Corporate Finance

Important Business
Activities

Production

Marketing

Finance

Finance is the provision of money

at the time when it is required.

Corporate
Finance
defined
as
the
management of flow of funds in a firm and
its deals with the financial decision making
of the firm.

It is that part of the management activity,

which is concerned with the planning, and
controlling of the firms financial resources.

It also deals with various sources of raising

of the funds for the firm and its effective
utilization

Scope of Finance Function

Overall financial planning and control,

Raising funds from different sources,

Selection of fixed assets,

Management of working capital, and

Any other individual financial event.

Finance Functions
Finance functions or decisions can be divided as
follows
Long-term financial decisions
Long-term

asset-mix

or

investment

decision

or

capital

budgeting decisions.
Capital-mix or financing decision or capital structure and

leverage decisions.
Profit allocation or dividend decision

Short-term financial decisions

Short-term asset-mix or liquidity decision or working capital

management.
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FINANCE FUNCTIONS
Investment decision (those relating to resource
allocation)
Liquidity decision (those relating to investment in
current assets)
Financing or capital structure decision (those
covering the financing of these investments)
Dividend decision (those determining how much
cash be taken out and how much reinvested)

Investment Decisions

The investment decisions include those

decisions that create revenues and profits
such as:
introducing a new product line
introducing a more efficient distribution
system.
The investment decisions are the decisions
relating to assets composition of the firm.

Assets represent investment or uses of the funds

that the firm makes in expectation of earning a
return for its investors.

The assets can be classified into fixed assets and

current assets, and therefore the investment
decisions of fixed assets are known as Capital
Budgeting decisions and the investment
decisions of current assets are known as Liquidity
decisions/ Working Capital Management.

Capital Budgeting
Decisions

Includes

Which asset should be purchased out of different

alternative options,
To buy an asset or to get it on lease,
To produce a part of the final product or to

procure it from some other supplier,

To buy or not an other firm as a running concern,
Proposal of merger of other group firms to avail

the synergies of consolidation, etc.

All these decision have long-term

implications and are generally irreversible.

The objective of Capital Budgeting

decisions is to identify those assets, which
are worth more than they cost.

Liquidity Decision

Liquidity decision deals with the management of

current assets of the firm. The current assets do
not contribute directly to the earnings, yet their
existence is necessitated for the proper, efficient
and optimum utilization of fixed assets.

A finance manager has to ensure sufficient and

adequate working capital to the firm.

A trade-off between liquidity and

profitability is required.

Finance manager has to take various

decisions like how much and what
inventory to be maintained, and whether
and how much credit be given to
customers, etc.

Financing Decisions

Financing Decisions deal with the financing pattern

of the firm. As firms make decisions concerning
where to invest these resources, they have also to
decide how they should raise resources.

There are two main sources of finance for any firm.

Shareholders funds
Borrowed funds

The employment of these sources in combination

is also known as financial leverage.

Any combination of borrowed funds and

shareholders funds i.e., any financial leverage
can be selected and implemented by the firm as
it is related to the value of the firm.

A finance manager has to evaluate different such

combinations and adopt one which is optimum
for the firm.

Dividend Decision

Dividend decisions deal with the appropriation of

after tax profits.

These profits are available to be distributed among

the shareholders (subject to legal provisions) or can
be retained by the firm for reinvestment with in the
firm.

All firms whether small or big, have to decide how

much of the profits should be reinvested back in
the business and how much should be taken out
in form of dividend) i.e. return on capital. It
depends upon:

Reinvestment opportunities available to the

firm,
The opportunity rate of return of the
shareholders

Finance Managers Role

Raising of Funds
Allocation of Funds
Profit Planning
Understanding Capital Markets

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GOAL OR OBJECTIVE OF THE

FINANCIAL MANAGEMENT

A goal of the firm may be defined as a target

against which the firm's operating
performance can be measured.

There are several goals of financial

management such as
maximization of sales revenue, net profit, return
of investment, size of the firm, percentage market
share, etc.

The two essential objectives of the

financial management are:
The maximization of the profits of the firm
The maximization of the shareholders wealth.

Profit Maximization

Maximizing the rupee income of firm

Resources are efficiently utilized
Appropriate measure of firm performance
Serves interest of society also

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Objections to Profit Maximization

It is Vague
It Ignores the Timing of Returns
It Ignores Risk
Assumes Perfect Competition
In new business environment profit maximization is regarded
as
Unrealistic
Difficult
Inappropriate
Immoral

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Maximizing Profit after Taxes or EPS

Maximising PAT or EPS does not maximise the

economic welfare of the owners.

Ignores timing and risk of the expected benefit

Market value is not a function of EPS.

Maximizing EPS implies that the firm should

make no dividend payment so long as funds can
be invested at positive rate of returnsuch a
policy may not always work.
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Shareholders Wealth Maximization

Maximizes the net present value of a course of

action to shareholders.

Accounts for the timing and risk of the

expected benefits.

Benefits are measured in terms of cash flows.

Fundamental

objectivemaximize

market value of the firms shares.

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the

Need for a Valuation

Approach

SWM requires a valuation model.

The financial manager must know,

How much should a particular share be worth?
Upon what factor or factors should its value
depend?

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Risk-return Trade-of

Financial decisions of the firm are guided by the riskreturn trade-of.

The return and risk relationship:

Return = Risk-free rate + Risk
premium

Risk-free rate is a compensation for time and risk

premium for risk.
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Risk Return Trade-of

Risk and expected return move in tandem; the greater the

risk, the greater the expected return.

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Overview

Agency Problems: Managers Versus

Shareholders Goals

There is a Principal Agent relationship between

managers and shareholders.

In theory, Managers should act in the best interests of

shareholders.

In practice, managers may maximise their own wealth

(in the form of high salaries and perks) at the cost of
shareholders.
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Agency Problems: Managers Versus

Shareholders Goals

Managers

may

perceive

their

role

as

reconciling

conflicting

objectives of stakeholders. This stakeholders view of managers role

may compromise with the objective of SWM.

Managers may avoid taking high investment and financing risks that
may otherwise be needed to maximize shareholders wealth. Such
satisfying behaviour of managers will frustrate the objective of
SWM as a normative guide.

This conflict is known as Agency problem and it results into

Agency costs.

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Agency Costs

Agency

costs

include

the

less

than

optimum share value for shareholders and

costs incurred by them to monitor the
actions of managers and control their
behavior.

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Corporate Governance

Refers to the set of rules, processes and

customs that affects the manner in which
an organisation is administered.

The need of CG emerges on account of

divergence of interest, particularly between
the owners and management.

Four pillars of CG

Transparency

Full disclosure

Independent monitoring

Fairness to all stakeholders