CHAPTER 1

INTRODUCTION TO
CORPORATE FINANCE
S. MARIA IMMANUVEL
Learning Objective

Meaning of Corporate Finance

Major Decision in Corporate finance
Principles of corporate finance
Financial markets
Role of Finance manager
Agency problems
??? Major Questions ???
Corporate Finance Questions

▪ Are companies’ market price justified?

▪ How to measure the projects’ worth for the company?
▪ How to account for risks associated with the project?
▪ Should we give managers higher salaries or higher bonuses?
▪ Does it matter how to finance the project: by debt or by equity?
▪ Would you like the company to have much debt?
▪ Should company borrow money from banks or issue bonds?
▪ Would you like the company to pay high dividends?
Corporate Finance : Meaning
Introduction to Corporate Finance

▪ Corporate finance deals with the capital structure of a corporation,

including its funding and the actions that management takes to
increase the value of the company.
▪ Corporate finance includes the tools and analysis utilized to
prioritize and distribute financial resources.
▪ The ultimate purpose of corporate finance is to maximize the value
of a business through planning and implementation of resources
while balancing risk and profitability.

https://corporatefinanceinstitute.com/resources/fpa/corporate-finance-industry/
Introduction to Corporate Finance

▪ Corporate finance refers to planning, developing and controlling the

capital structure of a business.
▪ It aims to increase organizational value and profit through optimal
decisions on investments, finances as well as dividends.
▪ It focusses on capital investments aimed at meeting the funding
requirements of a business to attain a favorable capital structure

https://www.wallstreetmojo.com/corporate-finance/
Introduction to Corporate Finance

Every decision that a business makes has financial

implications, and any decision which affects the

finances of a business is a corporate finance decision.

Corporate Finance : Major
Decisions
Major Decisions in Corporate Finance

Capital Budgeting Capital Structure

Working capital
Dividend Distribution
requirements
Major Decisions in Corporate Finance – Capital Budgeting

▪ Capital Budgeting - The Allocation decision – Investment decision

▪ Ascertaining the fund requirements of your business
▪ Where do you invest the scarce resources of your business?
▪ What makes for a good investment?
▪ Judging feasibility and profitability of investment decisions
Major Decisions in Corporate Finance – Capital Budgeting

▪ Today’s capital investments generate future cash returns.

▪ Sometime, the cash inflows last for decades
▪ The longer it has to wait for cash flow back in, the greater the cash
inflow required to justify the investment
▪ Financial manager has to pay attention to the timing of cash inflows,
not just their cumulative amount
▪ Financial Managers know (or quickly learn) that cash returns are not
guaranteed. An investment could be a smashing success or dismal
failure
 Major Decisions in Corporate Finance – Capital Budgeting

Total Value of Assets: Total Firm Value to Investors:

Current
Liabilities
Current Assets Long-Term
Debt

Fixed Assets What long-term

1 Tangible investments Shareholders’
should the firm Equity
2 Intangible choose?
Major Decisions in Corporate Finance – Financing Decision

▪ Capital – firm’s sources of long term financing

▪ Where do you raise the funds for these investments?
▪ Generically, what mix of owners money (equity) or borrowed
money(debt) do you use?
▪ Borrowed Money – pay back the debt plus a fixed rate of interest
▪ Borrow from a bank or borrow by issuing bonds
▪ Debt is good but too much can land the company in bankrutpcy

▪ Equity financing – no fixed return, get a share of future profits

▪ Two ways : issue new share or reinvest the cash generated from its operation
Major Decisions in Corporate Finance – Financing Decision

Current
Liabilities
Current
Assets Long-Term
How should the Debt
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible Shareholder
2 s’ Equity
Intangible
Major Decisions in Corporate Finance – Dividend Decision

▪ The Dividend Decision

▪ How much of a firms funds should be reinvested in the business?
▪ How much should be returned to the owners?
Major Decisions in Corporate Finance – Working capital
requirements

Managing capital for day today operations

Current
Liabilities
Current
Assets Net
Working
Long-Term
Capital Debt

How should
Fixed Assets
short-term
1 Tangible assets be
managed and Shareholder
2 financed? s’ Equity
Intangible
Firm and the Financial Markets
The Firm and the Financial Markets

Firm Firm issues securities (A) Financial

markets
Invests
Retained
in assets cash flows (F)
(B)
Short-term debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Taxes (D)
The cash flows from
Ultimately, the firm
the firm must exceed
must be a cash Government
the cash flows from
generating activity.
the financial markets.
Role of The Financial Manager

(2) (1)

Firm's Financial Financial

(4a)
operations manager markets

(3) (4b)

(1) Cash raised from investors

(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
Financial Markets

▪ Primary Market
▪ Issuance of a security for the first time

▪ Secondary Markets
▪ Buying and selling of previously issued securities
▪ Securities may be traded in either a dealer or auction market
▪ BSE
▪ NSE
Financial Markets

Stocks and
Investors
Bonds
Firms securities
Money Bob Sue
money

Primary Market
Secondary
Market
Principles and objectives of
Corporate Finance
Principles of Corporate Finance

▪ Invest in projects that yield a return greater than the minimum

acceptable hurdle rate.
▪ The hurdle rate should be higher for riskier projects and reflect the
financing mix used - owners funds (equity) or borrowed money (debt)
▪ Returns on projects should be measured based on cash flows
generated and the timing of these cash flows they should also
consider both positive and negative side effects of these projects.
▪ Choose a financing mix that minimizes the hurdle rate (Cost of capital)
and matches the assets being financed.
Principles of Corporate Finance

▪ If there are not enough investments that earn the hurdle rate, return
the cash to stockholders.
▪ The form of returns - dividends and stock buybacks - will depend
upon the stockholders characteristics.

