25000 25000 25000 25000 50000

0.941
0.840 0.750 0.670 0.598 0.534

23525
21000 18750 16750 14950 13350 8325

-76475
-55475 -36725 -19975 -5025 +8325

Contd.
Internal Rate of Return
NPV= NPV=-100000+ =0 So, IRR=12.98 =0 + + + + +

 Thanks

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