1.1 Fundamentals of Corporate Finance

Corporate finance is all about managing a company's money. It covers everything from planning investments to deciding how to finance operations. This topic lays the groundwork for understanding how businesses make smart financial choices.

Financial managers juggle many tasks to keep a company financially healthy. They analyze investment opportunities, manage working capital, and assess risks. Their goal? To make decisions that grow the company and keep shareholders happy.

Financial Management

Corporate Finance and Financial Planning

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• Corporate finance involves managing a company's financial resources, including financial planning, investment decisions, and financing decisions
• Financial planning consists of analyzing investment opportunities, determining capital requirements, and creating a financial plan to achieve the company's goals
• Effective financial management requires setting clear financial objectives, developing strategies to achieve those objectives, and regularly monitoring and adjusting the financial plan as needed
• Financial managers use various tools and techniques (ratio analysis, budgeting, forecasting) to assess a company's financial health and make informed decisions

Working Capital and Risk Management

• Working capital management involves managing a company's short-term assets (accounts receivable, inventory) and liabilities (accounts payable) to ensure sufficient liquidity for daily operations
• Effective working capital management helps companies maintain a healthy cash flow, minimize the cost of financing, and avoid financial distress
• Risk management involves identifying, assessing, and prioritizing potential risks (financial, operational, strategic) that could impact a company's financial performance
• Financial managers use various risk management strategies (hedging, insurance, diversification) to mitigate potential risks and protect the company's financial stability

Investment Decisions

Capital Budgeting and Time Value of Money

• Capital budgeting is the process of evaluating and selecting long-term investments (new equipment, expansion projects) that are expected to generate future cash flows
• Financial managers use various capital budgeting techniques (net present value, internal rate of return, payback period) to assess the profitability and feasibility of investment opportunities
• The time value of money concept recognizes that money available today is worth more than the same amount in the future due to its potential to earn interest
• Financial managers use the time value of money principles to compare the value of cash flows occurring at different times and make informed investment decisions

Shareholder Value Creation

• The primary goal of financial management is to maximize shareholder value, which represents the economic value created for shareholders through a company's operations and financial decisions
• Financial managers strive to make investment and financing decisions that generate returns exceeding the cost of capital, thereby creating value for shareholders
• Shareholder value can be measured using various metrics (total shareholder return, economic value added) that consider both the capital gains and dividends received by shareholders
• Effective financial management aligns the interests of managers and shareholders, ensuring that decisions are made in the best interest of the company and its owners

Financing Decisions

Capital Structure and Debt Financing

• Capital structure refers to the mix of debt and equity financing used by a company to fund its operations and investments
• Financial managers aim to find the optimal capital structure that minimizes the cost of capital and maximizes shareholder value
• Debt financing involves borrowing money from lenders (banks, bondholders) and agreeing to repay the principal and interest based on a predetermined schedule
• Companies may choose debt financing for various reasons (tax benefits, lower cost compared to equity, maintaining ownership control) but must also consider the risks (financial distress, default) associated with high levels of debt

Equity Financing and Its Implications

• Equity financing involves raising capital by selling ownership interests in the company to investors (common stock, preferred stock)
• Companies may choose equity financing to raise long-term capital without the obligation to repay the funds or to share ownership and risk with investors
• Equity financing can be more expensive than debt financing due to the higher required rate of return demanded by equity investors to compensate for the additional risk
• Issuing new equity can dilute the ownership percentage of existing shareholders and may signal to the market that the company's stock is overvalued