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 resource utilisation and expenditure minimisation. Factors that contribute to its decision include term requirements of the company, urgency, risk appetite, etc.

A business undertakes such decisions to achieve pre-set financial goals while ensuring maximisation of shareholder value. Apart from understanding what corporate finance is, understand what it covers.

Corporate financeSee more from basic to advanced

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

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

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

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

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,

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,

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

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

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

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

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

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

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

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

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.

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

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

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

Corporate Income Taxes

Look at Table 6.1, which shows corporate income tax rates in 11 countries. These are the tax rates imposed by the national governments, but corporations

Applying the Net Present Value Rule

Many projects require a heavy initial outlay on new production facilities. But often the largest investments involve the acquisition of intangible assets. For example, U.S.

Choosing Capital Investments When Resources Are Limited

Our entire discussion of methods of capital budgeting has rested on the proposition that the wealth of a firm’s shareholders is highest if the firm

Internal (or Discounted Cash Flow) Rate of Return

Whereas payback and return on book are ad hoc measures, internal rate of return has a much more respectable ancestry and is recommended in many

Book Rate of Return and Payback

1. Book Rate of Return Net present value depends only on the project’s cash flows and the opportunity cost of capital. But when companies report

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

How Individual Securities Affect Portfolio Risk

This brings us to our next major takeaway: The risk of a well-diversified portfolio depends on the market risk of the securities included in the

Calculating Portfolio Risk

We have given you an intuitive idea of how diversification reduces risk, but to understand fully the effect of diversification, you need to know how

Diversification and Portfolio Risk

You now have a couple of benchmarks. You know the discount rate for safe projects, and you have an estimate of the rate for average-risk

Over a Century of Capital Market History in One Easy Lesson

Financial analysts are blessed with an enormous quantity of data. There are comprehensive databases of the prices of U.S. stocks, bonds, options, and commodities, as

Using the NPV Rule to Choose among Projects

Almost all real-world investment decisions entail either-or choices. Such choices are said to be mutually exclusive. We came across an example of mutually exclusive investments

Example – IM&C’s Fertilizer Project

1. The Three Elements of Project Cash Flows You can think of an investment project’s cash flow as composed of three elements: Total cash flow

Company and Project Costs of Capital

The company cost of capital is defined as the expected return on a portfolio of all the company’s outstanding debt and equity securities. It is

Some Alternative Theories of Portfolio Theory and the Capital Asset Pricing Model

The capital asset pricing model pictures investors as solely concerned with the level and uncertainty of their future wealth. But this could be too simplistic.

Validity and Role of the Capital Asset Pricing Model

Any economic model is a simplified statement of reality. We need to simplify in order to interpret what is going on around us. But we

The Relationship between Risk and Return

In Chapter 7, we looked at the returns on selected investments. The least risky investment was U.S. Treasury bills. Since the return on Treasury bills

Harry Markowitz and the Birth of Portfolio Theory

Most of the ideas in Chapter 7 date back to an article written in 1952 by Harry Markowitz.[1] Markowitz drew attention to the common practice

Diversification and Value Additivity

We have seen that diversification reduces risk and, therefore, makes sense for investors. But does it also make sense for the firm? Is a diversified

Monte Carlo Simulation

Sensitivity analysis allows you to consider the effect of changing one variable at a time. By looking at the project under alternative scenarios, you can

Break-Even Analysis and Operating Leverage

1. Break-Even Analysis When we undertake a sensitivity analysis of a project or when we look at alternative scenarios, we are asking how serious it

Sensitivity and Scenario Analysis

Uncertainty means that more things can happen than will happen. Therefore, whenever managers are given a cash-flow forecast, they try to determine what else may

Certainty Equivalents – Another Way to Adjust for Risk

In practical capital budgeting, a single risk-adjusted rate is used to discount all future cash flows. This assumes that project risk does not change over

Analyzing Project Risk

Suppose that a coal-mining corporation needs to assess the risk of investing in a new company headquarters. The asset beta for coal mining is not

Measuring the Cost of Equity

To calculate the weighted-average cost of capital, you need an estimate of the cost of equity. You decide to use the capital asset pricing model

What Agency Problems Should You Watch Out For?

The CEO, CFO, and other managers cannot be perfect agents of their shareholders. The managers are human beings who cannot completely set aside their own

Marvin Enterprises Decides to Exploit a New Technology – an Example

To illustrate some of the problems involved in predicting economic rents, let us leap forward several years and look at the decision by Marvin Enterprises

Economic Rents and Competitive Advantage

Profits that more than cover the cost of capital are known as economic rents. Economics 101 teaches us that in the long run, competition eliminates

Look First to Market Values

Let us suppose that you have persuaded all your project sponsors to give honest forecasts. Although those forecasts are unbiased, they are still likely to

How Firms Organize the Investment Process

1. The Capital Budget Senior management needs some forewarning of future investment outlays. So for most large firms, the investment process starts with the preparation

Real Options and Decision Trees

When you use discounted cash flow (DCF) to value a project, you implicitly assume that the firm will hold the assets passively. But managers are

The Efficient Market Hypothesis

Economists define three levels of market efficiency, depending on the kinds of information incorporated in security prices. In the first level, prices incorporate all information

Differences between Investment and Financing Decisions

In some ways, financing decisions are more complex than investment decisions. The number of different securities and financing strategies is well into the hundreds (we

Biases in Accounting Measures of Performance

Anyone using accounting measures of performance had better hope that the accounting numbers are accurate. Unfortunately, they are often not accurate, but biased. Applying EVA

Measuring and Rewarding Performance: Residual Income and Economic Value Added

Almost all top executives of firms with publicly traded shares have compensation packages that depend in part on their firms’ stock price performance. But their

Management Compensation

Monitoring can’t be perfect. Therefore, compensation plans must be designed to attract competent managers and to give them the right incentives. For U.S. public companies,

Monitoring the Investment

Agency costs can be reduced by monitoring a manager’s efforts and actions and by intervening when the manager veers off course. Monitoring can prevent the

Debt and Types of Debt

When companies borrow money, they promise to make regular interest payments and to repay the principal. However, this liability is limited. Stockholders have the right

Common Stock

1. Ownership of the Corporation A corporation is owned by its common stockholders. You can see from Figure 14.4 that in the United States, 39%

Patterns of Corporate Financing

Corporations invest in long-term assets, such as property, plant, and equipment, and in current assets, such as inventory and accounts receivable. Figure 14.1 shows where

The Five Lessons of Market Efficiency

The efficient-market hypothesis emphasizes that arbitrage will rapidly eliminate any profit opportunities and drive market prices back to fair value. Behavioral-finance specialists may concede that

Behavioral Finance

Why might prices depart from fundamental values? Some believe that the answer lies in behavioral psychology. People are not 100% rational 100% of the time.

Bubbles and Market Efficiency

So far, we have asked whether individual stocks are “priced right,” given the information that investors can see or acquire. But what about the market

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