CORPORATE FINANCE
Investments
Maximise
Capital
Distribution
Firm Govvernance
Value
Financing
4 CORPORATE PRINCIPLES
• Investment decision
• Capital distribution- how to use the profit
• Corporate Governance – ESG: Environmental Social Governance
• Funding and Capitalization decision – Capital Structure
Investment Decision Rules-
• Return on Capital- EBIT/Book value of investment
• Payback period- Measures how quickly a project will cover its initial investment
• Economic Value Added, EVA = C0 + (It – It-1) - rIt-1
Where, C0 = Cashflow
(It – It-1) = Change in asset base
rlt-1 = Economic return on asset (lt is the book value after adjusting depreciation)
• Discounted Cash Flow DCF = C0 + C1/(1+r) + Ct/ (1+r)t
• Internal rate of return- NPV= C0 + C1/(1+r) + Ct/ (1+r)t
Best decision rule is NPV using DCF
M&A is profitable for acquirors where:
• Target firms purchased below fair value
• Target performance exceeds expectations
• Combination generates synergies not present when two companies were separate
• Combined cost of capital improves NPV
CAPITAL DISTRIBUTION
, Dividend Signaling
• Positive Signaling- Investors prefer cash-in-hand return, increase in dividend shows higher
profit/revenue i.e., success.
• Negative Signaling- Firms that did not pay dividend before pays now which reflect lower
growth or less investment opportunities
EQUITY REPURCHASES
• Open Market Purchase
• Repurchase tender offers
• Privately Negotiated repurchases
CORPORATE GOVERNANCE
• Structure of the company
• Procedures followed in the company
• Selection of Board of Directors- 30% independent directors(only industry experience, not
capital provider or management participant)
• Regulations followed for shareholders (1 shareholder-1 vote, Dividend policy, corporate
actions)
CAPITALIZATION DECISION
The firms can source capital via-
• Debt
• Equity
PECKING ORDER THEORY
Pecking order theory, firms choose to finance with:
• Internal Equity, then
• Debt, then
• External equity
Lecture 2
Modigliani-Miller → Optimal Capital structure
o Capital structure does not impact the business valuation
o There are no market frictions- No transaction costs, fees etc
It is difficult for the small businesses to use MM compared to the larger firms.
M&A
REASONS FOR ACQUISITION-
• Synergy
• Reducing competition
• Acquiring star employees
• Increasing market share/influence
• Shareholder pressure etc.
TARGET COMPANY MOTIVATION
• Cash exit (for founders, families without succession plans) •
• Cash to grow further (if employees, managers stay on in enlarged entity)
• 30% Premium over prior share price! • Brand, marketing platform, expand sales
• Shareholder pressure
• PROFITABILITY, share NPV > stand-alone
Investments
Maximise
Capital
Distribution
Firm Govvernance
Value
Financing
4 CORPORATE PRINCIPLES
• Investment decision
• Capital distribution- how to use the profit
• Corporate Governance – ESG: Environmental Social Governance
• Funding and Capitalization decision – Capital Structure
Investment Decision Rules-
• Return on Capital- EBIT/Book value of investment
• Payback period- Measures how quickly a project will cover its initial investment
• Economic Value Added, EVA = C0 + (It – It-1) - rIt-1
Where, C0 = Cashflow
(It – It-1) = Change in asset base
rlt-1 = Economic return on asset (lt is the book value after adjusting depreciation)
• Discounted Cash Flow DCF = C0 + C1/(1+r) + Ct/ (1+r)t
• Internal rate of return- NPV= C0 + C1/(1+r) + Ct/ (1+r)t
Best decision rule is NPV using DCF
M&A is profitable for acquirors where:
• Target firms purchased below fair value
• Target performance exceeds expectations
• Combination generates synergies not present when two companies were separate
• Combined cost of capital improves NPV
CAPITAL DISTRIBUTION
, Dividend Signaling
• Positive Signaling- Investors prefer cash-in-hand return, increase in dividend shows higher
profit/revenue i.e., success.
• Negative Signaling- Firms that did not pay dividend before pays now which reflect lower
growth or less investment opportunities
EQUITY REPURCHASES
• Open Market Purchase
• Repurchase tender offers
• Privately Negotiated repurchases
CORPORATE GOVERNANCE
• Structure of the company
• Procedures followed in the company
• Selection of Board of Directors- 30% independent directors(only industry experience, not
capital provider or management participant)
• Regulations followed for shareholders (1 shareholder-1 vote, Dividend policy, corporate
actions)
CAPITALIZATION DECISION
The firms can source capital via-
• Debt
• Equity
PECKING ORDER THEORY
Pecking order theory, firms choose to finance with:
• Internal Equity, then
• Debt, then
• External equity
Lecture 2
Modigliani-Miller → Optimal Capital structure
o Capital structure does not impact the business valuation
o There are no market frictions- No transaction costs, fees etc
It is difficult for the small businesses to use MM compared to the larger firms.
M&A
REASONS FOR ACQUISITION-
• Synergy
• Reducing competition
• Acquiring star employees
• Increasing market share/influence
• Shareholder pressure etc.
TARGET COMPANY MOTIVATION
• Cash exit (for founders, families without succession plans) •
• Cash to grow further (if employees, managers stay on in enlarged entity)
• 30% Premium over prior share price! • Brand, marketing platform, expand sales
• Shareholder pressure
• PROFITABILITY, share NPV > stand-alone
