CORPORATE FINANCE:

What corporate finance is?

Corporate finance is all about every decision that company makes that involves money; it’s what every business has to do. Every business has to make basic corporate financial decision.

To start with Corporate Finance is the Balance Sheet:

Conventional accounting balance sheet:

Conventional Balance Sheet is where you have constraints by accounting rules i.e. accounting standard rule governed on how a balance sheet is set.

On one side how assets are break up: tangible: intangible, short term: long term, financial or non-financial. There are dozen’s to categorize.

On other side is the slice & dice your liabilities into diff category: long term debt-short term debt, non interest: interest debt etc. Then what equity is worth, book value, and then what accountant thinks your company equity is worth.

Financial Balance Sheet:

Financial Balance Sheet is often considered as the simpler balance sheet but at the same time complex. Financial balance sheet is basically in two categories. Investments already made & investments yet to make.

When you invest in growth company much of the value comes from growth assets, investment you going to make in future, other side is borrow or use your money. Now in publically traded company, it can take form of bonds or stock, but basically in debt & equity there is only two ways of raising money. Financial Balance Sheet gives a broader & simpler vision of a company.

The best way is to illustrate a financial Balance Sheet is to show 2 different companies:

Let see Coronet which provides electricity to New York City. Its regulated in such a way that price increases assets by commission, its earning is 3% or 4%, its is a mature company, and other is EBay a company which came out of dot.com, eCom boom for which bulk of value comes from invest in future, and in Coronet value comes from the investments already made i.e. assets in place, these r investment made 20, 50, 70 yrs ago which was around 18billion.There are growth investments as well by small size com which are 3billion were out of 18billion, 80% comes from assets placed & less than 20% from growth investments.

Other side of Balance Sheet is the Amount of Debt Equity that it has is 7billion in debt & 11billion in Equity, so this firm is about 40 in debt & 60 in equity. Which is not unusual for a mature company?

But in eBay 6billion is (assets in placed) investments already made and about 70 billion from growth assets. Other interesting thing is most funding comes from Equity & a tiny slice of debt.

Now let’s relate Firms to its life cycle of company.

EBay is young and firms in early age of its Life Cycle tend to get most value from growth and tend to fund through equity, for very simple reason, they can’t afford to carry debt, can’t service, make interest payments, principle payments wit investments they have not even thought of yet, and they even pay very lilted dividends.

Other spectrum: mature company get bulk value form investments already made, they fund them with significant amount of debt and often pay large dividend this gives what typically a company in Life Cycle does and frame what company is in Life Cycle.

Now let’s think what Corporate Finance is all about:

There are 3 basic principles:

1.Investment Principle:

When you as a business make investments it try to invest in assets, projects, new investments that earn a return which is greater than some minimum acceptable hurdle rate. Every investment has a hurdle to cross and that hurdle should be more for riskier & safer investments the hurdle should reflect the risk of investment and also were you raise the money from which also drive the hurdle rate.

When you think of return on investment: return should be measured based on the Cash Flows on that investment. Counting earnings should reflect when a Cash Flow comes in (cash flow earlier is worth more than later)

In words of the Prof: “No room for garnishing in investment analysis”

Fine investment that earn a return greater than min acceptable hurdle rate.

2. Financing Principle:

Basically mix of Debt & Equity to minimize hurdle rate which is right for your company.

Type of debt should reflect the kind of assets you have, long term assets then long term debt. How much each we want to use and a mix that will min our overall cost of funding our business. Now it costs less to borrow den raise money, reason debt attack advantage as interest expenses but Equty doesn’t. Now it’s not necessary to follow that a company must have 100% debt. In fact it turns out to be cost of funding which is a dynamic process..

3. Dividend Principle:

Which says if u can’t find investment that makes your hurdle rate? Take money out of business as there is no law which says u have to keep reinvesting, but if it is a publicly traded company things get more complicated as u got to return dividend to the stockholders, as dividend, cash or buy back.

You have a single objective in corporate finance i.e. to create a value for your business.

Basic Details:

Hurdle rate: Let’s restate it should be higher for riskier investment and lower for safer once and also it’s a mix of Debt & Equity.

How to measure Risk: Through the eyes of marginal investors in business.

Marginal investors : Most likely they are the investors to set price on your company’s stock which is most in pub coma will be owned a lot of company nd trades that stock frequently doen by the founders, investors, FII etc.

Debt Equity mix: what cost you borrow money & raise Equity and take some kind of weighted avg.

Returns: cash flows are clean way of thinking about returns, accounting earning will be subject to whatever discreetly choices you make as an accountant as even small changes move earning around. CF and earning are different but den you want to concentrate more Cash flows then u want to wait and win Cash Flows bring some Quality concerns into the corporate financials final return value which reflects Cash Flow and its timing.

1 issue every 1 has....:

How much cash is too much cash: It depends on how much you trust the managers of the company.

One way is to think of dividend principle: when should I return to stockholder?, When we choose to return then should I pay dividend or buy back answer is as simple as your Stockholder like dividends give dividend or buy back think who your stockholder are.

CF has 1 single objective maximum value of your business, pick good investment, fund them right and pay right amount of dividend.

Source: aswathdamodaran\webcast