1. Corporate Finance Introduction

2. Course introduction
The course aims to equip participants with basic concepts and necessary skills in raising capital and managing financial assets of a firm.
Our focus will be Valuation, Capital Structure and its effect in firm’s value and bankruptcy, Long Term Financing and Merger & Takeover

3. Remember You have covered Capital Market, IPO, Secondary Market
Agency Relationship
Time Value of Money
FCF, EVA and Operating Cash Flow
Intrinsic Value
WACC
Capital Budgeting
Cash Flow estimation
Dividend

4. Summary of assessment Test Activities No. Weight
Quizzes & Class tests (Individual) 4
20%
Assignments (Individual) 1 5%
Class participation & Presentation -
10%
Attendance
Mid Term Exam
15%
Project work & presentation ( Group )
15 %
End-term Exam
30 %
TOTAL
100%

5. Question
How a company and its management to take maximum advantage of market situation to increase wealth of its shareholders?
This is exactly what we will discuss in Corporate Finance

6. Introduction
Every decision that a business makes has financial implications, and any decision which affects the finances of a business is a corporate finance decision.
Defined broadly, everything that a business does fits under the rubric of corporate finance.

8. What is Corporate Finance?
The activities involved in managing cash flows in a business environment

9. Why is corporate finance important to all managers?
Corporate finance provides the skills managers need to:
Identify and select the corporate strategies and individual projects that add value to their firm.
Forecast the funding requirements of their company, and devise strategies for acquiring those funds.

10. The Core Principles of Finance
The 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 the future.
Compensation for risk
Investors expect compensation for bearing risk.

11. The Core Principles of Finance
Don’t put your eggs in one basket
Investors can achieve a more favorable trade-off between risk and return by diversifying their portfolios.
Markets are smart
Competition for information tends to make markets efficient.
No arbitrage
Arbitrage opportunities are extremely scarce.

12. Business Organizational Forms
Sole Proprietorships
No Distinction Between Business & Owner
Easy To Set Up, Operate; Business Earnings Taxed As Personal Income
Limited Life, Limited Access to Capital, Unlimited Personal Liability
Partnerships
Two Or More Owners
Joint and Several Liability
Limited Life, Limited Access to Capital, Unlimited Personal Liability
Limited Partnerships
One Or More General Partners with Unlimited Personal Liability
Most Partners are Totally Passive with Limited Liability - Limited Partners; Share of Profits Taxed as Partnership Income

13. Business Organizational Forms
Separate Legal Entity With Many of the Economic Rights & Responsibilities of Individuals
Unlimited Life, Limited Liability, Separable Contracting, Unlimited Access to Capital
Owned by Shareholders, Who Elect the Board of Directors
Corporations
25%, 30%
Banking 5% dividend
Are there any disadvantages for corporations?
YES! Double taxation

14. The Companies ACT, 2063 (2006)
Public Placement: More than 50 shareholders
Private Placement: 50 private placement
The number of shareholders of a public company shall be seven in minimum and a maximum of any number
No mandatory for IPO except banks
The paid up capital of a public company shall be a minimum of ten million rupees,

15. The Traditional Accounting Balance Sheet
Most students coming into corporate finance have had an accounting class… It pays to revisit the basic accounting balance sheet…

16. The Financial View of the Firm
And contrasting it with a financial balance sheet..
Financial balance sheets are forward looking and incorporate expectations about the future… Growth potential is reflected in financial balance sheets but not in accounting balance sheets.
Note also the consolidation of all financing into debt and equity.

17. The 5 Basic Corporate Finance Functions
Financing
(Capital-Raising)
Capital Budgeting
Financial Management
Risk Management
Corporate Governance

18. The Financing Function
Businesses can raise money in 2 ways:
externally from investors or creditors
IPOs
Primary market transactions
Secondary market transactions
internally by retaining operating cash flows
Most common method

19. Raising Capital: Key Facts
Most financing from internal rather than external sources
Most external financing is debt. In Nepal?
Primary vs. secondary market transactions or offerings
Financial intermediaries declining as a source of capital for large firms. Is it true in Nepal?
Securities markets growing in importance

20. The Capital Budgeting Function
Capital Budgeting – selecting the best projects in which to invest the firm’s resources

21. The Capital Budgeting Function
The capital budgeting process consists of three steps.
Step 1 - identifying potential investments
Step 2 - analyzing those investments to identify which will create shareholder value
Step 3 - implementing and monitoring the investments selected in step 2

