Summary Principles of Corporate Finance

CLASS 1 – BAM Ch1 – INTRODUCTION


Corporate finance  financial decision making
1. What investment should the corporation make? (spending)
2. How should it pay for those investments? (raising)




Goal of Financial Management  to create VALUE,
That is when the Corporation can earn a higher return that shareholders can earn
for themselves.
Where outside investment opportunities set the standard for internal investments,
the opportunity cost, e.g. the cost of capital.




Five key themes:
1. Corporate Finance is all about maximizing VALUE
2. Where the opportunity cost of capital sets the standard for investment
decisions
3. A safe dollar is worth more than a risky dollar


1 | Pagina
264681744
Anne Aantjes

, 4. Smart investment decisions create more value than smart financing
decisions
5. Good governance matters (due to e.g. the principal-agent problem)


Real assets vs. Financial assets and Securities
(securities are a type of fin. assets which can be traded, incl. bonds and stocks)
Investment decision = purchase of real assets Capital Budgeting or
Expenditure (CAPEX)
Financing decision = sale of financial assets




Capital structure = choice between debt and equity financing


Financing equity:
1. Issuing shares
2. Retaining cash flows


A Corporation is a legal entity where shareholders have limited liability.
 Upside: separation of Ownership vs. Control, as it gives
‘permanence’
 Downside: principle-agent problems, differences in interests
 Downside: Tax drawback, as corporations pay tax and shareholders are
taxed again




2 | Pagina
264681744
Anne Aantjes

,CLASS 1 – BAM Ch33 – GOVERNANCE & CORPORATE CONTROL AROUND THE
WORLD


Corporation raise cash from Financial Markets (e.g. stock exchange) and
Financial Institutes (e.g. Banks)
- Markets are relatively more important in Anglo-Saxon economies (US, UK)


Ownership and control in:
- US, UK: mostly simply Stockholders, usually one class of common stock (1
share, 1 vote)
o with ‘fiduciary duty’ for Managers to the shareholders (enforceable by
law)
- Germany: traditionally Banks play a significant role in corp. governance.
o Now various complex corporate ownership structures, as also in
France, Italy etc.
- Japan: Keiretsu (network of companies, usually organized around a major
bank)


European Boards of Directors, two tier boards:
1. Board of Directors
2. Supervisory Board


Shareholder vs. Stakeholder  Anglo-Saxon is generally focused on Shareholder,
Germane/France/Japan more on Stakeholder.




3 | Pagina
264681744
Anne Aantjes

, CLASS 2 – BMA Ch 5 – NET PRESENT VALUE AND OTHER INVESTMENT
CRITERIA


“A dollar today is worth more than a dollar tomorrow”, the Time Value of Money.
Discounting future Cash Flows with the Cost of Capital.


Methods, in order of use (high to low):
1. Net Present Value (NPV)  ∑ Cash Flown / (1 + cost of capital)n
Rule: accept when NPV > 0

2. Internal Rate of Return (IRR)  IRR = (payoff / investment) – 1
Or NPV = C0 + (C + discount rate ) + … = 0
Which finds the Discount Rate where the NPV =
0
Rule: accept when opportunity cost of capital < IRR

IRR Pitfalls:
 Are you lending or borrowing?
 Multiple Rates of Return
 Mutually exclusive projects  find common
period

3. Payback period (PB)  # years after which investment is
recovered
Discounted Payback is an improvement over
Payback
Rule: accept when PB < specified cutoff period

4. Book Rate of Return (BRR)  accounting, BRR = Book income / Book
Assets
Influenced by e.g. depreciation; CAPEX vs.
OPEX)

5. Profitability Index (PI)  PI = NPV / Investment
E.g. when funds are limited, you choose the
highest “biggest bang for your buck”.




4 | Pagina
264681744
Anne Aantjes