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DISTANCE
LEARNING CENTRE
AHMADU BELLO UNIVERSITY
ZARIA, NIGERIA

COURSE MATERIAL

MASTER IN BUSINESS ADMINISTRATION (MBA)
BUAD 804: CORPORATEFINANCIAL MANAGEMENT

1
COPYRIGHT PAGE
© 2016 Distance Learning Centre, ABU Zaria, Nigeria
All rights reserved. No part of this publication may be reproduced in any form or by any
means, electronic, mechanical, photocopying, recording or otherwise without the prior
permission of the Director, Distance Learning Centre, Ahmadu Bello University, Zaria,
Nigeria.
First published 2016 in Nigeria.
ISBN:
Published and printed in Nigeria by:
Ahmadu Bello University Press Ltd.
Ahmadu Bello University,
Zaria, Nigeria.
Tel: +234
E-mail:
2
COURSE WRITERS/DEVELOPMENT TEAM
SalisuAbubakar(PhD)
JamiluAbdulkadir (Subject Matter Experts)

Prof. AbiolaAwosika (Subject Matter Reviewers)
Halima Shuaibu

Adeyemo, Peter Adekunle (Language Editor)

Prof. Adamu Z. Hassan (Formatting Editor)

NasiruTanko Graphics
Ibrahim Otukoya
3
QUOTES
Open and Distance Learning has the exceptional ability of meeting the challenges of the three
vectors of dilemma in education delivery – Access, Quality and Cost.
– Sir John Daniels
Money is a tool. Used properly it makes something beautiful– used wrongly, it makes a mess.
– Bradley Vinson
Money is like manure. If you spread it around, it does a lot of good, but if you pile it up in one
place, it stinks like hell.
– Clint W. Murchison
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CONTENTS
Title Page ---------------------------------------------------------------------------------------------
Copyright----------------------------------------------------------------------------------------------
Quotes--------------------------------------------------------------------------------------------------
1.0 Course Information---------------------------------------------------------------------------
2.0 Course Description----------------------------------------------------------------------------
3.0 Course Introduction--------------------------------------------------------------------------
4.0 Course Outcome-----------------------------------------------------------------------------
5.0 Activities to Meet Course Objectives----------------------------------------------------
6.0 Grading Criteria and Scale------------------------------------------------------------------
7.0 Course Structure and Outline--------------------------------------------------------------
8.0 Discussion Forum------------------------------------------------------------------------------
8.1 Topical Discussions-------------------------------------------------------------------------
8.2 Discussion Questions-----------------------------------------------------------------------
9.0 Study Modules---------------------------------------------------------------------------------
9.1 Module 1:Overview and Nature of Corporate Finance, Financial
Management and Financial Reporting ----------------------------------
Introduction---------------------------------------------------------------------------------------
9.1.1 Objectives----------------------------------------------------------------------
9.1.2 Study Sessions--------------------------------------------------------------------
9.1.2.1 Study Session 1-------------------------------------------------------------------
Discussion Question(s)----------------------------------------------------------
9.1.2.2 Study Session 2-------------------------------------------------------------------
9.1.2.3 Study Session 3 -------------------------------------------------------------------
9.1.2.4 Study Session 4-------------------------------------------------------------------
9.2 Module 2: Financial Management Issues in Corporate Investment and Dividend
Decisions------------------------------------------------------
Introduction----------------------------------------------------------------------------
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9.2.1 Objectives------------------------------------------------------------------
9.2.2 Study Sessions------------------------------------------------------------------
9.2.2.1 Study Session 5--------------------------------------------------------------------
Discussion Question(s) ----------------------------------------------------------
9.2.2.2 Study Session 6-------------------------------------------------------------------
9.2.2.3 Study Session 7-------------------------------------------------------------------
Discussion Question(s) ---------------------------------------------------------
9.2.2.4 Study Session 8------------------------------------------------------------------
9.3 Module 3-------------------------------------------------------------------------------------
Introduction----------------------------------------------------------------------------
9.3.1 Objectives----------------------------------------------------------------------
9.3.2 Study Sessions--------------------------------------------------------------------
9.3.2.1 Study Session 9-------------------------------------------------------------------
Discussion Question(s) -----------------------------------------------------------
9.3.2.2 Study Session 10------------------------------------------------------------------
Discussion Question(s)-----------------------------------------------------------
9.3.2.3 Study Session 11------------------------------------------------------------------
9.3.2.4 Study Session 12-----------------------------------------------------------------
9.3.2.5 Study Session 13-------------------------------------------------------
Discussion Question(s)--------------------------------------
10.0 Further Reading-------------------------------------------------------------------------------
11.0 Glossary-----------------------------------------------------------------------------------------
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PREAMBLE
Hello and welcome to the Corporate Financial Management (BUAD 804). For ease
of identification and referral, let us use ‘CFM’as acronym for the course. CFM is
one of the courses in your Master in Business Administration (MBA) programme. I
assure you that you will find the course interesting and educative. From the basic
rudimentary aspects of corporate financial management to the more technical
aspects, you would be exposed adequately in order to strengthen your managerial
expertise on the area of corporate financial management.
The topical issues contained in CFM are spread to cover wide range of financial
management issues of corporate organisations. We will lay more emphasis on the
application of theories using practical scenarios and case studies. When the course
is exhausted, your technical and tactical abilities to problem-solving and other
decision making in respect to corporate finance and its management would be
enhanced significantly. So, fasten your seat belt and enjoy the ride.
1.0 COURSE INFORMATION

Course Code: BUAD 804
Course Tite: Corporate Financial Management
Semestre: Second
Credit Units: 3
Course Status: Core
Lecturer’s Information
Instructor:Dr.SalisuAbubakar
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2.0 COURSE DESCRIPTION
Finance and its management is a cardinal instrument for the success of any
corporate entity. Corporate finance revolves around three key basic decisions that
firms engage in namely: investment, financing, and dividend decisions. The
effectiveness and efficiency of the management of finance of a modern day
business are very sensitive, to the competitive advantage and future survival of
corporate entities and their capacity to operate beyond boarders.
This course covers issues relating to corporate finance and its management. The
course acquaints you with both basic and advance knowledge ,thereby, focusing on
corporate finance and financial management, corporate financial reports and their
analysis and interpretation, appraisal and management of corporate financing
options, capital market operations, and international corporate finance.
3.0 COURSE INTRODUCTION

Finance is a vast field of study. There is no organisation, whether private or public,
that can be run without money (finance). In fact, finance is like blood to the body
without which there will be no life. Finance is basically classified into two broad
categories: corporate finance and public finance. This course (CFM) is rooted in
the corporate finance and its effective and efficient management. The delivery
system is online, using this course material developed solely to provide all the
necessary information and guidance to you. The course is to be covered in 15 to 16
weeks. The topics to be covered as well as the relevant materials you should
consult are provided.
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Discussion questions are also developed for your discussion; while assignments
(group and individual) are posted on the course site. The time limit for posting
discussions and answers to the assignments are indicated and you should send
them to the drop box as and when due. Finally, you will be required to write a
semester examination at the conclusion of the course.
Coursework
The coursework for CFM comprises the group assignments/discussion topics,
individual assignments/discussion topics, and the group chapter discussion
questions. You must ensure that all assignments are completed and submitted by
the due dates through posting to the drop box or as requested.
Academic Honesty
The ethics of academics is built on integrity. Integrity is not only honesty but
truthfulness and fair dealing, when it comes to issues bothering on the academia.
You are instructed, requested, encouraged and expected to conduct yourself in
conformity with the highest standards in academic honesty. It is assumed and
expected in a learning community that academic honesty is practised. You should
acknowledge the sources of materials or works of others consulted and provide
clear citation as appropriate. Assignments or discussions submitted for onward
grading will be subjected to plagiarism check, to determine whether or not it would
be acceptable. Therefore, it is your responsibility to ensure that answers to
assignments or contribution to group assignments/discussion topics are products of
your own efforts. If you are found to have committed any form of academic
misconduct during this course, you will, at a minimum, receive a failing grade in
the course.
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Participative Learning
I encourage you to assume yourself a manager or member of the management
team, entrusted with the finance and financial management issues in a corporate
organisation. Your actions can make or mar the success of the organisation. Also
think about team work and the recent trends in local and global issues, on corporate
finance and financial management. So, let’s do this together and have fun at the
same time!
4.0 COURSE OUTCOME AND OBJECTIVES

On successful completion of the course, you will be enabled to:
1. Understand the basics of corporate finance, financial management, and
financial reporting.
2. Identify, explain and synthesise the various financial objectives of corporate
organisations.
3. Analyse and interpret corporate financial reports and their information
content.
4. Appraise corporate financing options in terms of their sources, effectiveness,
efficiency and economy.
5. Apply analytical technique(s) in evaluating capital budgeting decisions.
6. Analyse the sources of finance to corporate organisations.
7. Appraise projects undertaken by corporate organisations for decision making
purposes.
8. Evaluate the cost of raising capital by corporate organisations.
9. Describe and analyse the functions and importance of capital market and
security exchanges in corporate financing.
10. Determine the effective combination of debt and equity.
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11. Understand the international financial environment, its evolution, and
methods used to manage risk in global markets.
5.0 ACTIVITIES TO MEET COURSE OBJECTIVES

This course is both theoretical and practical in nature. You are hereby informed that
a lot of readings, writings, online searching and researching, and practical case
study analyses are required. You will share your findings and conclusions with
others in an interactive manner, via discussions and short essays. Financial
management issues to be dwelled on should have bearing on practical applications
of the theories, principles and concepts through case study analyses. The case study
analyses will be both individual and group. In the case of a group, you are required
to participate fully and be a team player. Your assessment is partly based on your
contribution and the group effort.. Also, tutorials will be arranged within the two
weeks on campus activities in which questions will be clarified to enable you
understand fully what you’ve learnt.
Group Assignment/Case Study Analyses

A good manager is the one that can work in and work with teams/groups. Your
ability to execute tasks as a team with good spirit, commitment and enthusiasm
will make you successful in any business undertaking. In CFM course, you will be
divided into teams and group, case study/assignments will be given to each group
for analysis. The group case studies are pre-set based on the Study Sessions and at
the end of each study session. Thus, five group case study/assignments analyses
questions will be given every other week (every fortnight/once in two weeks)
commencing from week 2. This means that your group case study analyses will be
given in weeks 2, 4, 6, 8, and 10.All case study analyses and other assignments are
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to be completed by midnight (GMT+1) on the due date as noted on the Course
Structure. Late submission of assignments will not be accepted. You are
expected to be a team player and work together as a team on your group
assignments. Since your assessment will be based on your participation,
contribution and team spirit, I advise you to use the ten basics of group dynamics
by Daniel Fincke as a guide. For leadership role, however, anyone of you is free
and encouraged to be the group leader. You will be privileged to have first-hand
experience about leading or enhance your leadership qualities. Being bold and
courageous is part of what managers do. For a comprehensive understanding of
this material, keeping current with the reading is strongly encouraged.
Individual Assignment
Just as it applies to the group assignments, a total of six individual
assignments/case studies will be given to you every other week (every
fortnight/once in two weeks) commencing from week 1. The individual
assignments do not coincide with the group assignments in terms of the weeks they
would be given. This means that your individual assignments will be given in
weeks 1, 3, 5, 7, 9, and 11. Assignments are to be completed by midnight
(GMT+1) on the due date as noted on the Course Structure. Late submission will
not be accepted.
Individual Case Study Analysis
As stated in the Course Structure, this course (CFM) is to be covered within 15
weeks, excluding revision and examination. Weeks 14 & 15 are dedicated to on-
campus interactions, where necessary. As for this course, however, individual case
study questions will be given to you, one for week 14 and another for week 15. As
applicable to other assignments, you are to provide your answers to the case study
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questions and post them before or by midnight (GMT+1) on the due date as noted
on the Course Structure. Late submission will not be accepted.
1. Study Session Discussion Questions

