FE 514 Introduction to Corporate Finance

Introduction

1. Corporate Finance Basics

a. Definition: Corporate finance deals with how businesses manage their financial resources and how they fund their activities. Think of it as understanding the financial “health” and “choices” of a company.

b. Importance: Why care? Every business decision has a financial implication. Whether a company should launch a new product, invest in new machinery, or even hire new employees – they all impact the company’s finances.

2. Value Based Management

a. Definition: It’s a management approach where employees act in the best interest of shareholders. The main goal? Increase company value.

b. Key Metrics:
– Free Cash Flow: Cash a company has after paying its expenses. It’s like checking how much pocket money you have after paying your bills.
– EVA (Economic Value Added): Profit minus the cost of capital. If a company makes $100 but had to spend $30 on loans, the EVA is $70.
– MVA (Market Value Added): The difference between the current market value of a company and the capital contributed by investors. If a company is worth $500 now but investors put in $300, the MVA is $200.

3. Importance of Financial Statements

a. What are they?: Reports that show a company’s financial performance.

b. Why are they crucial?: They give a clear snapshot of where a company stands financially. Imagine trying to assess someone’s health without any tests or measurements; that’s what businesses are without financial statements.

4. Working Capital Management

a. Definition: Ensuring a company has enough short-term assets (like cash) to cover its short-term liabilities.

b. Importance: It’s like making sure you have enough money in your wallet for daily expenses. Companies don’t want to be caught short!

5. Risk

a. What is it?: The chance that an investment’s actual return will differ from the expected return.

b. Impacts on Firm Value: More risk can lead to higher returns but also bigger losses. Think of it like betting; more significant risks can bring bigger rewards, but you can also lose more.

6. Valuation

a. Corporate Valuation: How much is a company worth? This is essential for things like mergers, acquisitions, or even stock investments.

b. Security Valuation: Pricing things like stocks or bonds. If you’ve ever heard of stock prices going up or down, that’s security valuation in action!

7. Investment Decisions

a. Importance: Companies often have to decide where to put their money for the best returns.

b. Uncertainty: The future is unpredictable. Companies need to guess future cash flows and how much they should discount them based on risk.

8. Financing Sources

a. What are these?: Where companies get their money. This could be from issuing stocks, taking on debt, or even reinvesting profits.

b. Decision-making: Companies must decide the best source of financing. It’s like choosing between taking a loan or using your savings for a big purchase.

9. Agency Problems and Ownership

a. Definition: The potential conflict between managers (agents) and shareholders (owners). Managers might take actions that benefit themselves over the shareholders.

b. Wealth Maximization: The primary goal of corporate finance. Ensuring actions taken maximize shareholder value.

10. Role of Financial Institutions

a. Definition: Organizations like banks, insurance companies, and mutual funds.

b. Importance: They play a massive role in how corporate finance functions, offering loans, investments, and more.

11. Ethical Dilemmas: Sometimes, what’s best financially isn’t the most ethical choice. Companies have to navigate these challenges regularly.

By Topics

I. FINANCIAL ANALYSIS AND PLANNING

1. The Financial System and Firm Value
   • Goals of the Corporation: Imagine the corporation as a person. What does it want? To make money and grow in value.
   • Determinants of Value: What makes a company valuable? Things like its profits, assets, brand reputation, etc.
   • EVA, MVA, FCFs: Think of these as health checkups for the company – tools to check if it’s financially fit.
   • Components of Risk: Just like our life has uncertainties, companies also face risks.
2. Financial Statements and Cash Flow Analysis
   • Overview of Financial Statements: Like a report card for companies – showing profits, losses, assets, debts.
   • Financial Ratios: Like checking the pulse or blood pressure for companies.
   • Statement of Cash Flows: This shows how cash moves in and out of a company.

II. FINANCING DECISIONS

3. Corporate Growth and Financing
   • Growth: Companies want to grow, just as plants do. How fast and where they get their “nutrition” (money) is the topic here.
   • External Financing and Growth: Sometimes, the plant needs external nutrients. Similarly, companies might need external money for growth.
4. Short-Term Financing
   • Working Capital Management: Making sure a company has enough money for daily activities.
   • Cash Management & Conversion: Like checking how much pocket money you have and how quickly you can get more.
5. Risk Analysis and Leverage
   • Business & Financial Risk: Different uncertainties a company faces.
   • Leverage: Think of it as using borrowed money to try and amplify profits. But, it can also amplify losses.

III. LONG-TERM FINANCING

6. Capital Structure Decisions
   • This deals with how a company structures its finances. Like how a house can be built with a mix of wood, bricks, and steel.
   • Agency and Distress Costs: When managers (agents) make decisions, it can sometimes lead to issues or costs.
7. Dividend Policy and Value
   • Dividend: The money a company shares with its shareholders. How and when to do this is the discussion here.
   • IPOs & SEOs: When companies raise money by going public or selling more shares.

IV. VALUATION

8. Bond and Stock Valuation
   • Bonds & Stocks: Different ways to invest in a company.
   • Valuation: How much are these investments worth?
9. Cost of Capital
   • This is like the interest a company pays on the money it uses. It can come from debts, stocks, or reinvested profits.
10. Corporate Valuation
    • The big question: How much is the entire company worth?

V. INVESTMENT ANALYSIS

11. NPV and Investment Rules
    • NPV: Net Present Value, a tool to see if an investment is worth it.
    • Investment Rules: Guidelines to decide on investments.
12. Cash Flow Estimation
    • Predicting how much cash a company will have in the future.
13. Risk Analysis in Capital Budgeting
    • Before making big financial decisions, companies need to consider risks. This is like checking weather predictions before planning a picnic.