27Jul, 2024
Corporate Finance MBA 2ND SEM

Corporate Finance MBA 2ND SEM



Disclaimer:

These notes were generated with the assistance of AI and are intended for informational purposes only. I am not the original author of the content. The material summarized here is based on information from a textbook I purchased. For a more comprehensive understanding and additional context, please refer to the textbook directly. Below is the link to the PDF version of the book :

Unit 1: Concepts of Finance

Unit 2: Fund Flow and Cash Flow

Unit 3: Long-Term Financial Sources and Dividend Policies

Unit 4: Cost of Capital and Capital Structure

Unit 5: Capital Budgeting and Risk Management

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Unit 1: Concepts of Finance

Finance involves the management of money and other financial assets and covers personal, corporate, and public finance. The primary objectives are profit maximization, which focuses on short-term gains, and wealth maximization, which aims to increase shareholder value. The Indian financial system comprises financial institutions, markets, instruments, and services. Financial management functions include planning, organizing, controlling, and directing financial activities, with key decisions on investments, financing, and dividends.

Main Topics Chart:

Concept Description
Finance Objectives Profit maximization, wealth maximization
Indian Financial System Institutions, markets, instruments
Financial Management Planning, organizing, controlling
Finance Manager’s Decisions Investment, financing, dividends

Scope and Objectives of Finance:

      • Finance: The study of how individuals, businesses, and organizations manage their money and other financial assets.

      • Scope: Includes personal finance, corporate finance, and public finance.

      • Objectives:
            • Profit Maximization: Focus on increasing short-term profits.

            • Wealth Maximization: Focus on increasing the value of the firm for its shareholders.

      Indian Financial System:

          • Components: Financial institutions, financial markets, financial instruments, and financial services.

          • Financial Management Functions: Planning, organizing, controlling, and directing the financial activities.

          • Decisions of Finance Manager:
                • Investment Decisions: Capital budgeting and allocation of funds.

                • Financing Decisions: Choosing between equity and debt financing.

                • Dividend Decisions: Determining the portion of profits to be distributed as dividends.

           

          Unit 2: Fund Flow and Cash Flow

          Fund flow analysis tracks the movement of funds within a business, involving a schedule of changes in working capital and a fund flow statement. Cash flow analysis summarizes cash inflows and outflows, categorized into operating, investing, and financing activities, and is crucial for assessing liquidity and financial flexibility. Working capital is the difference between current assets and liabilities, and the cash conversion cycle measures the time taken to convert inventory into cash.

          Main Topics Chart:

          Concept Description
          Fund Flow Statement Sources and uses of funds
          Cash Flow Statement Operating, investing, financing activities
          Working Capital Current assets minus liabilities
          Cash Conversion Cycle Inventory to cash conversion time

          Fund Flow Concept:

              • Fund Flow Statement: Shows the movement of funds within the business.

              • Preparation:
                    • Schedule of Changes in Working Capital: Lists changes in current assets and liabilities.

                    • Fund Flow Statement: Derived from the balance sheet, showing sources and applications of funds.

              Cash Flow Concept:

                  • Cash Flow Statement: Summarizes cash inflows and outflows.

                  • Preparation: Involves operating, investing, and financing activities.

                  • Managerial Uses: Assessing liquidity, financial flexibility, and operational efficiency.

                  • Working Capital: The capital available for day-to-day operations.

                  • Determination: Based on current assets minus current liabilities.

                  • Cash Conversion Cycle: The time taken to convert inventory into cash.

                 

                Unit 3: Long-Term Financial Sources and Dividend Policies

                Long-term financial sources include equity shares, debentures, and convertible securities, with foreign equity and debt as additional options. Dividend policies are influenced by factors like earnings, growth opportunities, and shareholder preferences. Dividend theories, such as Graham Gordon, Walter, and MM, provide varying perspectives on the relevance of dividends. Investment accounting involves recording and managing investment transactions and recognizing income.