These are the questions that follow every Study Session. They are to be discussed
by you in consultation with others’ responses. The weekly assignments and their
due dates are listed in the Course Structure. Submit your group’s responses each
week they are due.
2. Personal Introduction
You need to be known by your group members. I requested that for the first
assignment, please prepare a short profile of yours, capturing information relating
to your current work status, management experience, your dreams and aspirations,
and expected skills/knowledge to be gained from CFM. You can, moreover, share
any other useful information you consider appropriate.
3. Discussion Post and Responses
Prepare to post your original thoughts on each forum topic and respond to two
other classmates. Sharing WHY your opinion is the same, or differs, is the key to
an enlightening discussion. Indicate clearly whose post you are responding to and
what specific point you are addressing. Also, bringing in additional outside
resource and knowledge as well as related life experiences would enhance your
response and command additional points.
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6.0 GRADING CRITERIA AND SCALE
6.1 Grading Criteria
Grades will be based on the following percentages
Individual Assignments 10%
Group Assignment/Discussion Questions 10%
Discussion Topic Participation 10%
Quizzes/Other Assignments 10%
Semester Examination 60%
TOTAL 100%
6.2 Grading Scale

The following is the grading scale as recommended by the Board of examiners of
the Centre:
A = 70 – 100
B = 60– 69
C = 50 – 59
F = 0 – 49
As you work on your research in this course and throughout your

graduate programme, here are some examples of open education
resources that will serve you well.
Open education resources

OSS Watch provides tips for selecting open source, or for procuring free or open software.
SchoolForge and SourceForge are good places to find, create, and publish open software.
SourceForge, for one, has millions of downloads each day.
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Open Source Education Foundation and Open Source Initiative, and other organisation like
these, help disseminate knowledge.
Creative Commons has a number of open projects from Khan Academy to Curriki where teachers
and parents can find educational materials for children or learn about Creative Commons licenses.
Also, they recently launched the School of Open that offers courses on the meaning, application,
and impact of "openness."
Numerous open or open educational resource databases and search engines exist. Some examples
include:
 OEDb: over 10,000 free courses from universities as well as reviews of colleges and rankings of
college degree programmes
 Open Tapestry: over 100,000 open licensed online learning resources for an academic and general
audience
 OER Commons: over 40,000 open educational resources from elementary school through to higher
education; many of the elementary, middle, and high school resources are aligned to the Common
Core State Standards
 Open Content: a blog, definition, and game of open source as well as a friendly search engine for
open educational resources from MIT, Stanford, and other universities with subject and description
listings
 Academic Earth: over 1,500 video lectures from MIT, Stanford, Berkeley, Harvard, Princeton, and
Yale
 JISC: Joint Information Systems Committee works on behalf of UK higher education and is involved
in many open resources and open projects including digitising British newspapers from 1620-1900!
Other sources for open education resources
Universities
 The University of Cambridge's guide on Open Educational Resources for Teacher Education
(ORBIT)
 OpenLearn from Open University in the UK
Global
 Unesco's searchable open database is a portal to worldwide courses and research initiatives
 African Virtual University (http://oer.avu.org/) has numerous modules on subjects in English, French,
and Portuguese
 https://code.google.com/p/course-builder/ is Google's open source software that is designed to let
anyone create online education courses
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 Global Voices (http://globalvoicesonline.org/) is an international community of bloggers who report
on blogs and citizen media from around the world, including on open source and open educational
resources
Individuals (which include OERs)
 Librarian Chick: everything from books to quizzes and videos here, includes directories on open
source and open educational resources
 K-12 Tech Tools: OERs, from art to special education
 Web 2.0: Cool Tools for Schools: audio and video tools
 Web 2.0 Guru: animation and various collections of free open source software
 Livebinders: search, create, or organise digital information binders by age, grade, or subject (why re-
invent the wheel?)
Legal help
 New Media Rights is trying to help digital creators use public domain or open materials legally. They
have guides on how to use free and open software materials in various fields.
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7.0 COURSE STRUCTURE AND OUTLINE
7.1 Course Structure
WEEK/DATE MODULE STUDY SESSIONS ACTIVITY INDIVIDUAL ASSIGNMENTS REMARKS
Visit the DLC website to

Weeks 1 & 2 RESUMPTION AND REVIEW OF THE COURSE SITE view & review the course
site
Week 3 1.Study the course material of 1. As a newly appointed Go through the DQs and
this session Financial Manager of one of post your
Study Session 1: the fast growing Information comments/response as
2.Watch the video of this study Technology firms, explain how appropriate. Also note the
session your first 2 months in office will submission deadline for
3.Listen to the audio of this be, in terms of financial assignments.
study session management issues of the
company.
4. Read: Chapter one of Ross,
S.A., Westerfield, R.W. and
Jordan, B.D. (2008)
Fundamentals of Corporate
Finance (8thedition): New York:
McGraw Hill Irwin. ISBN 978-0-
07-353062-8. pp1 – 19.
5. Read: Chapter one of
Pandey, I.M. (2010) Financial
Management. (10th edition).
India: Vikas Publishing House,
New Delhi. pp 2 – 16.
MODULE 1: 1.Study the course material of
Week 4 this session
2.Watch the video of this study
session
3.Listen to the audio of this
study session
Study Session 2:
4. Read: Chapter one of Frazer,
17
L.M. and Ormiston, A. (2009)
Understanding Financial
Statements (8thedition). New
Delhi, India: PHI Learning
Private Limited ISBN-978-81-
203-3022-1.
5. Read: Abubakar, S. (2010)
Regulation and the Economics
of Corporate Financial Reporting
in Nigeria. Journal of
Management and Enterprise
Development, Vol. 7, No. 2, pp
65-72.
6. Review the posted response
to last week’s Discussion
Question
Week 5 1.Study the course material of 1. Discuss the relationship
Study Session3: this session between reported earnings
and financial reporting quality
2.Watch the video of this study of corporate organisations.
session
Week 6
study session
4. Read: Chapters two, three,
four, five & six of Frazer, L.M.
and Ormiston, A. (2009)
Understanding Financial
Statements (8thedition). New
Delhi, India: PHI Learning
Private Limited ISBN-978-81-
203-3022-1.
Week 7 1.Study the course material of1. Read: Case 10.1 (Hind
Study Session4: this session Petrochemicals Company) in
Management (10th edition) on
session p251 and answer the Qs
3.Listen to the audio of this therein.
study session
4. Read: Chapter 10 of Pandey,
18
I.M. (2010) Financial
Management (10th edition).
MODULE 2: India: Vikas Publishing House,
New Delhi. pp220 - 252.
Question
Week 8 Study Session5: 1.Study the course material of

this session
session
study session
4.Read: Chapters nine,
seventeen &eighteen of Pandey,
I.M. (2010) Financial
New Delhi. pp 189 – 212 & 420 -
458.
1.Study the course material of 1. Analyse the mini case of

this session Conch Republic Electronics
(Part2) in Ross, S.A.,
2.Watch the video of this study Westerfield, R.W. and Jordan,
session B.D. (2008) Fundamentals of
Study Session 6: 3.Listen to the audio of this Corporate Finance (8thedition)
study session on p367 and answer the
questions that follows.
4. Read: Chapters eight &
2. Analyse the mini case of A
twelve of Pandey, I.M. (2010)
Job at S&S Air in Ross, S.A.,
Financial Management (10th
Westerfield, R.W. and Jordan,
edition). India: Vikas Publishing
B.D. (2008) Fundamentals of
House, New Delhi. pp158-182&
Corporate Finance (8thedition)
272-291.
on pp401-402 and answer the
5. Read: Chapter eleven of
questions that follows.
Ross, S.A., Westerfield, R.W.
and Jordan, B.D.
19
Week 9 (2008)Fundamentals of
Corporate Finance (8th edition).
New York: McGraw Hill Irwin.
ISBN 978-0-07-353062-8. pp337
– 367.
6. Read Chapters seven
&nineteen of Pandey, I.M.
(2010) Financial Management
(10th edition). India: Vikas
Publishing House, New Delhi.
pp130-151& 464-481.
7. Read: Chapters twelve &
thirteen of Ross, S.A.,
Westerfield, R.W. and Jordan,
B.D. (2008) Fundamentals of
Corporate Finance (8thedition).
New York: McGraw Hill Irwin.
ISBN 978-0-07-353062-8. pp368
– 403.
Question
Week 10
MID SEMESTER BREAK
Week 11 1.Study the course material of 1. Select two companies from

this session any industry and assess their
operating and financial
Study Session 7: 2.Watch the video of this study leverage for 3 years each.
session
study session
4. Read: Chapters fourteen,
fifteen &sixteen of Pandey, I.M.
MODULE 3:
(2010) Financial Management
(10th edition). India: Vikas
Publishing House, New Delhi. pp
316-412.
5. Read Chapter sixteen of
20
and Jordan, B.D. (2008)
Finance (8th edition). New York:
07-353062-8. pp 480 – 513.
Week 12 1.Study the course material of1. Read Case 3.2
this session (HitechChem Limited) in
Study Session 8: 2.Watch the video of this study
Management (10th edition) on
session pp 75-76 and answer the Qs
3.Listen to the audio of this therein.
study session
4. Read: Chapters two, three,
five &six of Pandey, I.M. (2010)
Financial Management (10th
edition). India: Vikas Publishing
House, New Delhi. pp17-70&
90-126.
Question
Week 13 1.Study the course material of 1. Analyse 3-year
this session performance of a merged
Study Session 9: company of your choice.
2.Watch the video of this study Would you suggest demerger
session for the company? Why?
study session
4.Read: Chapter thirty two of
New Delhi. pp756-785.
Week 14 1.Study the course material of 1. Study the mini case of S&S
this session Air Goes International in Ross,
Week 15 S.A., Westerfield, R.W. and
2.Watch the video of this study Jordan, B.D. (2008)
21
Study Session10: session Fundamentals of Corporate
3.Listen to the audio of this Finance (8thedition) on p753
and answer the questions that
study session follow.
4. Read: Chapter twenty two of
and Jordan, B.D. (2008)
Finance (8thedition). New York:
07-353062-8. Pp726-740.
5. Read: Chapter 34 of Pandey,
I.M. (2010)Financial
New Delhi. pp806-823.
Question
Week 16
ON-CAMPUS ACTIVITIES/TRAINING/TUTORIALS/PRACTICALS
Week 17
Week 18 REVISION
Week 19
Weeks 20 & 21 SEMESTER EXAMINATION
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7.2 Course Outline
MODULE 1– Overview and Nature of Corporate Finance, Financial

Management and Financial Reporting
Study Session1
 Introduction to the Nature of Corporate Finance and Financial Management
 Evolution and field of finance
 Corporate financial manager
 Forma of business organization
 The goal of financial management
Study Session2
 Overview of Corporate Financial Reporting
 Overview of Corporate Financial Statements
 Theories on Corporate Financial Reporting
 Financial position and performance
 Relevance of ratio analysis
 Types of financial ratios
Study Session3
 Analysis and Interpretation of Corporate Financial Information
 Users of financial information
MODULE 2 – Financial Management Issues in Corporate Investment and

Dividend Decisions
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Study Session 4
 Investment and Dividend Decisions
 Concept of time value of money
 Cost of capital
 Theories of cost of capital
Study Session 5
 Capital Budgeting
 Capital Budgeting Decisions
Study Session 6
 Capital Market and Corporate Finance
 The Concept of Capital Market
 Capital Market Efficiency
 Return and Risk
MODULE 3 – Financial Management Issues in FinancingDecisions
Study Session 7
 Capital Structure
 Theory and Practice of Capital Structure
Study Session 8
 Valuation of Financing Sources
 Valuation of Bonds and Shares
 Portfolio Theory and Assets Pricing Models
 Beta Estimation and the Cost of Equity
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Study Session9
 Corporate Restructuring and Combination
Study Session10
 International Corporate Finance
 Concept of International Finance
 The Foreign Exchange Market
8.0 DISCUSSION FORUM
8.1 Topical Discussions

