CORPORATE FINANCE

Answer 1
Sources of funds
Companies always seek sources of funding to grow their business. Funding, also
called financing, represents an act of contributing resources to finance a program,
project, or need. Funding can be initiated for either short-term or long-term purposes.
The different sources of funding include:
• Common stock
• Preferred stock
• Bonds and Debentures
• And retained earnings
Common Stock
Companies can raise funds from the public in exchange for a proportionate ownership
stake in the company in the form of shares issued to investors who become
shareholders after purchasing the shares.
Alternatively, private equity financing can be an option, provided there are entities or
individuals in the company’s or directors’ network ready to invest in a project or
wherever the money is needed for.
Compared to debt capital funding, equity funding does not require making interest
payments to a borrower.
However, one disadvantage of equity capital funding is sharing profits among all
shareholders in the long term. More importantly, shareholders dilute a company’s
ownership control as long as it sells more shares.
Shareholding Pattern Reliance Industries Ltd.
No Of Shares 6765994014 100%
Promoters 3322748048 49.11%
Foreign 1566801364 23.16%
Institutions
Mutual Funds 370365477 5.47%
Others 130870166 1.93%
General Public 567941189 8.39%
Financial 595059142 8.79%
Institutions

Preferred stock
Preferred shareholders have priority over common stockholders when it comes to
dividends, which generally yield more than common stock and can be paid monthly or
quarterly.

Page | 1
 These dividends can be fixed or set in terms of a benchmark interest rate like the
London InterBank Offered Rate (LIBOR), and are often quoted as a percentage in the
issuing description.
Adjustable-rate shares specify certain factors that influence the dividend yield, and
participating shares can pay additional dividends that are reckoned in terms of
common stock dividends company's profits. The decision to pay the dividend is at the
discretion of a company's board of directors.
Preferred Stock vs. Common Stock
While preferred stock and common stock are both equity instruments, they share
important distinctions. First, preferred stock receive a fixed dividend as dividend
obligations to preferred shareholders must be satisfied first. Common stockholders,
on the other hand, may not always receive a dividend. A company may fully pay all
dividends (even prior years) to preferred stockholders before any dividends can be
issued to common stockholders.

Secondly, preferred stock typically do not share in the price appreciation (or
depreciation) to the same degree as common stock. The inherent value of preferred
stock is the ongoing cash proceeds investors received. Common stock, on the other
hand, is more difficult to value. However, because it is not tied to semi-fixed payments,
investors hold common stock for the potential capital appreciation.

BOND
Bonds are investment securities where an investor lends money to a company or a
government for a set period of time, in exchange for regular interest payments. Once
the bond reaches maturity, the bond issuer returns the investor’s money. Fixed income
is a term often used to describe bonds, since your investment earns fixed payments
over the life of the bond.
Companies sell bonds to finance ongoing operations, new projects or acquisitions.
Governments sell bonds for funding purposes, and also to supplement revenue from
taxes. When you invest in a bond, you are a debtholder for the entity that is issuing
the bond.

Preferred Stock vs. Bonds

Preferred stock is often compared to as bonds because both may offer recurring cash
distributions. However, as there are many differences between stocks and bonds,
there are differences with preferred equity as well.
In terms of similarities, both securities are often issued at face value or par value. This
value is used to calculate future dividend payments and is unrelated to the market
price of the security. Then, companies may issue dividends similar to how bonds issue

Page | 2
coupon payments. Though the mechanism is different, the end result is ongoing
payments derived from an investment.
There are still many differences between the two. Preferred stock dividend payments
are not fixed and can change or be stopped. However, these payments are often taxed
at a lower rate than bond interest. In addition, bonds often have a term that mature
after a certain amount of time. There is theoretically no "end date" to preferred stock.

Retain Earnings
Retained Earnings (RE) are the accumulated portion of a business’s profits that are
not distributed as dividends to shareholders but instead are reserved for reinvestment
back into the business. Normally, these funds are used for working capital and fixed
asset purchases (capital expenditures) or allotted for paying off debt obligations.
Voting Rights, Calling, and Convertibility
Preferred shares usually do not carry voting rights, although under some agreements
these rights may revert to shareholders that have not received their dividend.
Preferred shares have less potential to appreciate in price than common stock, and
they usually trade within a few dollars of their issue price, most commonly $25.
Whether they trade at a discount or premium to the issue price depends on the
company's creditworthiness and the specifics of the issue: for example, whether the
shares are cumulative, their priority relative to other issues, and whether they are
callable.
If shares are callable, the issuer can purchase them back at par value after a set date.
If interest rates fall, for example, and the dividend yield does not have to be as high to
be attractive, the company may call its shares and issue another series with a lower
yield. Shares can continue to trade past their call date if the company does not
exercise this option. Some preferred stock is convertible, meaning it can be exchanged
for a given number of common shares under certain circumstances.
The board of directors might vote to convert the stock, the investor might have the
option to convert, or the stock might have a specified date at which it automatically
converts. Whether this is advantageous to the investor depends on the market price
of the common stock.