                Main Topics Chart:

                Concept Description
                Long-Term Financial Sources Shares, debentures, convertible securities
                Dividend Policies Factors, theories (Graham Gordon, Walter, MM)
                Investment Accounting Recording, managing transactions

                Long-Term Financial Sources:

                    • Shares and Debentures: Equity shares, preference shares, and debentures.

                    • Convertible Securities: Instruments that can be converted into equity.

                    • Foreign Equity and Debt Securities: Involves international investment instruments.

                  Dividend Policies:

                      • Factors Affecting Dividend Decisions: Earnings, stability of earnings, growth opportunities, cash flow, and shareholder preferences.

                      • Dividend Theories:
                            • Graham Gordon Model: Focuses on the relationship between dividends and stock price.

                            • Walter Model: Suggests the dividend policy is irrelevant in determining the value of the firm.

                            • MM Theory (Modigliani-Miller): Proposes that dividend policy is irrelevant in a perfect market.

                      Investment Accounting:

                          • Concepts and Methods: Recording and managing investment transactions, valuation of investments, and recognizing income.

                         

                        Unit 4: Cost of Capital and Capital Structure

                        The cost of capital includes equity, retained earnings, and the weighted average cost of capital (WACC). Capital structure theories, such as trading on equity, net income, net operating income, agency trade-off, and pecking order, provide frameworks for balancing debt and equity financing. Leverage analysis examines the impact of fixed costs (operating leverage) and debt (financial leverage) on profitability.

                        Main Topics Chart:

                        Concept Description
                        Cost of Capital Equity, retained earnings, WACC
                        Capital Structure Theories Trading on equity, net income/operating income, agency trade-off, pecking order
                        Leverage Analysis Operating, financial leverage

                        Cost of Capital:

                            • Equity: Cost of raising funds through equity.

                            • Retained Earnings: Opportunity cost of retained earnings.

                            • Weighted Average Cost of Capital (WACC): Average rate of return required by all the company’s investors.

                          Capital Structure Theories:

                              • Trading on Equity: Using borrowed funds to increase returns on equity.

                              • Net Income Approach: Suggests that changes in capital structure affect the cost of capital and value of the firm.

                              • Net Operating Income Approach: Proposes that capital structure is irrelevant.

                              • Agency Trade-Off Theory: Balances the cost of debt and equity.

                              • Pecking Order Theory: Firms prefer internal financing first, then debt, and equity as a last resort.

                            Leverage Analysis:

                                • Operating Leverage: Impact of fixed costs on profitability.

                                • Financial Leverage: Use of debt to finance the firm’s assets.

                                • Combined Leverage: Combined effect of operating and financial leverage.

                               

                              Unit 5: Capital Budgeting and Risk Management

                              Capital budgeting involves planning and managing long-term investments using methods like payback period, average rate of return (ARR), net present value (NPV), and internal rate of return (IRR). Capital rationing allocates limited resources among projects. The concepts of risk and return are essential, with techniques for decision-making under uncertainty involving statistical and probabilistic methods to analyze and mitigate risk.

                              Main Topics Chart:

                              Concept Description
                              Capital Budgeting Payback period, ARR, NPV, IRR
                              Capital Rationing Allocating limited resources
                              Risk and Return Analyzing and mitigating risk

                              Capital Budgeting:

                                  • Nature and Significance: Process of planning and managing a firm’s long-term investments.

                                  • Methods:
                                        • Payback Period: Time taken to recover the initial investment.

                                        • Average Rate of Return (ARR): Average annual profit divided by the initial investment.

                                        • Net Present Value (NPV): Difference between the present value of cash inflows and outflows.

                                        • Internal Rate of Return (IRR): The discount rate that makes the NPV of an investment zero.

                                        • Capital Rationing: Allocating limited capital resources among various projects.

                                  Risk and Return:

                                      • Concept: The potential return on any investment is associated with the risk taken.

                                      • Decision-Making Techniques: Analyzing risk factors and using statistical and probabilistic methods to make informed decisions under uncertainty.

                                    These summaries encapsulate the key concepts and theories in corporate finance