1.

Introduction of Corporate Finance

1.1 Corporate Finance
Corporate finance can be defined as a body of knowledge that deals with the
following three issues.
 What long term strategic investments a firm should undertake?
 What long term financing alternatives that a firm should use to raise capital
to finance its long term strategic investments?
 How much short term cash flow does a company need to ensure smooth day
you day operations of firm?
Long term strategic investments decisions are also known as the capital
budgeting decisions.
Long term strategic financing decisions involve a decision on mix of debt and
equity financing for the company and are known as capital structure decision.
Dividend policy decision also falls into this category.
Management of short term cash flows relate to working capital management.
The above mentioned three issues are discussed and analyzed within the basic
framework of time value of money and principle of risk and return. Moreover, the
financial statement analysis helps the management moving toward the right path in
interest of shareholders.
Thus we can define corporate finance as a study of the principles, policies and
institution that shape corporate financial decision.
Corporate finance displays the movements of funds (money, capital, and other
financial assets,), by which the company gets involved into quantitative and
qualitative money relations with different entrepreneurial subjects, employees and all
other subjects of its financial environment.
 Foreign Interest
Tax
Investor
Other costs

Firm Output Revenue - Profit

Market

Reinvestment
+

Owner
Dividends

Corporate Money Flow

Corporate finance is a segment of finance which deals with the decision taken
by the different corporations. Corporate finance studies and analyzes the tools that
mandatory in arriving at such corporate finance is the maximization of corporative
value by minimizing corporate risk. In corporate finance, we analyze the long term
and short-term decision. It includes:
 Capital investments decision
 Working capital management
 Financial risk management

1.2 Principles of Corporate Finance

Some principles of finance are:
 Time value of money
 Compensation of risk
 Do not put your eggs in one basket
 Markets are smart
 No arbitrage
1. Time value of money
The opportunity to earn a return on invested funds means that a dollar today is
worth more than a dollar in future. A dollar today represents present value and a
dollar in future represents future value.
2. Compensation of risk
Risk is the chance of financial loss and variability of return. Investors expected
compensation forbearing risk.
3. Do not put your eggs in one basket
Investor can achieve a more favorable trade off between risk and return by
diversifying their portfolios.
High risk High return
Low risk Low return
4. Markets are smart
Competition for information tends to make market efficient.
5. No arbitrage
Arbitrage opportunities are extremely scarce. Arbitrates is the practices of
taking advantages of price differential b/w two or more markets. Arbitrates
opportunity means the opportunity to buy an assets at a low price then immediately
selling it on a different market for a higher price. Like as if one person buys assets of
Rs.100 and sale it to Rs.200, the difference of Rs.100 shows arbitrage profit.

1.3 Financial Manager’s Goals

There are some goals of financial managers.
 Maximize profit
 Maximize shareholder’s wealth
 Stakeholders focus
1. Maximize profit
 Earning reflect past performance, rather than current or future performance.
 Ignore the timings of profit.
 Ignore cash flows.
 Ignore risk.
 Earning per shares is backward looking, dependent on accounting
principles.
2. Maximize shareholder’s wealth
 Maximizes stock price, not profits.
  Shareholders as residual claimants, have better incentives to maximize firm
value.
 A firm’s stock price reflects the timing, magnitude, and risk of cash flows
that investors expect a firm to generate over time.
3. Stakeholders focus
 Stakeholders are those persons who have some economic interest in the
business like as government, employees, suppliers, customers, etc.
 Many firms seek to preserve the interest of other stakeholders, such as
employees, customers, tax authorities and communities where the firm
operates.
 Doing so provide long term benefits to shareholders and is in line with the
primary goal of maximizing shareholders wealth.

1.4 Scope of Corporate Finance

Financial managers should seek to maximize shareholder’s wealth by
performing the basic functions of corporate finance. Select instruments for which the
marginal benefits exceed the marginal cost.