These are weekly topics which I shall post on the MBA dashboard. The topics will
centre on theoretical issues, contemporary issues and/or emerging events in the
discipline at the time of posting. You are expected to study and contribute to such
discussions. Contribution at these sessions is necessary.
8.2 Discussion Questions

These are pre-determined topics to be assigned to groups of your course mates,
who would develop a thesis around the topics, submit the thesis to an assigned
forum where all participants will interact and make comments to add to the
knowledge and move the conversation forward.
25
9.0 STUDY MODULES
9.1 MODULE 1: Overview and Nature of Corporate Finance, Financial

Management and Financial Reporting
Introduction
Corporate Financial Management (henceforth referred to as CFM) is a field of
finance that studies corporate financial management, with emphasis on the
financial aspects of managerial decisions in corporate entities. CFM revolves
around the basic functions of corporate financial management (investment,
financing, and dividend decisions), corporate financial reporting, capital market,
corporate financing options, capital structure, and issues on international corporate
finance. This module focuses on the basics of corporate finance, financial
management, and financial reporting. Here, I will provide the general information
on the course and explain the basic concepts, so that your mind is adequately
prepared for the course and your understanding of the integral aspects of the
course boosted.
9.1.1 Objectives
At the completion of this Module, you will be adequately and appropriately
enabled to:
1. Understand the nature of corporate finance, financial management, and
financial reporting.
2. Analyse and interpret corporate financial reports and their information
content.
3. Appraise corporate financing options in terms of their sources, effectiveness
and efficiency.
26
4. Evaluate and select the best technique(s) used in capital budgeting
decisions.
5. Identify, explain and synthesise the various financial objectives of corporate
organisations.
6. Understand the basic principles in corporate finance and its management.
27
9.1.2MODULE 1 STUDY SESSIONS
9.1.2.1 STUDY SESSION 1: Nature of Corporate Finance
Section and Subsection Headings
Introduction
Learning Outcomes
(A) Financial Management

 Main Features of Financial Management
 Importance and Value of Financial Management
(B) Evolution of Finance
i The Transitional Phase (1940-1970s):Here, focus was on the tools of
financial analysis designed
ii The Modern Phase (1980s-Date):
(C) Fields of Finance

i Public Finance
ii Securities and Investment Analysis
iii International Finance
iv Institutional Finance
v Financial Management
(D) Corporate Finance and Financial Manager

(E) Forms of Business Organisations
Sole Proprietorship
Merits of Sole Proprietorship
28
(F) The Goal of Financial Management
(G) Scope of Finance
(H) Financial Management Functions

Summary
(I) Discussion Questions
Introduction
In this study session, you will be introduced to the basics of corporate financial
management which will form the basis of the subsequent discussion that will
follow. As you will understand, financial management is about effective and
efficient management of organisation’s finances or financial resources. In other
words, financial management is the study of corporate finance and capital
markets, emphasising the financial aspects of managerial decisions. It covers all
areas of finance, including the valuation of real and financial assets, risk
management and financial derivatives, the trade-off between risk and expected
return, and corporate financing and dividend policy.
Learning Outcomes
At the end of this study session you should be able to:
1. Explain theNature of Corporate Finance and Financial Management.

2. Discuss the Goal of Financial Management.
3. Differentiate between Corporate Finance and the Financial Manager.
29
(A) Financial Management
In simple terms, financial management is about effective and efficient
management of organisation’s finances or financial resources. In other words,
financial management is the study of corporate finance and capital markets,
emphasising the financial aspects of managerial decisions. It covers all areas of
finance, including the valuation of real and financial assets, risk management and
financial derivatives, the trade-off between risk and expected return, and corporate
financing and dividend policy.
Pandy (2005) defines financial management as that managerial activity which

is concerned with the planning and controlling of the firm’s financial
resources. It is a field of management concerns with the acquisition, financing
and management of a firm’s assets with some overall goal(s) in mind. Financial
management deals with the general institution and procedures involved in the
acquisition and disbursement of funds either in an organisation or in government.
Weston & Copeland (1998) see financial management as the aspect of

management that deals with management of the investment, financing and
dividend activities of the firm in order to achieve its broad goals and specific
objectives.
 Main Features of Financial Management

 Analytical Thinking
 Continuous Process
 Basis of Managerial Decisions
 Maintaining Balance between Risk and Profitability
 Coordination Value between Processe
30
 Importance and Value of Financial Management
 Sound financial management creates values and organisational agility
through the allocation of scarce resources among competing organisational
needs and business opportunities.
 It is an aid to the implementation and monitoring of business strategies
which helps achieve organisational objectives.
(B) Evolution of Finance

 Traditional Phase (1890-1930s): Historically, the discipline of finance
was considered as part of economics before emerging as a separate field
of study in 1890. The emphasis then was on legalistic matters relating to
mergers, consolidation, formation of new but large firms and obtaining
more capital for expansion. The economic depressions of the 1930s in
Europe and America made the study of finance to focus on defensive
aspects of survival, preservation of liquidity, prevention of bankruptcy and
liquidation. The rampant business failures and massive abuses relating to
financial transactions led governments to regulate businesses. As such, the
emphasis then was on a company’s maintaining a sound financial structure.
 The Transitional Phase (1940-1970s):Here, focus was on the tools of

financial analysis designed for diagnosis. There was also a shift in
emphasis from right hand side of the balance sheet to the left hand side in
the form of assets analysis. In the early 1950s through the later part of 1970,
renewed interest in financial security, the case of diversification as well as
efficient portfolio selection received considerable attention.
31
 The Modern Phase (1980s-Date): The concern of finance was on
economic and financial liberation to achieve optimal resources management
globally. Corporate entities and national economies introduced reforms such
as marked based systems, rationalisation of public enterprises through
commercialisation and privatisation and adoption of tighter fiscal and
monetary policies, repeal or abrogation of many decrees and acts that were
considered obstacles to the success of the reforms. Principle of a lean and
effective government and a private sector led growth.
(C )Fields of Finance
As an academic discipline, finance can be viewed as being made up of five
specialised fields (Hampton, 1992). The five fields are as follows:
i. Public Finance: It is a field of finance used by federal, states and local
governments where large sums of money are received from many sources to
be utilised in accordance with detailed policies and procedures. The bulk of
government funds are derived from taxes, royalties and such other sources
of revenue; and government dispenses funds according to the legislative
provisions and other limitations for the welfare, security and social well-
being of the citizenry. As such, the main goal government pursues in public
finance is non-profit unlike a business organisation.
ii. Securities and Investment Analysis: This field of finance is used by

individual and institutional investors in studying the legal and investment
characteristics of each type of security; measure the degree of risk and
return involved in each investment and forecast the probable performance in
the market. In a nutshell, it deals with the ability to recognise and select
financial assets, which yield maximum return for a given level of risk or
32
minimum risk at any given return level. In addition, it deals with
quantitative skills of portfolio formation and management.
iii. International Finance: This field of finance studies economic transactions

among nations and individuals internationally. As each country has its
national currency, for any transaction involving citizens of different
countries, foreign exchange problems must be addressed. This may give rise
to so many risks that may affect a firm that deals with citizens of other
countries in effecting payment or receipts
iv. Institutional Finance: This field of finance examines financial institutions

such as banks, insurance companies, unit trusts, pension funds and credit
unions with the overall objectives of knowing where to raise funds readily
and cheaply or place funds more profitably. These institutions gather money
from individual savers and accumulate sufficient amounts, which could be
readily available to finance business transactions, the purchase of private
homes and commercial facilities, and the variety of other activities that
require substantial amount of capital. In short, institutional finance deals
with savings and capital formation for an enhanced economic growth and
development.
v. Financial Management: This field of finance deals with financial

problems in individual firms by seeking cheaper sources of funds with a
view of investing the funds in profitable business activities. Thus, according
toUmoh (1997), the essence of financial management is the effective and
efficient administration of an organisation’s financial resources to achieve
the stated goals of the organisation, whether such goals are couched in
33
maximum profitability, shareholders wealth maximisation or market share
dominance. In short, financial management or business finance as it is
alternatively called, is the field of greatest concern to corporate financial
officers and it forms the main focus of our study of finance.
ITQ: Finance as an academic discipline can be viewed as being made up of

five specialised fields namely:
ITA: Public finance, Securities and investment analysis, International Finance,

Institutional finance and Financial Management.
(D) Corporate Finance and Financial Manager

A financial manager is a person who is responsible, in a significant way, to carry
out the finance functions. It should be noted that, in a modern enterprise, the
financial manager occupies a key position. He is one of the members of the top
management team, and his role, day-by-day, is becoming more pervasive,
intensive and significant in solving the complex funds management problems.
Now, his function is not confined to that of a scorekeeper maintaining records,
preparing reports and raising funds when needed, nor is he a staff officer in a
passive role of an adviser. The finance manager is now responsible for shaping the
fortunes of the enterprise, and is involved in the most vital decision of the
allocation of capital. In his new role, he needs to have a broader and far-sighted
outlook, and must ensure that the funds of the enterprise are utilised in the most
efficient manner. He must realise that his actions have far-reaching consequences
on the firm because they influence the size, profitability, growth, risk and survival
of the firm, and as a consequences, affect the overall value of the firm. The
financial manager, therefore, must have a clear understanding and a strong grasp
34
of the nature and scope of the finance functions. Some of the main functions of a
financial manager include:
 Funds Raising
 Funds Allocation
 Profit Planning
 Understanding Capital Market.
ITQ: Define financial management.
ITA: Financial management can be defined as the effective and efficient
management of organisational resources.
(E) Forms of Business Organisations
The three basics forms of business organisations are:
 Sole proprietorship
 Partnership
 Corporations
1. Sole Proprietorship: This is a business owned by one person who operates
it for his own profit.
Merits of Sole Proprietorship
- It is easy to form.
- Freedom of taking decision.
- All profits go to the owner.
35
Demerits of Sole Proprietorship
- Inadequate capital.
- Unlimited liability.
- Lack of continuity when the owner dies.
2. Partnership: When two or more persons associated to conduct a business
for the purpose of making profit, a partnership is said to exist.
Merits of Partnership
- Large capital.
- Benefit of combined judgment.
- There is continuity.
Demerits of Partnership
- Unlimited liability.
- Difficulty in taking decision.
- It is difficult to liquidate a partnership.
3. Corporation: This type of business is a legal entity distinct from its owners
and managers.
Merits of Corporations
- Limited liability.
- Easy transfer of ownership.
- Perpetual life span.
Demerits of Corporations
- Large expenses in the process of incorporation.

- Too much government regulations.
- Lack of secrecy.
36
(F) The Goal of Financial Management
For an effective and efficient financial management, a firm must set out some
specific goals or objectives. According to Van Horne and Wachowicz (2000),
although various objectives are possible, the central goal of a firm is to
maximise the wealth of the firm’s present owners, which is much more than the
goal of maximisation of profit of the firm.
(G) Scope of Finance
The three most important finance activities of a business firm are:
 Production
 Marketing
 Finance.
A firm secures whatever capital it needs and employs it (i.e., finance activity) in
activities, which generate returns on invested capital (production and marketing
activities).
(H) Financial Management Functions

These are the three financial management decisions that organisations make
during the course of their operations. They are: Financing decisions (deciding on
when, where, from whom, and how to acquire both short and long-term funds, to
meet the organisation’s investment); investment decisions (evaluation and
measurement of the prospective projects in terms of their cash flow and
profitability for effectiveness); and dividend decisions (deciding on the
proportion of profit to be distributed and the proportion to be retained for
expansion i.e., dividend payout ratio).
37
ITQ: Mention the three key financial management functions.
ITA: They are financing decisions, investment decision and dividend decisions.
Summary
In this study session, we have discussed the basics of corporate financial

management which form the basis of the discussions that followed. As you have
learned, financial management is about effective and efficient management of
organisation’s finances or financial resources. In other words, financial
management is the study of corporate finance and capital markets, emphasising
the financial aspects of managerial decisions. It covers all areas of finance,
including the valuation of real and financial assets, risk management and financial
derivatives, the trade-off between risk and expected return, and corporate
financing and dividend policy

1. Define the concept of corporate finance and discuss the salient points
contained in the definition.
2. Who is the financial manager and what are his/her responsibilities?
3. Business organisations need finance to operate. Identify the forms of
business organisations and explain how each of them raises its finance.
4. Identify and discuss the goals of financial management.
5. Finance functions include decisions on financing, investment and dividend.
Explain these decisions in respect of short and long-term.
6. Capital budgeting, capital structure and working capital management are
recognised as the basic financial management decisions of corporations.
38
Explain each of them, concentrating on the questions that need to be
answered.
7. Define the concept of wealth maximisation and explain how it takes care of
any conflict that arises between shareholders’ and managers’ goals.
8. Discuss the major functions of finance.
9. Identify forms of business and discuss their financial challenges.
10. Analyse the known functions of the financial manager.
11. What do you understand by the scope of finance? Discuss the goals of
financial management.
References
1. Frazer, L.M. and Ormiston, A. (2009) Understanding Financial Statements
(8th Edition). New Delhi, India: PHI Learning Private Limited
ISBN-978-81-203-3022-1.
2. Pandey, I.M. (2010) Financial Management (10th Edition). New Delhi:

Vikas Publishing House, India.
3. Ross, S.A., Wesrerfield, R.W. and Jordan, B.D. (2008) Fundamentals of

Corporate Finance (8th Edition). New York: McGraw Hill Irwin.
ISBN 978-0-07-353062-8.
4. Vanhorne, J.C (2006). Financial Management and Policy (12th Edition).

London: Prentice Hall International, Inc.
5. Weston, J. Fred & Brigham, F. Eugene (2002). Managerial Finance (7th

Edition). The Dryden Press.
6. Berk, J & Demarzo, P (2011). Corporate Finance (2nd Edition). India:

Pearson Education Inc.
7. Arnold, G (2010). Essentials of Corporate Financial Management (2nd

Edition). India: Pearson Education Inc.
8. Emery, D. R., Finnery, J. D & Stowe, J. D (2007). Corporate Financial

39
Management (3rd Edition). India: Pearson Education Inc.
9. Lawrence, J Gitman (2000). Principle of Managerial Finance. Harper &

Row Publishing Company.
10. Vanhorne, J. C & John, M. Machowicz (2004). Fundamental of Financial

Management (11th Edition). Pearson Education Inc.
11. Brigham, E. F (1997). Financial Management: Theory & Practice. The

Dryden Press.
12. Stanley, B Block & Geoffrey, A. Hart (2002). Foundations of Financial

Management (10th Edition). New York: McGraw Hill Companies
Inc. Irwin.
13. Ross, S.A., Wesrerfield, R.W & Jeffrey, J (2002). Corporate Finance (4th
Edition). New York: McGraw Hill Irwin.
14. Weston, J. Fred & Copeland, T. E (1998). Managerial Finance (7th

Edition). UK: The Cassel Publishing House.
15. Bodie, Z., Kane, A & Marcus A. J (1998). Essentials of Investment (3rd
40
9.1.2.2 STUDY SESSION 2:
Corporate Financial Reporting
Introduction
Learning Outcomes
(A) Financial Reporting
(B) Financial Reporting Theories
(C) Corporate Financial Statements
(D) Financial Position and Performance
(E) Relevance of Ratio Analysis in Financial Planning
1. Analysing Financial Statements

2. Used in Judging Efficiency of the Business
3. Ability to Point a Weakness
4. Assist in Formulation of Plans
5. Comparison of Performance
(F) Types of Financial Ratios
a) Short-Term Solvency and Liquidity:

(i) Current ratio
(ii) Liquidity/quick acid test ratio
(iii) Stock turnover
(iv) Debtors turnover
(v) Average collection period
41
(vi) Creditors turnover
(vii) Creditors average payment period

b) Indicates the average period for which creditors remain unpaid.
Long -Term Solvency and Stability:
(i) Long-term debt to shareholders fund

(ii) Total debt to shareholders fund
(iii) Gearing ratios
(iv) Proprietary ratios
(v) Fixed interest cove
(vi) Fixed dividend cover
c) Efficiency and Profitability
(i) Net Profit Margin
(ii) Gross Profit to Sales
(iii) Return on Capital Employed (ROCE)
(iv) Assets turnover
(v) Expenses to Sales
(v) Stock Holding period

d) Potential and Growth:
(1) Dividend per share
(2) Dividend cover
(3) Earnings per share
(4) Earnings Yield
(5) Dividend Yield
(6) Price Earnings ratio
(G) Limitations of Ratio Analysis
42
(H) Cash Flow Information
Summary
Introduction
You are welcome to study session two. In this session, you will understand
theoverviews of Corporate Financial Reporting, Statements as well as Financial
Position, Performance and Cash Flow Information.
Learning Outcomes
At the end of the study session, you should be able to:
1. Explain theOverviewsof Corporate Financial

ReportingandStatements.
2. Discuss the Financial Position and Financial Performance.
3. Discuss the Cash Flow Information.
(A) Financial Reporting

Corporate organisations use accounting to communicate to all stakeholders about
their operating performance and position at a particular time period. The process
through which companies communicate to the public about their operations is
called financial reporting. Corporate financial reporting is the medium
through which companies communicate to the external society, about their
operational performance in terms of profitability, efficiency, and
responsibility. It is largely an effort to assess financial performance in terms of
how well or how poorly the reporting entity performed during a particular date
(van Beest, Braam & Boelens, 2009). In other words, it is a process of making
43
information public through the use of reports that are considered financial in
nature.
Financial reporting of a corporate entity constitutes a combination of qualitative

and quantitative financial reports, which are referred to as a company’s bill of
health. Various stakeholders take their decisions relative to a company’s
performance and position, based on the information supplied by it in its annual
financial reports and accounts. Financial reporting by companies is effected via
the preparation and publication of financial statements. These financial statements
are required to exhibit certain degree of quality, in terms of their information
content. Belkaoui (2002) suggests that, information contained in the financial
reports should possess certain qualities as relevance, verifiability, understand-
ability, neutrality, timeliness, comparability, and completeness.
ITQ: What is financial reporting?
ITA: Financial reporting can be defined as the process through which

organisations disclose their operations to the public.
(B) Financial Reporting Theories

Theories under the environment of corporate financial reporting are usually
discussed based on the amount of information that is required and the government
intervention (McGee & Tarangelo, 2009). However, in most of accounting
literature, corporate financial reporting theories are discussed based on two
schools of thought. They are referred to as the Leftist theory and Rightist theory.
While the leftists (Leftwich, 2004; Leftwich& Zimmerman, 2002; Holland, 1999;
Hendriksen, 1970; Cramer, 1969) are of the view that financial reporting ought not
to be regulated, the rightists (Ghofar & Saraswati, 2008; Benston, 2007; Benston,
44
Bromwich & Wagenhofer, 2006; Burgstahler, Hail &Leuz, 2006) argue that it
should be. These thoughts divide the market in which organisations operate into
two: the free market and regulated market (Wolket al, 2002).
Bello (2010) says that, even though financial reporting is a regulatory activity and
is likely to remain so in the unforeseeable future, leftists argue that firms may
provide better information in unregulated market in competing with other firms
for capital. A study by Stiegler (1975) reveals that regulations have not improved
any quality of financial report. In the same vein, Benston (2007) concludes that,
prior to regulation in the United States; firms met the entire regulatory
requirements voluntarily. You should therefore read the arguments for and against
regulation, as contained in the study of Bloomfield (2002) and in the publications
of Revsine, Collins and Johnson (2008), Melville (2009), Ormiston and Fraser
(2009).
ITQ: According to the accounting literature, financial reporting is based on two schools
of thought namely:
ITA: The leftist theory and the rightist theory.
(C) Corporate Financial Statements

Financial Statements are records that outline the financial activities of
companies, organisations and/or any other body. They usually present financial
information of those bodies in a clear and concise manner for their internal
uses and for the regulatory authorities and/or the general public. For the
purpose of business entities, financial statements normally include: balance sheet,
income statements, cash flows, and statements of retained earnings, among others.
(D) Financial Position and Performance

45
Financial Ratios: Financial Ratios are numerical relationship that relates two or
more accounting numbers as stated in the business financial statements. Financial
ratios analysis is used in evaluating the business’ financial conditions and
performances to determine its financial health or otherwise. Ratios are useful
indicators of the financial strength of business organisations and are used in
making comparison among businesses or make a prediction of their future
performance. The process of calculating the various financial ratios and
interpreting same for managerial decision making is called Ratio Analysis.
ITQ: Who are the category of people that uses the financial statements?
ITA: Managers, shareholders, investors, employees, financial institutions, governments,

competitors, etc.
(E) Relevance of Ratio Analysis in Financial Planning
Ratio analysis is an important tool used in analysing the financial performance of

a business. The following are some of the relevance of ratio analysis:
1. Analysing Financial Statements
Ratio analysis is an important technique of financial statement analysis. Financial

ratios are useful for understanding the financial position of the company. Different
groups such as Investors, Management, Bankers and Creditors use ratios to
analyse the financial situation of the company for their decision making purpose.
2. Used in Judging Efficiency of the Business
Financial ratios are important tools for judging the efficiency of the company in
terms of its operations and management. They help in the assessment of how well
the company has utilised its resources.
46
3. Ability to Point a Weakness
Financial ratios can also be used in identifying the weakness attributable to

company's operations even though its overall performance may be quite good.
Management can then pay attention to the weakness areas and take remedial
measures to overcome them.
4. Assist in Formulation of Plans
Although accounting ratios are used to analyse the company's past financial
performance, they can also be used to estimate future financial performance. As a
result, they help formulate the company's future plans.
5. Comparison of Performance
It is important for a company to know how well it is performing over the years in
relation to other firms of similar nature. Also, it is important to know how well its
different divisions are performing among themselves over the years. Ratio analysis
facilitates such comparison.
ITQ: What is ratio analysis?
ITA: The process of calculating the various financial ratios and interpreting same for
managerial decision making is called Ratio Analysis.
In summary, financial ratio analysis is a key business skill that a financial manager
must possess. This is because; the financial ratios illustrate the strengths and
weaknesses of a business. By examining ratios over time, the financial manager
can notice any unusual fluctuations in ratios and can note how the business is
progressing. Ratios can also assist in financial analysis and forecasting the future
of the business.
ITQ: What are the relevance of ratio analysis in financial planning?

ITA: Analysing financial statement, used in judging efficiency in business, ability to
point a weakness, assist in formulation47 of plans and comparison of
performance.
(F) Types of Financial Ratios
Financial ratios are broadly categorised into balance sheet ratios, income
statement ratios as well as balance sheet/income statement ratios. Another way to
classify ratios is to group them into liquidity or short-term solvency ratios, gearing
or long-term solvency ratios, profitability and efficiency ratios, and lastly, the
growth ratios. Below are some of the commonly encountered financial ratios and
the method of calculating each:
e) Short-Term Solvency and Liquidity:

The ratios which measure this include:
(i) Current ratio.

(ii) Liquidity/quick/acid test ratio.
(iii) Stock turnover.
(iv) Debtors turnover.
(v) Debtors average collection period.
(vi) Creditors turnover.
(vii) Creditors average payment period.
(vi) Current ratio =
Current Assets
Current Liabilities
 Indicates the ability of a business to meet its short-term liabilities as they

fall due, out of its short-term assets.
(vii) Liquidity/quick acid test ratio =
Current Asset - Stock
Current Liabilities
48
 Extent to which current liabilities are covered by immediately realisable
assets.
(viii) Stock turnover =

Cost of Sales
Average Stock
 Indicates the velocity in number of times per period at which the average
figure of trading stock is being "turned over" i.e., sold.
(ix) Debtors turnover=
Credit Sales
Debtors
 The number of times debts are "turned over"

The higher the turnover ratio, the better the liquidity of the company.
(x) Average collection period =

Debtors
Credit Sales
 How long it takes debtors to pay up

Helps to ascertain how the debtors are paying up.
(vi) Creditors turnover=
Credit Purchases
Creditors
 Indicates the average period for which it takes debtors to pay up.
49
(vii) Creditors average payment period=
Creditors
Credit Purchases
f) Indicates the average period for which creditors remain unpaid.

Long -Term Solvency and Stability:
Applicable ratios are:
(i) Long-term debt to shareholders’ fund

(ii) Total debt to shareholders' fund
(iii) Gearing ratios
(iv) Proprietary' ratios
(v) Fixed interest cover
(vi) Fixed dividend cover.
(vii) Long-term debt to shareholders fund =

Long-Term Debt
Shareholders Fund (SHF)
 If it is high; investment is risky.

It shows a great dependency on borrowed funds.
(viii) Total debt to shareholders fund =

Total Debt
Shareholders' Funds
 If it is high; investment is risky.

It shows a great dependency on borrowed funds.
50
(ix) Gearing ratios =
Fixed Interest Capital
Equity + Reserves
OR
Fixed Interest Capital
Equity + Fixed Interest Capital
If it is above 50%, it is high
If it is below 50%, it is low
(x) Proprietary ratios =

Tangible Assets
Shareholders Fund
Shareholders' fund
Tangible Assets
It shows exposure in terms of liabilities a company has. The higher the

percentage the better for the creditors while the lower the percentage the riskier
for the creditors.
(xi) Fixed interest cove =

Profit before Interest and Tax
Fixed Interest
The higher the fixed interest cover the greater the confidence of shareholders.
51
(xii) Fixed dividend cover=
Profit after Tax
Dividend Payable
The higher the dividend cover the greater the confidence to investors.
g) Efficiency and Profitability

(i) Net profit to sales

(ii) Gross profit to sales
(iii) Return on capital employed (ROCE)
(iv) Assets turnover
(v) Expenses to sales
(vi) Stock holding period.
(vi) Net Profit Margin =
Net Profit x 100
Sales
(vii) Gross Profit to Sales =

Gross Profit x 100
Sales
(viii) Return on Capital Employed (ROCE) =

Net Profit x 100
Capital Employed
52
(ix) Assets turnover =
Sales
Capital Employed
(v) Expenses to Sales =
Expenses x 100
Sales
(x) Stock Holding period=

Average Stock x 365
Cost of Sales
To determine the number of days, say 1 month or 1 week of holding stock.
h) Potential and Growth:

(7) Dividend per share=

Dividend Payable
Number of Issued Ordinary Shares
(8) Dividend cover =

Profit after Tax
Dividend Payable
Show percentage of earning being retained to enhance expansion.
(9) Earnings per share =

Profit after Tax - Preference Dividends
53
Number of Issued Ordinary Shares
(10) Earnings Yield =

Earnings per Share x 100
Market Value
(11) Dividend Yield =

Dividend per Share x 100
Market Value
(12) Price Earnings ratio =

Market Value
Earnings per Share

ITQ: What are the commonly encountered financial ratios?
ITA: Short-term solvency and liquidity, long-term solvency and stability,

efficiency and profitability, potential and growth.
(G) Limitations of Ratio Analysis
Although ratio analysis is useful in financial management, there are limitations to

its use, some of which are listed below:
1. Many large companies actually operate a number of different divisions

in quite different industries, making it difficult to develop a meaningful
set of industry averages for comparison purposes.
2. Even for those companies operating in one industry, it is difficult to
decide on a proper basis for comparison. Ratios of a company have
meaning only when they are compared with some standards.
3. The interpretation and comparison of ratios are also rendered invalid by
the changing value of money. The accounting figures presented in the
54
statements are expressed in monetary units which are assumed to be
constant. In fact, prices change over the years and as a result, assets
acquired at different dates will be expressed at different Naira value in
the balance sheet. This makes comparison meaningless.
4. The differences in definitions of items in the balance sheet and Income
Statements make the interpretation of ratios difficult. In practice,
differences exist as to the meaning of certain terms. e.g., Capital
Employed.
5. The ratios calculated at a point in time are less informative and effective
as they suffer short-term changes.
(H) Cash Flow Information

Cash flow is an expense or a revenue stream that varies a cash account over
certain period of time. Cash inflows usually occur from operations financing or
investment activities. It might also occur as a result of donations in cash. Cash
outflows on the other hand happen as a result of expenses and/or investment.
The Statement of Cash flow is therefore a concise summary of the firm's cash flow
over a given period of time. It should also be noted that a ‘statement of cash flows’
in accounting shows the entire amount of cash generated and used by a business
over a period of time. It can be used in gauging a business financial strength. A
typical Cash flow statement usually comprises of Operating Cash Flow,
Investment Cash Flow and Financing Cash Flow. The key characteristics of
cash flow statement are:
 It gives a summary of cash inflows and outflows of cash during a particular

period.
 It links the balances in the balance sheet at the beginning of the period and
at the end of the period after considering the result of the income statement.
55
The ending balance of a given period becomes the opening balance of
another period.
 The net increase or decrease in cash and marketable securities should be
equivalent to the difference between the cash and marketable securities on
the balance sheet at the beginning of the year and end of the year.
 As opposed to accounting profits, business organisations often focus
attention on both operating cash flow, which is used in managerial decision
making, and free cash flow which is closely monitored by financial
managers as evidence of the ability to meet financial obligations.
Operating Cash Flow (OCF) is the cash flow which a firm generates from
normal operations, that is, from the production and sale of goods and
services. Free Cash Flow (FCF) on the other hand is the amount of cash
flow available to debt and equity holders after meeting all operating needs
including depreciation on fixed assets.
ITQ: What is a cash flow?
ITA:Cash flow is an expense or a revenue stream that varies a cash account

over certain period of time.
Summary
In this study session, you have been made to understand the overviews of
Corporate Financial Reporting, Statements as well as Financial Position,
Performance and Cash Flow Information.
56
1. Discuss the usefulness of corporate financial statements.
2. What are the components of corporate financial statements/reports?
3. Theories that exist in the area of corporate financial reporting can be
categorised into Leftists and Rightists. Explain the arguments of the
proponents of each.
4. What is the specific information that can be generated from each of the
components of corporate financial reports?
5. What are corporate earnings?
6. In determining the earnings quality of a corporation, a checklist is used.
What are the items used as the checklist?
7. Explain the problems in analysing a financial statement.
8. Identify two business organisations within the same industry and analyse
their financial position and performance.
9. Discuss the limitations of a company's financial statement.
10. What are the issues in financial reporting? Discuss them.
11. Discuss the economics of corporate financial reporting.
References
(8th Edition). New Delhi, India: PHI Learning Private Limited ISBN-978-
81-203-3022-1.
2. Pandey, I.M. (2010) Financial Management (10th Edition). New Delhi:
Vikas Publishing House,India.
Corporate Finance (8th Edition). New York: McGraw Hill Irwin. ISBN 978-
0-07-353062-8.
57
4. Vanhorne, J.C. (2006). Financial Management and Policy (12th Edition).
6. Berk, J.&Demarzo, P. (2011). Corporate Finance (2nd Edition). India:
7. Arnold, G. (2010). Essentials of Corporate Financial Management (2nd
8. Emery, D. R., Finnery, J. D.& Stowe, J. D. (2007). Corporate Financial
9. Lawrence, J Gitman (2000). Principle of Managerial Finance. Harper &
Row Publishing Company.
10. Vanhorne, J. C.& John, M. Machowicz (2004). Fundamental of Financial
11. Brigham, E. F. (1997). Financial Management: Theory & Practice. The
Dryden Press.
12. Stanley, B. Block & Geoffrey, A. Hart (2002). Foundations of Financial
Management (10th Edition). New York: McGraw Hill Companies Inc.
Irwin.
13. Ross, S.A., Westerfield, R.W.& Jeffrey, J. (2002). Corporate Finance (4th
14. Weston, J. Fred & Copeland, T. E. (1998). Managerial Finance (7th
15. Bodie, Z., Kane, A.& Marcus A. J. (1998). Essentials of Investment (3rd
58
Corporate Financial Information
Introduction
Learning Outcomes
(A) Analysis and Interpretation of Corporate Financial Information
Corporate Financial Information/Statement
(B) Uses of Financial Information/Statements
. Managers
.Shareholders
.Prospective Investors
. Financial Institutions
.Suppliers
.Customers
.Employees
.Competitors
. Governments
Summary
(C) Discussion Question
59
Introduction
In this study session, you will understand the Analysis & Interpretation of
Corporate Financial Information, Accounting Information Useful for Managerial
Action and Application of Financial Information in Decision Situations. Also,
International Financial Reporting Standards (IFRS) and Corporate Financial
Reporting will be discussed.
Learning Outcomes
At the end of the study, you should be able to:
1. Understand the Analysis & Interpretation of Corporate Financial

Information.
2. Know the Accounting Information Useful for Managerial Action.
3. Explain the Application of Financial Information in Decision
Situations.
4. Discuss the International Financial Reporting Standards (IFRS) and
Corporate Financial Reporting
(A) Analysis and Interpretation of Corporate Financial Information
Corporate Financial Information/Statement is a record that outlines the

financial activities of companies, organisations and/or any other body. It usually
presents financial information of those bodies in a clear and concise manner for
their internal uses and for the regulatory authorities and/or the general public. For
the purpose of business entities, financial information/statements normally
include: balance sheet, income statements, cash flows, and statements of retained
earnings, among others.
ITQ: What is a financial information/statement?
(B) Uses
ITA: of Financial
Financial Information/Statements
information/statements are records that outline the financial activities of
companies, organisations and/or any other body.
60
Financial Information/Statements are used in a variety of ways. They are
important documents which provide useful information to a wide range of users as
listed below:
1. Managers require Financial Statements to manage the affairs of the company

by assessing its financial performance and position and taking important business
decisions.
2. Shareholders use Financial Statements to assess the risk and return of their
investment in the company and take investment decisions based on their analysis.
3. Prospective Investors need Financial Statements to assess the viability of

investing in a company. Investors may predict future dividends based on the
profits disclosed in the Financial Statements. Furthermore, risks associated with
the investment may be gauged from the Financial Statements. For instance,
fluctuating profits indicate higher risk. Therefore, Financial Statements provide a
basis for the investment decisions of potential investors.
4. Financial Institutions (e.g., banks) use Financial Statements to decide whether

or not to grant a loan or credit to a business. Financial institutions assess the
financial health of a business to determine the probability of a bad loan. Any
decision to lend must be supported by a sufficient asset base and liquidity.
5. Suppliers need Financial Statements to assess the credit worthiness of a

business and ascertain whether to supply goods on credit. Suppliers need to know
if they will be repaid. Terms of credit are set according to the assessment of their
customers' financial health.
61
6. Customers use Financial Statements to assess whether a supplier has the
resources to ensure the steady supply of goods in the future. This is especially vital
where a customer is dependent on a supplier for a specialised component.
7. Employees use Financial Statements for assessing the company's profitability

and its consequence on their future remuneration and job security.
8. Competitors compare their performance with rival companies to learn and

develop strategies to improve their competitiveness.
General Public may be interested in the effects of a company on the economy,

environment and the local community.
9. Governments require Financial Statements to determine the correctness of tax

declared in the tax returns. Government also keeps track of economic progress
through analysis of Financial Statements of businesses from different sectors of
the economy.
ITQ: Financial statements are important documents which provide useful information to a
wide range of users. Mention the category of users who use the financial statements?
ITA: Managers, Shareholders, Prospective investors, Financial investors, Suppliers

Customers, Employees, Competitors and Governments.
Summary
In this study session, we have discussed the Analysis & Interpretation of

Corporate Financial Information, Accounting Information Useful for Managerial
Action and Application of Financial Information in Decision Situations
62
(C) Discussion Question
1. Identify and discuss the objectives in the analysis of corporate financial
information.
2. Financial analysts use the information contained in corporate financial
statements to analyse the operating performance of a corporation. What are
the sources of information on which the analysts base their analyses?
3. What are the tools and techniques used in the analysis and interpretation of
corporate financial information?
4. Why is the nature of accounting information useful for managerial actions?
5. Identify the accounting information needed to analyse the profitability of a
corporation.
6. What is liquidity and how can a corporation’s liquidity be ascertained?
7. Among other requirements for granting loans and advances by a financial
institution is the request for the applicant’s audited financial statements for
analysis. What are the financial information needed for a financial
institution to decide on whether or not to grant the loans and advances?
8. Read: case 6.1 (Action Performance Companies, Inc.) in Frazer, L.M. and
Ormiston, A. (2009) Understanding Financial Statements. (8th edition) on
pp 235-241 and analyse the case by answering the questions contained
therein.
9. Discuss how accounting information facilitates transactions between
financiers and those who require financing.
10. Accounting information plays an important role within the incomplete
contract theory. Discuss.
11. Discuss the meaning and importance of financial statements.
63
References
1. Frazer, L.M. and Ormiston, A. (2009) Understanding Financial
Statements (8th Edition). New Delhi, India: PHI Learning Private
Limited ISBN-978-81-203-3022-1.
2. Pandey, I.M. (2010) Financial Management (10th Edition). New

Delhi: Vikas Publishing House,India.
3. Ross, S.A., Wesrerfield, R.W. and Jordan, B.D. (2008) Fundamentals

of Corporate Finance (8th Edition). New York: McGraw Hill Irwin.
ISBN 978-0-07-353062-8.
4. Vanhorne, J.C. (2006). Financial Management and Policy (12th

Edition). London: Prentice Hall International, Inc.
5. Weston, J. Fred,& Brigham, F. Eugene (2002). Managerial Finance

(7th Edition). The Dryden Press.

7. Arnold, G. (2010). Essentials of Corporate Financial Management

(2nd Edition). India: Pearson Education Inc.
8. Emery, D. R., Finnery, J. D.& Stowe, J. D. (2007). Corporate

Financial Management (3rd Edition). India: Pearson Education Inc.
9. Lawrence, J.Gitman (2000). Principle of Managerial Finance. Harper

& Row Publishing Company.
64
10. Vanhorne, J. C.& John, M. Machowicz (2004). Fundamental of
Financial Management (11th Edition). Pearson Education Inc.
11. Brigham, E. F. (1997). Financial Management: Theory & Practice.

The Dryden Press.
12. Stanley, B. Block & Geoffrey, A. Hart (2002). Foundations of

Financial Management (10th Edition). New York: McGraw Hill
Companies Inc. Irwin.
13. Ross, S.A., Wesrerfield, R.W.& Jeffrey, J. (2002). Corporate Finance

(4th Edition). New York: McGraw Hill Irwin.

15. Bodie, Z., Kane, A.& Marcus A. J. (1998). Essentials of Investment

(3rd Edition). New York: McGraw Hill Irwin.
65
9.2 MODULE 2: FINANCIAL MANAGEMENT ISSUES IN CORPORATE
INVESTMENT AND DIVIDEND DECISIONS
Introduction
As you can recall, financial management functions of an organisation consist of
financing, investment and dividend decisions. Module one has successfully
introduced you to the conceptual issues on corporate finance and corporate
financial reporting. In this Module, you will be exposed to the two functions of
corporate financial management viz; investment and dividend decisions. It is one
thing to generate finance for an organisation; and it is another thing to effectively
and efficiently invest such finance for the purpose of maximising returns. The
returns from an organisation’s investment, determine the extent to which the
investors of capital, will be rewarded in form of dividend and retentions.
Investment decisions involve the analyses of investment projects in terms of their

cash flow (both inflow and outflow) and profitability. They are decisions often
supported by decision tools that are quantitative in nature. Usually, investment
decisions involve capital expenditure, hence, the need for capital budgeting. In
capital budgeting, an organisation decides on the ‘allocation of capital or
commitment of funds to long-term assets that would yield benefits (cash flows) in
the future’ (Pandey, 2010:4). Undertaking investments involve risks and
uncertainties, therefore, investment decisions are analysed based on their risks and
returns. Adequate tools of analysis exist that assist organisations in deciding what
to invest on, when to do the investment, how to go about the investment, and
where to channel the investment.
The returns realised from the investment decisions culminated in the profit of the
organisation. The decision on how much to distribute to the providers of capital
66
and for future expansion in terms of retention is termed dividend decisions. Every
organisation has its policy relating to dividends. Whereas some distribute all
profits as dividend, some retain all for expansion and growth; while others
distribute a proportion of the profits as dividend and retain the other proportion. In
each case, dividend decisions entail determining the dividend pay-out ratio and
retention ratio.
ITQ: What do you understand by investment decisions?
ITA: Investment decision has to do with the analysis of investment projects in terms of
their inflow, outflow and also profitability.
9.2.1 Objectives
At the completion of this Module, you will be adequately prepared to:
1. Analyse the sources of finance to corporate organisations.
2. Appraise projects undertaken by corporate organisations for decision
making purposes.
3. Evaluate the cost of raising capital by corporate organisations.
4. Describe and analyse the functions and importance of capital market and
security exchanges in corporate financing.
67
STUDY SESSIONS
9.2.2.1 STUDY SESSION 4: Corporate Finance and Investment
Section & Subsection Headings

Introduction
Learning Outcomes
(A) Concept of Investment
(B) The Concept of Time Value of Money
i Example of future value of single cash flow:
ii. Further example of compounding:

a. Multi-Period Compounding:
b. Calculation of Effective Interest Rate (EIR):
i. Annual compounding:
ii. Semi-annual compounding:
iii. Quarterly compounding:
iv. Monthly compounding:
I. Present Value of an Investment
II. Value of an Annuity Due:
a. Future Value of an Annuity Due
b. Present Value of an Annuity Due
(C) Cost of Capital
(D) Theories on Cost of Capital
(E) Dividend Theory

(F) Dividend Policy
Summary
(G) Discussion Questions
68
Introduction
In this study session, you will be able to understand Investment & Dividend
Decisions, Determination of Cash flows for Investment Decisions and the Cost of
Capital. You will further understand the Capital Investment Decisions as well as
Net Present Value (NPV).
Learning Outcomes
1. Understand the Investment & Dividend Decisions.

2. Explain the Determination of Cash flows for Investment Decisions.
3. Discuss the Cost of Capital.
4. Understand the Capital Investment Decisions and Net Present Value
(NPV).
(A)Concept of Investment
Investment is an expenditure of wealth to enable future production or other
advantageous economic yield (Aruwa and Abu, 2007). Investing is an activity that
is associated with the employing or using sources (money) to enhance the
investor’s future wealth. It means a sacrifice of current asset for future gains.
Investment in its broadest sense is the current commitment of funds based on
fundamental research to real and/or financial asset for a given period in
order to accumulate wealth in the future. The investor may be an individual or
an institution (such as pension fund, an investment company investing on behalf
of individual or government).
ITQ: What is investment as defined by Aruwa and Abu 2007?
ITA: Investment is an expenditure of wealth to enable future production or other

advantageous economic yield.
69
(B) The Concept of Time Value of Money
Time value of money is all about the assumption that it is better to receive money
sooner than later. The proponent of this idea believes that money received sooner
can be invested to generative positive value, that is, rate of return and produce
more money later. It is all about understanding the relationship between present
and future value of money. Put differently, time value of money explains that,
individual investors generally prefer the possession of a given amount of money
now instead of having the same amount of money at a future date. Three reasons
may be attributed to this which are Risk, Consumption and Investment.
Time value of money explains that money has a time value, money received now
is more valuable than same amount of money to be received in the future. If you
receive an amount now, you can invest it at an interest rate (r) and the amount will
grow at a factor (1+ r) so that at the end of the future period, what you have is the
principal plus the amount of interest that accrued on the principal. Discounting
and compounding methods are used to illustrate the concept of time value of
money. Compounding is when interest is paid on interest. It is the process of
calculating future value of cash flows from the present amount given.
Discounting on the other hand is the opposite of compounding. Under the
discounting technique, the future value of a given sum will be known and you will
be expected to determine the present value of the future sum(s).
ITQ: What is time value of money?
ITA:Time value of money is concerned with the assumption that it is better to receive
money sooner than later.
The various illustrations to be made under the time value of money concept shall
include interest rates, simple interest, compound interest, annuity, and so on. It
will also involve the description of the procedures of used in determining deposits
70
that might be needed to accumulate a future sum, finding growth or interest rates
loan amortisation as well as finding an unknown number of periods.
ITQ: What are the three factors that are attributed to time value of money?
ITA: They are: Risk, Consumption and Investment.
Illustrations of Some Basic Concepts of Time Value of Money:
III. Example of future value of single cash flow:
Suppose Mr. Jameel received a birthday gift of N10,000:00 from his Dad,
and he decided to invest this amount in a savings account of a bank which
attracts 10% interest per annum. How much future sum will Mr. Jameel
receive after one year?
The amount to be received at the end of year one will be=
Principal amount invested + Interest on the principal for 1 year
= N10, 000 + (10 × N10,000) Note: 10% = 0.10 or 0.1
100
= N10,000 + (0.10×10,000)
=N10,000 + N1,000= N11,000:00
Mr. Jameel will receive N11,000:00 at the end of year one.
Suppose Mr. Jameel decided to leave his money in the savings account for 2
years, how much will the amount grow to at the end of two years?
The amount to be received at the end of year two will be=
71
= {N10,000 + (0.10×10,000)} + 0.10 {N10,000+ (0.10×N10,000)}
= N11,000 + 0.10 (N11,000)
= N12,100:00
Mr. Jameel will receive the sum of N12,100:00 at the end of year two.
The future sum for any number of years can be calculated using the
following procedure:
Let us assume:
FV = the future value of the sum invested
PV = present value of the amount invested
r = interest rate
n = number of periods or years
To calculate the future value of a given sum at the end of year one can be
done as follows:
Future Value first yr =Principal amount + Interest on the principal for 1 year
FV1 = PV + (PV × r)
FV1= PV (1+ r)
If you wish to get the future value for year two, it can be done as follows:
Note: the amount at the end of year one becomes the beginning amount of
year two, and the amount at the end of year two becomes the beginning
amount of year three, and so on.
72
Future Value end of yr2= FV end of yr1 + Interest on the FV end of yr1
i.e FV2 = FV1 + FV1 × r
We can factor out FV1 from above equation to have:
FV2 = FV1 (1 + r)
Since FV1 = PV (1 + r), we can therefore substitute as follows:
FV2 = PV (1+r) (1+r)
FV2 = PV (1+ r) 2
To calculate the future value of any given sum for a number of periods or
years, we use the following equation:
FVn= PV (1+ r) n, where;
FV = the future value of the sum invested
PV = present value of the amount deposited or invested
r = interest rate
n = number of periods or years
If we reconsider the example of Mr Jameel that invested the sum of N10,000:00

for two years at an interest rate of 10%, we can solve it as follows:
PV= N10,000:00
r = 10%
n= 2 years
73
FV2 = PV (1 + r)2
FV = 10,000 (1.10)2
FV = 10,000 (1.21) = N12, 100:00
The amount to be received by Mr Jameel at the end of year two is N12, 100:00
ii. Further example of compounding:
Suppose Mrs Jamee Ahmade an investment of the sum of N1,000,000 into a

savings deposit account that pays 10% interest compounded annually. How
much will her investment amount to at the end of the third year?
Solution:
Present value (PV) = 1,000,000
Rate (r) = 10%
End of 1st year = 100,000 + (1,000,000 x )
= N1,100,000
End of the 2nd year = 1,100,000 + (1,100,000 x )
= N1,210,000
End of the 3rd year = 1,210,000 + (1,210,000 x )
= N1,331,000
74
Mrs Jameelah will receive the sum of N1,331,000:00 from her investment at the
end of year three.
We can also use the formula FVn = PV (1 +r)n
Where FV = Future Value
PV = Present Value
r = interest rate
n = number of years
For Mrs Jameelah’s investment of N1,000,000:00 for 3 years at 10% interest, we

can determine the future value as follows;
FV3= PV (1= r)3
FV3 = 1,000,000 (1+ 0.10)3
FV3 = 1,000,000 (1.331) = N1,331,000:00
Note: the expression (1+ r)n is the compound interest factor which can be found in
the table at the appendix of this book.
I. Multi-Period Compounding:
In the previous examples, we assumed that cash flows do occur once a year.
Sometimes, these cash flows can occur more than once a year. For example,
depending on the agreement between the investor and the financial institutions,
interest on deposits can be paid either monthly, quarterly or semi-annually.
75
Consider this example:
Suppose Mr. John has made an investment of N100,000 in a bank account that
pays an interest of 10 percent per annum, and the bank compounds interest semi-
annually (i.e., twice a year). How much will Mr. John get after a year?
Since the interest rate of 10% is per annum, and we are told that the bank
compounds interest semi-annually (i.e., twice a year), we therefore have to divide
the interest by 2. The semi-annual rate will be: 10% by 2= 5%.
Now, based on semi-annual rate of 5%, the bank will calculate interest on Mr John
deposit of N100,000 for the first six months at 5% and add this interest to the
principal. The bank will again calculate interest for another six months at 5% and
add it to the amount at the beginning of the second six months.
Therefore, the interest for the first six months will be:
Interest =N100,000X (10%/2)=N5,000
At the end of the first six months, the accumulated amount will be= principal +
interest = N100,000+ N5,000=N105,000
Now, the outstanding amount at the beginning of the second six months is
N105,000. Therefore, interest will be charged on this amount 'N105,000' at 5% for
six months:
Interest =N105,000 X (10%/2) =N5250
Thus, the total cumulative amount to be received at the end of year one will be:
N100,000 +N5,000+N5,250 =N110,250.
Note that, if the interest were compounded annually, Mr. John would have only
received an interest of: N100,000 X 10% =N10,000. But as interest was
76
compounded on semi-annual basis (i.e., interest was paid twice a year), he was
able to get higher interest of N10,250. He will still have received higher amount as
interest if the compounding is done quarterly or monthly.
I. Calculation of Effective Interest Rate (EIR):

The effective interest rate that the investor receives on his investment can be
calculated using the following formula:
EIR = [1+ r]nxm - 1
Where:
EIR = Effective Interest Rate
r = Annual rate of interest
n = Number of years
M = Number of compounding per year.
Let us reconsider our previous example of Mr. John who made a deposit of
N100,000 into a bank account at 10% interest compounded semi-annually, what is
the effective annual interest rate he receive on his deposit in the first year?
In the first year with interest compounded semi-annually at 10%, you will recall
that Mr. John received a total interest income of N10,250 per annum.
Using the formula, the effective interest rate (EIR) can be found thus:
77
EIR = [1+ r]nxm - 1
EIR = [1 + 0.10]1 x 2 - 1
EIR = [1.05]2 - 1
EIR = 1.1025 - 1 = 0.1025 or 10.25%
Another example:
If a bank pays 15 percent annual interest compounded quarterly on deposits. What

will be the effective rate of interest that the bank pays on 3 year deposit of
N50,000?
Solution:
The effective interest rate can be calculated thus:
EIR = [1+ r]nxm - 1
EIR = [1 + 0.15]3x4 -1
EIR = [1.0375]12 - 1
Solving or by using financial calculator, we have:
1.555 – 1= 0.555 or 55.5%

78
Note: In annual compounding, m=1, in semi-annual compounding m=2, in
quarterly compounding m=4, in monthly compounding m=12, in weekly
compounding m=52,
More examples of Multi-Period Compounding:
Let us look at more examples of multi-period compounding where interest is

computed on annual, semi-annual, quarterly and monthly bases:
Let us find out the compound value of N10, 000 when interest rate is 12 percent
per annum if compounded annually, semi-annually, quarterly and monthly for 2
years.
a. Annual compounding:
F2=10,000x (1.12)2=10,000 x 1.254=N12,544
b. Semi-annual compounding:
F2=10,000x [1 + 0.12]2 x 2 = 10,000 [1.06]4=N12,625
2
c. Quarterly compounding:
F3=10,000x [1 + 0.12]4 x 2= 10,000 [1.03]8 = N12,668
4
a. Monthly compounding:
F2 = 10,000x [1 + 0.12]12 x 2 = N10,000 [1.01]24
IV. Future Value of an Annuity:
An annuity is a series of equal payments or receipts over a specified period of
time. If you receive a hired purchase of a luxury bus and promise to make a fixed
79
payment of an amount either monthly, biannually or yearly over a specified
period, that fixed payment is referred to as annuity.
Example:
Suppose a constant amount of N10,000 is being deposited into a savings account

at the end of every year for 4 years at 6% interest rate, this implies that the
N10,000 deposited at the end of the first year will grow for only 3 years since the
payment is being made at the end of the year, and the second year payment will
grow for only 2 years, the third year will grow for just1 year, and the last payment
in the fourth year will yield no interest.
Using the concept of compound value of a lump sum, we will have:
1st Year =N10,000 x (1.06)3 = N11,910
2nd Year = N10,000 x (1.06)2 = N11,240
3rd Year = N10,000 x (1.06)1 = N10,600
4th Year will remain atN10,000 = N10,000

Future value N43, 750
The above computations for future value of an annuity can be expressed in the
following formula:
Fv4 = PV (1+r)3 + PV (1+r)2+ PV(1+r)1 + PV
Fv4 = PV [(1+r)3 + (1+r)2+ (1+r)1 + 1]
Where: PV = Annuity cash flow
r = Interest rate
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The future value of annuity in our previous example when N10,000 is deposited
into a savings account at the end of every year for 4 years at 6% interest rate will
be:
Fv4 = 10,000 (1.06)3 + (1.06)2 + (1.06)1 + 1
Fv4 = 10,000 x 4.375 = N43,750
Note, we can also use the compound value of annuity factor table (CVAF) to
calculate the future value of an annuity for any period. The method is:
Future value = Annuity cash flow x CVAFn,r
Where:
n = No of periods
r = Interest rate.
See CVAF at the appendix of this book.
V. Present Value of an Investment

We can use the present value method to determine the present worth of a future
amount that the investor expect to receive. This is done by the use of discounting
technique. Discounting is the process of determining the present worth of future
sum or sums.
Example:
If an employee of Sabeel Inter Business Systems Ltd expects to receive N500,000

as his retirement benefits 2 years from now, and if the prevailing rate of interest is
10%. What is the present value of the N500,000 to be received by the employee
two years to come?
81
Recall that in the compounding method discussed earlier,
FV = PV (1+r) n
When we change the subject of the formula:
PV = FV or PV = FV 1
(1+r) n (1+r) n
Where; PV = FV or PV = FV 1
(1+r) n (1+r) n
FV = Future Value (Sum)
PV = present value
r = Interest rate
n = No. of years
The present value of N500,000 for 2 years at 10% interest rate can be calculated
thus:
PV = FV or PV = FV 1
(1+r) n (1+r) n
PV = N500,000 = N500,000 = N413,233.14
(1+0.10)2 (1.21)
The present value of N500,000 two years from now at 10% interest is N413,
223.14.
82
Note: The factor 1/(1+r)n is called the present value interest factor (PVIF),and can
be found for (n) number of years and (r) interest rate for any amount.
Based on present value interest factor (PVIF), we can determine the present value
of any amount using the expression below:
PV = FVn x PVIFn,r
Where;
FVn = Future value of an amount at n period
PVIF = present value interest Factor to be found in the table
r = Interest rate
n = No. of years
In our previous example of Sabeel employee, the present value of N500,000 at

10% for 2 years is:
PV =N500,000 x 0.8265
= 413,250
Note:
0.8265 was obtained from PVIF table at 10% for 2 years, and the difference you
noticed between N413,223 and N413,250 is only a matter of rounding up error.
I. Present Value of Uneven Cash Flows

Investment made by of a firm does not frequently yield constant periodic cash
flows (annuity). In most instances the firm receive a stream of uneven cash flows.
Consider the following illustration:
83
What is the present value of N10,000;N15,000;N8,000;N11,000 and N8,000
respectively received in years 1 to 5 at 8%?
Using the formula:
PV = FV1 + FV2 + FV3 + .FV4 + FV5
(1+) (1+)2 (1+)3 (1+)4 (1+)5
Present value=10,000_ + 15,000_ + 8000_ +11,000+ 8000_
(1.08)1 (1.08)2 (1.08)3 (1.08)4(1.08)5
We can use calculator to discount each of the above factors and the present value
will beN39, 276
The equation can also be resolved by using present value of interest factor (PVIF).
We obtain the value of the PVIF and multiply by the respective amounts.
Therefore, the present value calculation for N10,000;N15,000;N8,000;N11,000

and N8,000 respectively received in years 1 to 5 at 8% is shown below:
Pv=10,000xPVIF1,.08+15,000xPVIF2,.08 + 8,000
=PVIF3,.08 + 11,000xPVIF4,.08 + 8,000xPVIF5,.08
=(10,000x0.926)+(15,000x0.857)+(8,000x0.794)+(11,000x0.735)+(8,000x0.681)
=N39,276
Generally, the Present Value of uneven cash flows using the PVIF table can be
found using the following expression:
PV=FVi x PVIFi, n
Where;
PV= Present Value
FVi = Cash flow at any one period
84
PVIFi, n = Present Value Interest Factor at n period.
VI. Value of an Annuity Due:

The concepts of compound value and present value of an annuity discussed earlier
are based on the assumption that series of cash flows occur at the end of the
period. In practice, cash flows could also occur at the beginning of the period.
When you want to rent a flat, the rent is normally paid in advance. Similarly, if
you intend to buy a refrigerator on an instalment basis, the dealer requires you to
make the first payment immediately, i.e., at the point of purchase and the
subsequent instalments to be made at the beginning of each period.
Annuity due is a series of fixed receipts or payments starting at the beginning of

each period for a specific number of periods.
c. Future Value of an Annuity Due

Suppose an investor deposits N100,000 into a savings account at the beginning of
each year for 4 years at 6% interest. How much will be the compound value of the
deposits at the end of 4 years? The deposit of N100,000 at the beginning of each
year for 4 years will earn interest as follows: first deposit of N100,00 will earn
interest for 4 years, the second for 3 years, the third for2 years and the last for 1
year. Using the Compound Value interest Factor table at 6% years1 to 4, we have:
F4 = N100,000 [1.262+1.191+1.124+1.06] =N100,000 x 4.637= N463,700

Usually, the compound value of an annuity due (i.e., payment made at the
beginning of the period) is more than normal annuity (where payment is made at
the end of the year) because it earns extra interest for one year.
d. Present Value of an Annuity Due
Let us consider an example of a 4-year annuity of N100,000 each year, the interest
rate being 10 percent. What is the present value of this annuity if each payment is
made at the beginning of the year? You may recall that when payments of
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N100,000 are made at the end of each year, the present value of annuity can be
calculated by the use of the following formula:
Present value= 1__ + 1__ + 1__ + 1__+=
(1.10)0 (1.10)1 (1.10)2 (1.10)3
ITQ: What is an annuity due?
ITA:Annuity due is a series of fixed receipts or payments starting at the beginning

of each period for a specific number of periods
(C) Cost of Capital

This is the cost of funds used in financing a business. Depending on the mode of
financing used, it might be referred to as cost-of-equity if it is financed solely
through equity or cost-of-debt if it is financed solely through debt. But the true life
situation is that, most companies are financed through the combination of debt and
equity and for those companies, their cost of capital is derived from a weighted
average of all capital sources, normally called the ‘weighted average cost of
capital’ (WACC). In other words, cost of capital represents the company’s cost of
financing and its minimum rate of return that a project must earn to increase
company value.
It should be noted that the cost of various capital sources varies from one company
to the other and depends on other factors such as profitability, credit worthiness;
operating history of company’s financing policies and so on. All companies must
therefore come up with definite road maps for financing their businesses at early
stages.
ITQ: What is cost of capital?
ITA: Cost of capital is the cost of funds used in financing a business.
86
What constitutes the cost of capital of a firm depends on the mode of financing
used or the capital structure of the firm. Cost of capital can be the cost of equity if
the business is financed solely through equity, or can be the cost of debt if it is
financed solely through debt. Many companies use a combination of debt and
equity to finance their businesses, and for such companies, their overall cost of
capital is derived from a weighted average of all capital sources, widely known as
the weighted average cost of capital (WACC). The cost of capital thus becomes a
critical factor in deciding which financing track to follow – debt, equity or a
combination of both. The cost of debt is merely the interest rate paid by the
company on such debt.
ITQ: What is weighted average cost of capital (WACC)?
ITA: WACC is the combination of both debt and equity to finance a company.
However, since interest expense is tax-deductible, the after-tax cost of debt is

calculated as: Yield to maturity of debt x (1 - t) where t is the company’s marginal
tax rate. The cost of equity is more complicated, since the rate of return demanded
by equity investors is not as clearly defined as can be on debt financing.
Theoretically, the cost of equity is approximated by the Capital Asset Pricing
Model (CAPM) = Risk-free rate + (Company’s Beta x Risk Premium).
Therefore, the firm’s overall cost of capital is based on the weighted average costs
of the various components of Capital. For example, if we consider debt and equity
as the only components of Capital, with a capital structure composition of 70%
equity and 30% debt; if the cost of equity is 10% and after-tax cost of debt is 7%,
therefore, its WACC would be (0.7 x 10%) + (0.3 x 7%) = 9.1%. This is the cost of
capital that would be used as discount rate by the firm.
87
Generally, companies strive to attain the optimal financing mix, based on the cost
of capital for various funding sources. Debt financing has the advantage of being
more tax-efficient than equity financing, since interest expenses are tax-
deductible.
ITQ: What constitutes the Cost of capital of a firm?
ITA: The cost of capital of a firm depends on the mode of financing used or the capital
structure of the firm.
(D) Theories on Cost of Capital

These are well-substantiated explanations of aspects of cost of capital, which are
organised and accepted as knowledge that applies in a variety of circumstances to
explain organisation’s cost of acquiring capital.
(E) Dividend Theory
Dividend decision of a firm is yet another crucial area of financial management.

Dividend is the return on investment to the shareholders (both equity and
preference) who have stake in the business of a firm.
(F) Dividend Policy
The important aspect of dividend policy is to determine the amount of earnings to

be distributed to the shareholders and the amount to be retained in the firm.
Retained earnings are the most significant internal sources of financing the growth
of the firm. On the other hand, dividends may be considered desirable from
shareholders’ point of view as they tend to increase their current returns.
Factors Affecting Dividend Policy
 Legal Provisions
 Contractual Constraints
88
 Liquidity Constraints
 Growth Prospects
 Owners Considerations
 Capital Market Consideration
 Tax Consideration.
Types of Dividends
 Cash Dividends
 Stock Dividends (Bonus Shares)
 Bond Dividends
 Liquidating Dividends
Summary
In this study session, we have discussed the Investment & Dividend Decisions,
Determination of CashFlows for Investment Decisions and the Cost of Capital.
Also, the Capital Investment Decisions as well as Net Present Value (NPV) were
discussed.

1. Define cash flow, cash inflow and cash outflow in relation to your
organisation or any organisation you are familiar with.
2. Explain incremental cash flow.
3. What are the components of cash flow?
4. How could you calculate depreciation for tax purposes within the premise
of corporate investment decisions?
89
5. How can the corporate investment decisions be taken to take care of
inflation?
6. Identify and explain the techniques used in investment decision analysis.
7. Define the firm’s cost of capital and explain its importance.
8. With clear examples, how can the cost of debt, preference capital and equity
be determined?
9. In investment decisions, how can projects with different lives be treated?
10. Define capital rationing and state reasons for it.
11. Identify and explain approaches to capital rationing.
12. Explain Gordon’s dividend model thereby identifying its assumptions and
limitations.
13. In relation to dividend, explain pay-out ratio, retention ratio and dividend
yield.
14. What do you understand by ‘bird-in-hand’ argument for dividend?
15. What is the relevance of dividend policy under market imperfections?
16. What are the objectives of dividend policy?
17. State and explain the different ways through which corporations pay
dividend.
18. Select four companies from four different industries of your choice. Obtain
or compute their EPS, DPS and Dividend Pay-out ratio for the last five
years. Analyse the results of each company, thereby discussing the dividend
policy of the company and assessing its effectiveness.
19. What are the relevant of dividend theories in financial management?
20. Discuss the role of investment and dividend decisions in explaining
corporate ownership structure.
90
References
(8th Edition). New Delhi, India: PHI Learning Private Limited ISBN-978-81-
203-3022-1.
2. Pandey, I.M. (2010) Financial Management (10th Edition). New Delhi: Vikas
Publishing House,India.
Corporate Finance (8th Edition). New York: McGraw Hill Irwin. ISBN 978-
0-07-353062-8.
7. Arnold, G (2010). Essentials of Corporate Financial Management (2nd
91
9. Lawrence, J.Gitman (2000). Principle of Managerial Finance. Harper & Row
Publishing Company.
Dryden Press.
Management (10th Edition). New York: McGraw Hill Companies Inc. Irwin.
13. Ross, S.A., Wesrerfield, R.W.& Jeffrey, J. (2002). Corporate Finance (4th
14. Weston, J. Fred & Copeland, T. E. (1998). Managerial Finance (7th Edition).
UK: The Cassel Publishing House.
15. Bodie, Z., Kane, A & Marcus A. J (1998). Essentials of Investment (3rd
92
Corporate Finance and Capital Budgeting
Introduction
Learning Outcomes
(A) Capital Budgeting
Summary
(C) Discussion Questions
Introduction
In this study session, you will be able to understand theCapital Budgeting

Decisions, Projects Analysis & Evaluation as well as Risk Analysis in Capital
Budgeting.
Learning Outcomes
1. Explain theCapital Budgeting Decisions.

2. Understand the methods of Capital Budgeting.
(A) Capital Budgeting
Capital budgeting is the process by which a business enterprise determines how

capital projects such as building a new plant or investing in long-term plant and
93
equipment are being worthy of undertaken. The procedure is normally to estimate
the prospective cash inflows and outflows of the project in order to determine if
the cash-inflows generated will be able to meet the expected cash outlay. There are
two popular groups of techniques which are used in conducting capital budgeting
appraisal. The first group is called the Traditional techniques which comprise of
the Payback period (PBP) and Accounting rate of return (ARR). We should note
that, traditional techniques do not take into account the time value of money in
analysis.
The second group is called the Discounted cash flow techniques which consists
of the Net present value (NPV), Profitability index (PI) and the Internal rate of
return (IRR) as methods of analysis. They are called discounted techniques
because they take into account the time value of money in analysis. However, all
the different techniques of Capital budgeting are based on the comparison of
cash inflows and outflow of a project even though they differ substantially in
their approach.
ITQ: What is capital budgeting? What are the techniques used for conducting
capital budgeting appraisal capital?
ITA:Capital budgeting is the process by which a business enterprise determines

how capital projects such as building a new plant or investing in long-term
plant and equipment are being worthy of undertaken. The techniques used
for conducting capital budgeting appraisal are: traditional techniques and
discounted cash flow techniques.
A brief description of each of the methods of Capital budgeting is given below:

1. Payback Period (PBP) measures the time in which the initial cash outlay is
repaid or recouped by the project. Cash flows are not discounted. A lower payback
period is preferred to longer payback period.
94
2. Accounting Rate of Return (ARR) measures the profitability of the project
calculated as projected total net income divided by initial or average investment.
Net income is not discounted. A higher ARR is preferred to a lower ARR.
3. Net Present Value (NPV) is equal to initial cash outflow less the sum of
discounted cash inflows. Higher NPV is preferred to a lower NPV, and an
investment is only viable if its NPV is positive.
4. Internal Rate of Return (IRR) is a method used in capital budgeting to
measure the profitability of potential investments. It is the discount rate at which
net present value of the project becomes zero. Higher IRR is referred to lower
IRR.
5. Profitability Index (PI) is the ratio of present value of future cash flows of a
project to initial investment required for the project. A project is most preferred if
its PI is greater than 1. When comparing among projects, the project with higher
PI is accepted.
ITQ: What are the methods of capital budgeting appraisal?
ITA: Payback period, Accounting rate of return, Net present value, Internal rate of
return and profitability index.
Summary
In this study session, we have discussed the concept of Capital Budgeting as well
as the method of capital budgeting.

1. What are the capital budgeting methods and techniques?
2. Capital budgeting works with projects cash flows that are forecasted. What
is the forecasting risk associated with capital budgeting?
95
3. Scenario, sensitivity, and simulation analyses are used in capital budgeting
in evaluating cash flows and NPV estimates involving asking what-if
questions. Explain the three analyses in relation to the capital budgeting.
4. State the procedure for conducting capital budgeting decisions.
5. Differentiate between risk and uncertainty.
6. Identify and explain the statistical measures of risk.
7. What is a Decision Tree? What is its usefulness?
8. What are the best ways to incorporate risk in capital budget?
9. Discuss the risk analysis in capital budgeting.
10. Explain the techniques in capital budgeting.
11. How does project evaluation link to strategic plans and budget process?
12. Discuss capital budgeting decision tools.
References
1. Frazer, L.M. and Ormiston, A. (2009) Understanding Financial Statements (8th

Edition). New Delhi, India: PHI Learning Private Limited ISBN-978-81-203-
3022-1.
2. Pandey, I.M. (2010) Financial Management (10th Edition). New Delhi: Vikas
Publishing House,India.
Corporate Finance (8th Edition). New York: McGraw Hill Irwin. ISBN 978-0-
07-353062-8.
96
6. Berk, J.&Demarzo, P. (2011). Corporate Finance (2th Edition). India: Pearson
Education Inc.
7. Arnold, G. (2010). Essentials of Corporate Financial Management (2nd
9. Lawrence, J.Gitman (2000). Principle of Managerial Finance. Harper & Row
Publishing Company.
Dryden Press.
Management (10th Edition). New York: McGraw Hill Companies Inc. Irwin.
13. Ross, S.A., Wesrerfield, R.W.& Jeffrey, J (2002). Corporate Finance (4th
15. Bodie, Z., Kane, A.& Marcus A. J. (1998). Essentials of Investment
97
Corporate Finance and Capital Market
Introduction
Learning Outcomes
(A) Capital Market
(B) Capital Market Efficiency Theory
(C) Efficient Market Hypothesis

i. The Weak Efficiency Hypothesis:
ii. Semi Strong Efficiency Hypothesis:
iii. Strong Efficiency Hypothesis:
(D) Capital Market Instruments
(E) Risk and Return
i Risk-Return Trade-off
ii Return = