Questions
- Why would one start a “company” sort of business?
- Raising funds is easy (IPO)
- Limited Liability
- Unlimited Life1
What is corporate Finance?
3 Major Decisions
In any corporate finance function, we cannot avoid these three finance functions
- Allocation decision
- Economics deals with scarcity of resources and how to deal with it.
- What makes for a good investment?2
- Financing decision
- Where to raise the funds for these investments3?
- Either through debt or equity or a mix.
- From the remaining profits after paying out the dividend
- Dividend Decision
- How much % for the dividends should be declared?
- If you don’t have enough opportunities, then instead of retaining money and destroying its value, we can return the money to the share holders as a higher dividends.
The Traditional Accounting Balance Sheet
In the U.S. way, Assets are left, Liabilities are right, unlike the Indian (British) system.
| Assets | Liabilities |
|---|---|
| Fixed Assets (Long4 Lived Real Assets) | Current Liability (Short-term liabilities of the firm) |
| Current Assets | Debt5 |
| Financial Investments | Other Liabilities (Depends on contracts entered into) |
| Intangible Assets (Good will, loyalty, patents trademarks) | Equity |
The Financial View of the Firm
| Assets | Liabilities |
|---|---|
| Assets in Place - Existing Investments - Generate cash flows today | Debt - Fixed claim on cash flows - Little or No role in management - Tax Deductible |
| Growth Assets | Equity |
What is the motive for the company to buy back?
- This is an alternative to dividend
First principles of Corporate Finance
- Invest in projects that yield a return greater than the minimum acceptable hurdle rate.
- Hurdle rate should be higher for riskier projects and reflect the financing mix used - equity vs debt
- returns 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 finance mix that minimizes the hurdle rate and matches the assets being financed.
Footnotes
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But the only company that lasted on the stock exchange from 1900s is “General Electric” ↩
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Warden of the hostel, where to spend the resources? Multimedia, card room, dance group, music group etc. ↩
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Companies don’t like to take debt. ↩
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Anything more than an year are long, and less than an year is short. ↩
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A loan taken by a company is called a “Trade Debit”. ↩