CONTENTS

Introduction

Nature and Scope of Corporate Finance

Role of finance function

Finance decisions for the firm

Investment decisions
Financing decisions
Dividend decisions
Working capital decisions

Integrated view of finance decisionmaking

Financial decision making framework

CONTENTS

Key issues in financial decision making

Objective function in finance

Agency cost and Corporate

Governance

Financial Management and Accounting

Financial objectives and organisational

strategy

INTRODUCTION

Basic
issues
essentially the
businesses.

in
finance
are
same for diverse

The key issues in finance are:

Where to raise financial resources from?

Wherein to invest the resources?

How best to manage the productiondistribution function?

How much of profit to distribute and

how much to retain?

NATURE AND SCOPE OF

FINANCIAL MANAGEMENT

Concerned with the

management of financial
resources.

Performs facilitation,
reconciliation, and control
functions.

Covers all decisions having

monetary implications.

ROLE OF FINANCE
FUNCTION

Finance is central to all

business activities.

Finance function reconciles the

conflicting interests of:

varied stakeholders and

different functional units.

FINANCE DECISIONS FOR

THE FIRM

Financial decision-making involves

procurement of funds and their
optimal utilization through:

Investment

Financing

Dividend and

Working capital decisions.

The First Principles

Maximize the value of the business (rm)

The Investment Decision

Invest in assets that earn a
return greater than the
minimum acceptable hurdle
rate

The hurdle rate

should reect the
riskiness of the
investment and
the mix of debt
and equity used
to fund it.

The return
should reect the
magnitude and
the timing of the
cashows as welll
as all side effects.

The Financing Decision

Find the right kind of debt
for your rm and the right
mix of debt and equity to
fund your operations

The optimal
mix of debt
and equity
maximizes rm
value

The right kind

of debt
matches the
tenor of your
assets

The Dividend Decision

If you cannot nd investments
that make your minimum
acceptable rate, return the cash
to owners of your business

How much
cash you can
return
depends upon
current &
potential
investment
opportunities

How you choose

to return cash to
the owners will
depend on
whether they
prefer dividends
or buybacks

INVESTMENT DECISIONS

Aim at selecting the most productive

avenues that maximize the ROI.

Examples include:

Expansion

Modernization and replacement

R&D expenditure.

Also referred to as capital budgeting

decisions.

Are critical for long-term survival and

growth.

INVESTMENT DECISIONS

10

Are taken in the light of their

probable impact on the wealth
of shareholders.

Involve huge capital outlay.

Have long-term implications.

Are usually irreversible.

FINANCING DECISIONS

11

Vaguely referred to as capital

structure decisions.

Mainly concerned with:

Identifying the suitable sources of

funds

Tapping of these sources.

Determine the financial risk.

Thrust is to bring down the cost of

financing.

FINANCING DECISIONS

12

The main issues involved are:

Where from to procure the requisite

funds?

What should be the optimal mix of

various sources of capital?

How much should be the proportion

of short-term and long-term funds?

How do the expectations of providers

of each source of capital change with
alteration in the capital mix?

FINANCING DECISIONS

13

Are taken in the light of their

likely impact on the wealth of
the stockholders.

A right blend of debtequity

affects the risk return profile of
the business.

DIVIDEND DECISIONS

14

Are mainly concerned with deciding the mix

of profits to be distributed as dividends and
those to be ploughed back for future
financing needs of business.

Depend on trade off between future financing

needs of the firm and current consumption
requirements of the shareholders.

Generally, firms in sectors with a high-growth

rate follow a policy of high retention and low
payout.

DIVIDEND DECISIONS

15

Determining the payout ratio and the

method of dividend payment are the two
concerns of dividend policy.

The payout ratio is decided in the light of its

probable impact on shareholders wealth

Normally, firms follow a policy of stable

dividends

Dividend policy is considered as a residue of

investment and financing policy.

WORKING CAPITAL
DECISIONS

16

Are concerned with the

management of current assets.

The two key decision points in

working capital management are:

Level of investment in current assets

Financing of current assets.

INTEGRATED VIEW OF
FINANCE DECISION-MAKING

17

The four key decision areas in

finance are the part of an integrated
decision making framework in
finance.

They are directly linked and

reinforce each other.

All the decisions have a common

objective function-shareholders
wealth maximization.

THE CLASSICAL OBJECTIVE

FUNCTION
STOCKHOLDERS
Hire & fire
managers
- Board
- Annual Meeting
Lend Money
BONDHOLDERS/
LENDERS

Maximize
stockholder
wealth

Managers

Protect
bondholder
Interests
Reveal
information
honestly and
on time

No Social Costs
SOCIETY
All costs can be
traced to firm

Markets are
efficient and
assess effect on
value

FINANCIAL MARKETS
18

WHAT CAN GO WRONG?

STOCKHOLDERS
Have little control
over managers

Lend Money
BONDHOLDERS

Managers put
their interests
above stockholders

Managers

Bondholders can
get ripped off
Delay bad
news or
provide
misleading
information

Significant Social Costs

SOCIETY
Some costs cannot be
traced to firm

Markets make
mistakes and
can over react

FINANCIAL MARKETS
19

20

FINANCIAL DECISION
MAKING FRAMEWORK

KEY ISSUES IN
FINANCIAL DECISION-MAKING

21

Investment
Decision

What business to be in?

What growth rate is appropriate?
What assets to acquire?

Financing
Decision

What mix of debt and equity to be used?

Can we change value of the firm by changing the capital
mix?
Is there an optimal debtequity mix?

Dividend
Decision

How much of the profit should be distributed as dividends

and how much should be ploughed back
Can we change value of the firm by changing the amount
of dividend?
What should be the mode of dividend payment

Working
Capital
Decision

What level of inventory is ideal?

What level of credit should be given to the customers?
What level of cash should be maintained?
How can the blockage of funds in the current assets be
minimized without compromising with profits?

22

OBJECTIVE FUNCTION IN
FINANCE

23

The goal of value maximization is

the widely accepted goal of the
business.

It reconciles the varied, often

conflicting, interest of the
stakeholders.

It is free from the limitations that

other objectives are faced with.

AGENCY COSTS AND

CORPORATE GOVERNANCE

24

The stakeholders in business are

multiple, their stakes are varied and
their objectives are often conflicting.

Conflict of interest between the varied

stakeholders causes agency problems.

To resolve such agency problems

monitoring and control mechanisms
become imperative.

AGENCY COSTS AND CORPORATE

GOVERNANCE

25

Such mechanisms entail costs that

are termed as agency costs.

Agency costs take the form of

either incentives to management
like bonuses, stock options or
monitoring and control costs like
audit fees, credit rating fees etc.

AGENCY COSTS AND CORPORATE

GOVERNANCE

26

Corporate governance is another

mechanism to protect the
interest of the shareholders.

Set of rules, processes, and

customs that enable the effective
management of firms in the best
interest of shareholders are
termed as corporate governance.

FINANCIAL MANAGEMENT AND

ACCOUNTING

27

Financial management is
intricately related to financial
and management accounting.

The accounting information

provides inputs for financial
decision making.

Financial decisions in turn get

reflected in the accounting
statements.

28

FINANCIAL MANAGEMENT AND

ACCOUNTING

29

FINANCIAL OBJECTIVES AND

ORGANIZATIONAL STRATEGY

30

DO NOT SLEEP DURING CLASS

HOURS