22. The Financial Management Function
Managing daily cash inflows and outflows
Forecasting cash balances
Building a long-term financial plan
Choosing the right mix of debt and equity

23. The Corporate Governance Function
Hires and promotes qualified, honest people, and structures employees’ financial incentives to motivate them to maximize firm value
In practice the incentives of stockholders, managers, and other stakeholders often conflict.
Dimensions of corporate governance:
Board of directors
Securities Exchange Board of Nepal, Nepal Rastra Bank, NEPSE, Beema Samiti

24. The Risk Management Function
Identifying, measuring, and managing all types of risk exposures
Some risks are insurable, and some risks can be reduced through diversification.
Financial instruments like forwards, futures, options, and swaps may also be used to hedge market risks such as interest-rate, price, and currency fluctuations.

25. Main Principle 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.
This is the big picture of corporate finance.
Tie in the course outline to the big picture. (I put session numbers on this page to show when we will be doing what)
Emphasize the common sense basis of corporate finance. Note that people have been running businesses, and some of them very well, for hundreds of years prior to the creation of corporate finance as a discipline.
Talk about the three major components of corporate finance - the investment, financing and dividend decisions, and how corporate finance views these decisions through the prism of firm value maximization.

26. Objective: Maximize the Value of the Firm
Choose a financing mix that minimizes the hurdle rate and matches the assets being financed.
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

27. 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.
This is the answer to the question posed in the previous overhead.
There are alternative objective functions (Maximize market share, maximize earnings, maximize growth …)
These are intermediate objective functions - maximizing market share by itself is valuable insofar as it increases pricing power and thus, potentially the market value.

28. The Classical Objective Function
STOCKHOLDERS
Hire & fire
managers
- Board
- Annual Meeting
Maximize
stockholder wealth
No Social Costs
Lend Money
Managers
BONDHOLDERS
SOCIETY
Protect
bondholder
Interests
Costs can be
traced to firm
This is the utopian world. None of the assumptions are really defensible as written, and skepticism is clearly justified:
Why do we need these assumptions?
Since, in many large firms, there is a separation of ownership from management, managers have to be fearful of losing their jobs and go out and maximize stockholder wealth. If they do not have this fear, they will focus on their own interests.
If bondholders are not protected, stockholders can steal from them and make themselves better off, even as they make the firm less valuable.
If markets are not efficient, maximizing stock prices may not have anything to do with maximizing stockholder wealth or firm value.
If substantial social costs are created, maximizing stock prices may create large side costs for society (of which stockholders are members).
Note that corporate finance, done right, is not about stealing from other groups (bondholders, other stockholders or society) but about making the firm more productive and valuable.
Reveal
information
honestly and
on time
Markets are
efficient and
assess effect on
value
FINANCIAL MARKETS

29. What can go wrong? Managers STOCKHOLDERS Managers put their interests
above stockholders
Have little control
over managers
Significant Social Costs
Lend Money
Managers
BONDHOLDERS
SOCIETY
Bondholders can
get ripped off
Some costs cannot be
traced to firm
Delay bad
news or
provide
misleading
information
This is my worst case scenario:
Stockholders have little or no control over managers. Managers, consequently, put their interests above stockholder interests.
Bondholders who do not protect themselves find stockholders expropriating their wealth.
Information conveyed to markets is noisy, biases and sometimes misleading. Markets do not do a very good job of assimilating this information and market price changes have little to do with true value.
Firms in the process of maximizing stockholder wealth create large social costs.
In this environment, stockholder wealth maximization is not a good objective function.
Markets make
mistakes and
can over react
FINANCIAL MARKETS

30. When traditional corporate financial theory breaks down, the solution is:
To choose a different mechanism for corporate governance
To choose a different objective for the firm.
To maximize stock price, but reduce the potential for conflict and breakdown:
Making managers (decision makers) and employees into stockholders
By providing information honestly and promptly to financial markets
At this point, things look pretty bleak for stock price maximization. These are the three choices that we have, if we abandon pure stock price maximization as an objective function.

31. Choose a Different Objective Function
Firms can always focus on a different objective function. Examples would include
maximizing earnings
maximizing revenues
maximizing firm size
maximizing market share
maximizing EVA
The key thing to remember is that these are intermediate objective functions.
To the degree that they are correlated with the long term health and value of the company, they work well.
To the degree that they do not, the firm can end up with a disaster
Consider each of these objectives. If you put them through the same tests that we did stock price maximization, you come up with far more problems with each.
Note that firms might pick an intermediate objective (like market share) when it is correlated with firm value but continue to use it, even after it loses this link. Do you want a 100% market share of a losing business?

