What is Corporate Finance? Fundamentals, Principles and Features

Corporate finance refers to activities and transactions related to raising capital for the creation, development and acquisition of a business. It is directly related to company decisions which have financial or monetary impacts. It can be considered as a liaison between the capital market and the organisation. The corporate finance definition also encompasses effective

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Corporate Investment and Financing Decisions

To carry on business, a corporation needs an almost endless variety of real assets. These do not drop free from a blue sky; they need to be paid for. The corporation pays for its real assets by selling claims on them and on the cash flow that they will generate. These claims are called

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The Financial Goal of the Corporation

1. Shareholders Want Managers to Maximize Market Value Major corporations may have hundreds of thousands of shareholders. There is no way that these shareholders can be actively involved in management; it would be like trying to run New York City by town meetings. Authority has to be delegated to professional managers. But how can

Fintech and the Changing World of Finance

The financial world is continually changing. A num­ber of markets that barely existed a few decades ago are now trillion-dollar businesses. In some cases, the innovation may be nothing more than someone spot­ting an untapped demand; in others, it may stem from new economic ideas. But change may also be a result of technological

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Future Values and Present Values

1. Calculating Future Values Money can be invested to earn interest. So, if you are offered the choice between $100 today and $100 next year, you naturally take the money now to get a year’s interest. Financial man­agers make the same point when they say that money has a time value or when they

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Looking for Shortcuts – Perpetuities and Annuities

1. How to Value Perpetuities Sometimes there are shortcuts that make it easy to calculate present values. Let us look at some examples. On occasion, the British and the French have been known to disagree and sometimes even to fight wars. At the end of some of these wars the British consolidated the debt

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More Shortcuts – Growing Perpetuities and Annuities

1. Growing Perpetuities You now know how to value level streams of cash flows, but you often need to value a stream of cash flows that grows at a constant rate. For example, think back to your plans to donate $10 billion to fight malaria and other infectious diseases. Unfortunately, you made no allowance

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How Interest Is Paid and Quoted

In our examples we have assumed that cash flows occur only at the end of each year. This is sometimes the case. For example, in France and Germany, the government pays interest on its bonds annually. However, in the United States and Britain, government bonds pay interest semiannually. So if a U.S. government bond

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Using the Present Value Formula to Value Bonds

If you own a bond, you are entitled to a fixed set of cash payoffs. Every year until the bond matures, you collect regular interest payments. At maturity, when you get the final interest payment, you also get back the face value of the bond, which is called the bond’s principal. 1. A Short

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How Bond Prices Vary with Interest Rates

Figure 3.1 plots the yield to maturity on 10-year U.S. Treasury bonds[1] from 1900 to 2017. Notice how much the rate fluctuates. For example, interest rates climbed sharply after 1979 when Paul Volcker, the new chairman of the Fed, instituted a policy of tight money to rein in inflation. Within two years the interest

The Term Structure of Interest Rates

When we explained in Chapter 2 how to calculate present values, we used the same discount rate to calculate the value of each period’s cash flow. This discount rate was the bond’s yield to maturity y. For many purposes, using a single discount rate is a perfectly acceptable approximation, but there are also occasions

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Explaining the Term Structure of Interest Rates

The term structure that we showed in Figure 3.4 was upward-sloping. Long-term rates of interest in December 2017 were more than 2.5%; short-term rates were about 1.8%. Why then didn’t everyone rush to buy long-term bonds? Who were the (foolish?) investors who put their money into the short end of the term structure? Suppose

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Real and Nominal Rates of Interest

It is now time to review more carefully the relation between inflation and interest rates. Suppose you invest $1,000 in a one-year bond that makes a single payment of $1,100 at the end of the year. Your cash flow is certain, but the government makes no promises about what that money will buy. If

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The Risk of Default

1. Corporate Bonds and Default Risk Look at Table 3.7, which shows the yields to maturity on a sample of corporate bonds. Notice that the bonds all mature in 2023, but their yields to maturity differ dramatically. With a yield of 13.0%, the bonds of Quorum Health appeared to offer a mouth-watering rate of

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How Common Stocks Are Traded

Boeing has 596 million shares outstanding. Shareholders include large pension funds and insurance companies that each own millions of shares, as well as individuals who own a handful. If you owned one Boeing share, you would own .0000002% of the company and have a claim on the same tiny fraction of its profits. Of

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How Common Stocks Are Valued

Finding the value of the stock of Boeing or GE may sound like a simple problem. Public com­panies publish quarterly and annual balance sheets, which list the value of the company’s assets and liabilities. For example, at the end of September 2017, the book value of all GE’s assets—plant and machinery, inventories of materials,

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Estimating the Cost of Equity Capital

In Chapter 2, we encountered some simplified versions of the basic present value formula. Let us see whether they offer any insights into stock values. Suppose, for example, that we forecast a constant growth rate for a company’s dividends. This does not preclude year-to-year deviations from the forecast: It means only that expected dividends

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The Link between Stock Price and Earnings per Share

Investors separate growth stocks from income stocks. They buy growth stocks primarily for the expectation of capital gains, and they are interested in the future growth of earnings rather than in next year’s dividends. They buy income stocks primarily for the cash dividends. Let us see whether these distinctions make sense. Imagine first the

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Valuing a Business by Discounted Cash Flow

Investors buy or sell shares of common stock. Companies often buy or sell entire businesses or major stakes in businesses. For example, we have noted BHP Billiton’s plans to sell its U.S. shale business. Both BHP and potential bidders were doing their best to value that business by discounted cash flow. DCF models work

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A Review of the Basics of Net Present Value

Vegetron’s chief financial officer (CFO) is wondering how to analyze a proposed $1 million investment in a new venture code-named project X. He asks what you think. Your response should be as follows: “First, forecast the cash flows generated by project X over its economic life. Second, determine the appropriate opportunity cost of capital