Objective : Maximize the Value of the Firm

The Objective in Decision Making

▪ In traditional corporate finance, the objective in decision making is to

maximize the value of the firm.
▪ A narrower objective is to maximize stockholder wealth. When the
stock is traded and markets are viewed to be efficient, the objective is
to maximize the stock price.
▪ All other goals of the firm are intermediate ones leading to firm value
maximization, or operate as constraints on firm value maximization.
The Objective in Decision Making

▪ Stock price is easily observable and constantly updated (unlike other

measures of performance, which may not be as easily observable, and
certainly not updated as frequently).
▪ If investors are rational, stock prices reflect the wisdom of decisions,
short term and long term, instantaneously.
▪ The stock price is a real measure of stockholder wealth, since
stockholders can sell their stock and receive the price now.
The Objective in Decision Making

▪ For stock price maximization to be the only objective in decision

making, we have to assume that
▪ The decision makers (managers) are responsive to the owners
(stockholders) of the firm
▪ Stockholder wealth is not being increased at the expense of
bondholders and lenders to the firm; only then is stockholder wealth
maximization consistent with firm value maximization
▪ Markets are efficient; only then will stock prices reflect stockholder
wealth
Goal of Financial Management

What should be the goal of a corporation?

▪ Maximize profit / revenues?
▪ Minimize costs? Intermediate
objective
▪ Maximize market share? functions
▪ Maximize the current value of the company’s stock?

▪ To the degree that they are correlated with the long term health and
value of the company, they work well. If not the firm can end up with a
disaster
Corporate Finance : Agency
Problem
Agency Problem

▪ Shareholders want managers to maximize current market value of

their investment in the firm
▪ Principal hires an agent to represent his/her interest. Authority is
delegated to professional managers
▪ Stockholders (principals) hire managers (agents) to run the company
▪ Do managers maximize shareholder wealth or manager wealth?
▪ Mangers have many constituencies “stakeholders” (Anyone with a
financial interest in the corporation)
Agency Problem

▪ Agency problem
▪ Conflict between shareholder’s and managers’ objectives create agency
problem
▪ Managers are agents for stockholders and are tempted to act in their own
interests rather than maximizing value
▪ Managerial goals may be different from shareholder goals: (Expensive
perquisites, Survival, Independence etc)
▪ Managerial compensation
▪ Incentives can be used to align management and stockholder interests
▪ The incentives need to be structured carefully to make sure that they
achieve their intended goal
Agency Problem

▪ Agency cost
▪ It is incurred when
▪ Managers do not attempt to maximize firm value
▪ Shareholders incur cists to monitor the managers and constraint their
actions
Summary : Corporate Finance is about

Planning the Finance Raising the Finance

Investing the Finance Monitoring the Finance

Bangalore Metro Rail Corporation Limited (BMRCL)

▪ Financing and Investment

▪ Bangalore Metro Rail Corporation Limited (BMRCL), a joint venture of Government of
India and Government of Karnataka
▪ The BMRCL had the responsibility to raise a long-term loan of around Rs 12,000
crore for the construction of the 72-km Phase II network, estimated to cost over Rs
26,000 crore. The BMRCL has tied up funds to the tune of 7,300 crores and hopes
to raise the remaining funds in due course of time.
▪ Asian Development Bank : India : Bengaluru Metro Rail Project
https://www.adb.org/projects/53326-001/main
▪ Asian Infrastructure Investment Bank (AIIB) : India: Bangalore Metro Rail Project - Line
R6 : https://www.aiib.org/en/projects/details/2017/approved/India-Bangalore-
Metro-Rail-Project-Line-R6.html
Bangalore Metro Rail Corporation Limited (BMRCL)

▪ The Bangalore Metro Rail Corporation Ltd (BMRCL) will receive a long-term loan of
Rs 2,300 crore (335 million USD) from the Asian Infrastructure Investment Bank (AIIB)
for the Phase II project. The deal was signed in New Delhi on Tuesday.

▪ BMRCL Gets Loan Of Rs 1,700 Crore From European Investment Bank

▪ The phase II is to be jointly financed by the EIB (500 million euros) and Asian
Infrastructure Investment Bank (300 million euros). "The first tranche of 300 million
euros was signed on Thursday," the finance ministry officials said.

▪ BMRCL loss dips from ₹912 crore to ₹477 crore : Restoration of services last year
resulted in increased revenue (July 02, 2022)
Indian companies investment decisions

▪ IndiGo on Monday announced a mega aircraft order for 500 Airbus A320neo family
planes, the largest-ever order placed by an airline in one go anywhere in the world.
(June 20, 2023). “This will provide IndiGo a further steady stream of deliveries
between 2030 and 2035
▪ Air India signs agreement with Airbus, Boeing for 470 new aircraft. Air India on
Tuesday firmed up its order for 250 Airbus aircraft and 220 new Boeing jets worth
$70 billion at list prices, the airline stated in a press release. (Jun 21, 2023)
Assignment - 1

▪ Read past six months business magazines and newspapers

▪ Bring any 10 major finance investment decision of Indian companies.
Assignment - 2

▪ Read the shareholding pattern given in the annual report of a

company.
▪ List the major shareholder and their percentage of owning of the
company?
▪ Who is the marginal investor in this firm? (Is it an institutional investor
or an individual investor?)
▪ Are managers significant stockholders in the firm? If yes, are their
interests likely to diverge from those of other stockholders in the
firm?