Corporate Finance and Policy Notes
Subject Overview
Corporate Finance and Policy covers time value of money and security valuation, cost of capital and capital structure theories, leverage and capital budgeting decisions, and dividend decisions and working capital management. A 4-credit core theory paper.
Subject at a glance
4
Units
30
Topics
4
Credits
4
Infographics
Unit-wise Syllabus
4 units — open any unit for detailed topic-wise notes, diagrams and important exam questions
- Meaning
- evolution
- objectives and scope of corporate finance
- role of the financial manager
- time value of money
- valuation of equity/debt/hybrid securities
- sources of finance (long and short term)
Future value
FV = PV (1 + r)^n
Present value
PV = FV / (1 + r)^n
PV of annuity
A × [1 − (1 + r)^(−n)] / r
Perpetuity
PV = A / r
Bond value
Σ coupon / (1 + kd)^t + face value / (1 + kd)^n
Study guide
This unit covers the objectives and scope of corporate finance, the financial manager's role, time value of money, valuation of equity, debt and hybrids and sources of finance. Practise present value and valuation problems.
- Concept and significance of cost of capital
- specific and weighted average cost of capital
- capital structure theories — Net Income
- Net Operating Income
- Traditional
- Modigliani-Miller (arbitrage process and agency cost)
- determinants of capital structure
- EBIT/EPS and ROI/ROE analysis
Cost of debt
Kd = I (1 − t) / net proceeds
Cost of equity (CAPM)
Ke = Rf + β (Rm − Rf)
Cost of equity (Gordon)
Ke = D1 / P0 + g
WACC
Σ wi ki
Study guide
You study cost of capital (specific and weighted), capital structure theories (NI, NOI, traditional, Modigliani-Miller), determinants and EBIT-EPS analysis. Compute WACC for a sample firm.
- Business and financial risk
- operating and financial leverage
- trading on equity
- nature and process of capital budgeting
- investment evaluation criteria (payback, ARR, NPV, benefit-cost ratio, IRR)
- risk analysis and capital rationing
Operating leverage
Contribution / EBIT
Financial leverage
EBIT / EBT
Combined leverage
Contribution / EBT
NPV
Σ CFt / (1 + k)^t − initial outlay
Benefit-cost ratio
PV of inflows / initial outlay
Study guide
You study business and financial risk, leverage, capital budgeting (payback, ARR, NPV, BCR, IRR), risk analysis and capital rationing. Practise NPV and IRR with cash flow tables.
- Issues in dividend decisions
- forms of dividend
- relevance and irrelevance theories
- working capital meaning
- nature
- conservative/matching/aggressive approaches
- static vs dynamic view
- factors determining working capital
- financing methods
Conservative
All permanent + part of temporary needs
Low risk, lower return
Matching (hedging)
Permanent needs; short-term for temporary
Balanced
Aggressive
Part of permanent needs too (rest short-term)
High risk, higher return
Study guide
You study dividend issues, forms, relevance and irrelevance theories, working capital approaches and financing. Compare conservative, matching and aggressive working capital policies.
Why Corporate Finance and Policy Matters
Corporate finance is the language of the CFO's office, and valuation and capital budgeting are staples of MBA finance interviews.
How to Prepare for Corporate Finance and Policy
- Practise NPV, IRR, WACC and leverage numericals daily.
- Study real capital structure decisions of companies.
- Compare dividend theories in a table.
Corporate Finance and Policy: Frequently Asked Questions
What is the weighted average cost of capital?
WACC is the average cost of all the firm's capital sources, weighted by their share in the capital structure.