Applied Sciences homework help. CORPORATE FINANCE
Corporate finance is an area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources.
What is Corporate Finance?
Three main questions need to be answered.
- What long-term investments should you make? That is, what lines of business will you be in, and what sorts of building, machinery and equipment will you need?
2.Where will you get the long-term financing to pay for your investment? Will you bring in other owners, or will you borrow the money?
3.How will you manage your everyday financial activities, such as collecting from customers and paying suppliers?
The Financial Manager
The financial management function is usually associated with a top officer of the firm, such as a finance director (FD) or chief financial officer (CFO).
Coordinates the activities of the treasurer and the controller.
Controller: handles cost and financial accounting, tax payments, and management information systems.
Treasurer: responsible for managing the firm’s cash and credit, its financial planning and its capital expenditures.
Finance function: is related to the three general questions above
Accounting function: takes all the financial information and data that arises as a result of ongoing business activities, and presents this in ways that allow management to assess the performance and risk of their firms (financial accounting) and make informed decisions on further corporate activity (management accounting).
Financial Management Decisions
Capital budgeting: the process of planning and managing a firm’s long term investments (so related to question 1). The financial manager tries to identify investment opportunities that are worth more to the firm that they cost to acquire (value of the cash flow generated by an asset exceeds the cost of the asset). They types of investment opportunity that would typically be considered depend in part on the nature of the firm’s business. Financial management must always not only be concerned with how much cash they expect to receive, but also with when they expect to receive it, and how likely they are to receive it. Size, timing, risk of future cash flows evaluation is the essence of capital budgeting.
Capital Structure:the mixture of long-term debt and equity maintained by a firm (second question: ways in which the firm obtains and manages the long-term financing it need to support its long-term investments).
Equity: the amount of money raised by the firm that comes from the owners’ investment.
Long-term debt:
long-term borrowing by the firm (longer than one year) to finance its long-term investments.
Two concerns in this area: 1. How much should the firm borrow, so which mixture of debt and equity is best? This choice will affect both risk and the value of the firm. 2.What are the least expensive sources of funds for the firm?
-Pie and shareholders and creditors from percentage of the cash flow.
-Firms have great flexibility in choosing a financial structure.
Working Capital Management
Working Capital: A firm’s short term assets and liabilities.Concerned with the third question. Managing working capital is a day-to-day activity which ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions. This involves a number of activities related to the firm’s receipt and disbursement of cash.
The goal of financial management
The financial manager in a corporation makes decisions for the shareholders of the firm. We thus need to answer a more fundamental question than listing possible goals: from the shareholder’s point of view, what is a good financial management decision?
-Good decisions increase the value of the equity and vice versa
-So, acting in the shareholder’s best interest. Goal: Shareholders are the last ones in getting money, so when they are winning, everybody is winning. maximize the current value per share of the existing equity.
-Avoids the problems stated earlier because there is no ambiguity or difference between long-term and short-term issues.
-Corporate finance: the study of the relationship between business decisions and the value of the equity in the business.
Primary versus secondary markets
Primary market: The original sale of securities by governments and corporations.
Secondary markets: Those markets in which these securities are bought and sold after the original sale.
-Equities are issued solely by corporations. Debt securities are issued by both government and corporations.
Corporation
Is a business created as a distinct legal entity composed of one or more individuals or entities. It is in size the most important form of business organization.
-It is a legal person, and so distinct from its owners, and has its own rights, duties and privileges.
-A corporation can even be a general or limited partner in a partnership, and can own equity in another corporation.
-Starting a corporation is more complicated than starting the previous two. It involves preparing articles of incorporation (or a charter), and amemorandum of association
The articles of incorporation must cotain a number of things, including the corporation’s name, its intended life (which can be forever), its business purpose, and the number of shares that can be issued. This normally has to be supplied to the country of origin. For most legal purposes the corporation is a ‘resident’ of that country.
The memorandum consists of rules describing how the corporation regulates its existence, e.g. the election of directors. The memorandum may be amended or extended from time to time by the shareholders.
Several advantages due to the separation of ownership and management:
1.Ownership (represented by shares of equity can be readily transferred
2.Life of the corporation is not limited
3.The company borrows money in its own name so, limited liability (own investment).
4.The three points above make this form the best form for raising cash.
Disadvantages:
1.It must pay taxes because it is a legal person, and money paid to shareholders in the form of dividend is taxed again as income to the shareholders. This is double taxation. Thus, taxation at the corporate and personal level.
-Corporations are also called joint stock companies, public limited companies or limited liability company.
Control of the firm: Control of the firm ultimately rests with shareholders. They elect the board of directors, who in turn hire and fire managers.
Shareholder rights: The conceptual structure of the corporation assumes that shareholders elect directors, who in turn hire managers to carry out their directives. Shareholders therefore control the corporation through the right to elect the directors.
Introduction to valuation: the time value of Money
Time value of Money refers in the most general sense to the fact that the euro today is worth more than an euro promised at some time in the future. E.g. because of missed interest (‘growing money’). It thus depends on the rate you can earn by investing.
Future value (FV): The amount of money an investment will grow to over some period of time at some given interest rate. Future value and compounding
Investing for a single period
If you invest for one period at an interest rate of r, your investment will grow to (x+(x*r)).
Investing in more than one period
Compounding is the process of accumulating interest on an investment over time to earn more interest.
Interest on interest: interest earned on the reinvestment of previous interest payments.
Compound interest: interest earned on both the initial principal and the interest reinvested from prior periods.
Simple interest: Interest earned only on the original principal amount invested. The four terms above show that by investing in more periods, the amount of money after interest consists of four compounds
Bond valuation:When a corporation or government wishes to borrow money from the public on a long term basis, it usually does so by issuing or selling debt securities that are generically called Bonds.
Interest rate risk:The risk that arises for bond owner from fluctuating interest rates is called interest rate risk
The indenture : The indenture is the written agreement between the corporation and the lender detailing the terms of the debt issue. It is sometimes referred to as deed of trust
IBRAHIM AGGUL