Page | 3
Answer 2
Pay back period
The term payback period refers to the amount of time it takes to recover the cost of an
investment. Simply put, it is the length of time an investment reaches a breakeven
point.
People and corporations mainly invest their money to get paid back, which is why the
payback period is so important. In essence, the shorter payback an investment has,
the more attractive it becomes. Determining the payback period is useful for anyone
and can be done by dividing the initial investment by the average cash flows.
Pay back period = Years before full recovery + Unrecovered cost at the start of
the year / Cash flow during the year You have year 3 which is the last year before
the investment turns positive.
Net Present Value (NPV)
Net present value (NPV) is the difference between the present value of cash inflows
and the present value of cash outflows over a period of time. NPV is used in capital
budgeting and investment planning to analyze the profitability of a projected
investment or project.
NPV is the result of calculations that find the current value of a future stream of
payments, using the proper discount rate. In general, projects with a positive NPV are
worth undertaking while those with a negative NPV are not.

NPV = Rt/(1 − 𝑖)𝑡

NPV = Net Present Value
Rt = net cash flow at the time t
I = discount rate
t = time of cash flow

Internal Rate of Return (IRR)

Internal Rate of Return, or IRR, is the rate of return at which a project breaks even and
is used by management to evaluate potential investments.
The internal rate of return (IRR) is a metric used in financial analysis to estimate the
profitability of potential investments. IRR is a discount rate that makes the net present
value (NPV) of all cash flows equal to zero in a discounted cash flow analysis.
IRR calculations rely on the same formula as NPV does. Keep in mind that IRR is not
the actual dollar value of the project. It is the annual return that makes the NPV equal
to zero.

Page | 4
Project A
(I) Payback period
= 4 + 500 / 10500
= 4.04762
(II) NPV
A B A/B
0 (40000) 0 (40000)
1 5000 (1+0.05)1 4761.90
2 12000 (1+0.05)2 10884.35
3 10000 (1+0.05)3 8638.37
4 12500 (1+0.05)4 10283.78
5 10500 (1+0.05)5 8227.02

NPV = Total of (A/B)

NPV = 2795
(III) IRR
NPV= FV0/(1+R)0 + FV1/(1+R)1 +FV2/(1+R)2 + FV3/(1+R)3 + FV4/(1+R)4 +
FV5/(1+R)5
0= (40000)/(1+R) 0 + 5000/(1+R)1 + 12000/(1+R)2 + 10000/(1+R)3 + 12500/(1+R)4
+10500/(1+R)5
IRR=7 %

Project B
(I) Payback period
= 4 + 2200/ 10500
= 4.209

(II) NPV
A B A/B
0 (50000) 0 (50000)
1 8500 (1+0.05)1 8095.23
2 15000 (1+0.05)2 13605.44
3 12000 (1+0.05)3 10366.05
4 12300 (1+0.05)4 10119.24
5 10500 (1+0.05)5 8227.02

NPV = Total of (A/B)

NPV = 412.98

Page | 5
 (III) IRR
NPV = FV0/(1+R)0 + FV1/(1+R)1 +FV2/(1+R)2 + FV3/(1+R)3 + FV4/(1+R)4 +
FV5/(1+R) 0=50000/(1+R)0 + 85000/(1+R)1 + 15000/(1+R)2 + 12000/(1+R)3 +
12300/(1+R)4 + 10500/(1+R)5
IRR= 5%

A B comment
Pay back period 4.04762 4.209 Project A’s is
more suitable
NPV 2795 412.08 NPV is higher,
Project A is
selected
IRR 7% 5% Higher the
discount rate,
here Project A
should be
selected

Chief Finance officer of M/s Priya Industries Ltd should select project A

Page | 6
Answer 3 (A)
A=P(1+I)n

Where as,
A = amount
P = principal amount = 300000
I = interest rate ( Quarterly) = 8 % = 8/4 = 2%
n = tenure = 5*4 = 20

= 300000(1+.02)20 = 445784.1

(B)
A = amount
P = principal amount = 20000 per year
I = interest rate = 10 % = 10/4 = 2.5%
n = tenure = 5*4 = 20

= Present value annuity method = P(1/(1+i))n

= 20000( 1 / (1+ 0.025))20
= 390243.90

We will select option A because net cash inflow is higher in option A

Page | 7
Answer 3 (B)

RELATIONSHIP OF THE BOND PRICE AND YIELDT

The yield and bond price have an important but inverse relationship. When the bond
price is lower than the face value, the bond yield is higher than the coupon rate.
When the bond price is higher than the face value, the bond yield is lower than the
coupon rate. So, the bond yield calculation depends on the price of the bond and the
coupon rate of the bond. If the bond price falls, the yield rises, and if the bond price
rises, the yield falls. Let us understand why this is the case

When interest rates fall, it causes a fall in the value of the related investments.
However, bonds that have been issued will not be affected in such a way. They will
keep paying the same coupon rate as issued from the beginning, which will now be
at a higher rate than the prevailing interest rate. This higher coupon rate makes these
bonds attractive to investors willing to buy these bonds at a premium.

Conversely, when interest rates rise, newer bonds will pay investors better interest
rates than existing bonds. Here, the older bonds are less attractive and will drop their
prices as compensation and sell at a discounted price

Current market price= 98.20 par value = 100

Interest rate = 6%
Current yield= annual interest payment/deb current price
= 106/98.20
=1.07

Current market price = 102

Par value=100
Interest rate=6%
Current yield = annual interest payment/ deb current price
=106/102 = 1.039

Page | 8