32. Maximize Stock Price, subject to ..
The strength of the stock price maximization objective function is its internal self correction mechanism
In the context of our discussion,
managers taking advantage of stockholders has lead to a much more active market for corporate control.
stockholders taking advantage of bondholders has lead to bondholders protecting themselves at the time of the issue.
firms revealing incorrect or delayed information to markets has lead to markets becoming more “skeptical” and “punitive”
firms creating social costs has lead to more regulations, as well as investor and customer backlashes.
The strength of market based systems is that they are both ruthless and quick in correcting errors, once they are spotted.
These constraints flow from the earlier framework, where we introduced what can go wrong with each linkage.

33. The Counter Reaction Managers STOCKHOLDERS Managers of poorly
run firms are put
on notice.
1. More activist
investors
2. Hostile takeovers
Protect themselves
Corporate Good Citizen Constraints
Managers
BONDHOLDERS
SOCIETY
1. Covenants
2. New Types
1. More laws
2. Investor/Customer Backlash
This summarizes the objective function of maximizing stockholder wealth, with the fixes noted on the last few pages.
Firms are
punished
for misleading
markets
Investors and
analysts become
more skeptical
FINANCIAL MARKETS

34. In response, boards are becoming more independent…
Boards have become smaller over time. The median size of a board of directors has decreased from 16 to 20 in the 1970s to between 9 and 11 in The smaller boards are less unwieldy and more effective than the larger boards.
There are fewer insiders on the board. In contrast to the 6 or more insiders that many boards had in the 1970s, only two directors in most boards in 1998 were insiders.
Directors are increasingly compensated with stock and options in the company, instead of cash. In 1973, only 4% of directors received compensation in the form of stock or options, whereas 78% did so in 2012.
More directors are identified and selected by a nominating committee rather than being chosen by the CEO of the firm. In 2012, 75% of boards had nominating committees; the comparable statistic in 1973 was 2%.
While these trends are positive, note that many of these better boards (at least as seen from the vantage point of 1998) were responsible for the scandals of the bull market (Enron, Worldcom, Tyco…) In bull markets and strong economies, boards tend to get lazy.

35. In Nepal
Every public company shall have a board of directors consisting of a minimum of three and a maximum of eleven directors.
At least one independent director, in the case of the number of directors not exceeding seven, and at least two independent directors, in the case of the number of directors exceeding seven.
Company Act 2063 Chapter 86 subsection 2 and 3

36. Recent Investment/ Financing Decisions
Company
Recent Investment Decisions
Recent Financing Decisions
Boeing (U.S.)
Delivers first Dreamliner after investing a reported $30 billion in development costs.
Reinvests $1.7 billion of profits.
ExxonMobil (U.S.)
Spends $7 billion to develop oil sands at Fort McMurray in Alberta.
Spends $12 billion buying back shares.
GlaxoSmith-Kline (UK)
Spends $4 billion on research and development for new drugs.
Pays $3.2 billion as dividends.
LVMH (France)
LVMH acquires the Italian Jeweler, Bulgari, for $5 billion.
Pays for the acquisition with a mixture of cash and shares.
Procter & Gamble (U.S.)
Spends $8 billion on advertising.
Raises 100 billion Japanese yen by an issue of 5-year bonds.
Tata Motors (India)
Opens a plant in India to produce the world's cheapest car, the Nano. The facility costs $400 million.
Raises $400 million by the sale of new shares.
Union Pacific (U.S.)
Invests $330 million in 100 new locomotives and 10,000 freight cars and chassis.
Repays $1.4 billion of debt.
Vale (Brazil)
Opens a copper mine at Salobo in Brazil. The project cost nearly $2 million.
Maintains credit lines with its banks that allow the company to borrow at any time up to $1.6 billion.
Walmart (U.S.)
Invests 12.7 billion, primarily to open 458 new stores around the world.
Issues $5 billion of long-term bonds in order to repay short-term commercial paper borrowings.
This table is taken directly from the book and shows examples of investment and financing decisions. It is highly encouraged to take examples for the current news and add them as topics of discussion in class. Students relate much better when they can reference an event for which they are familiar.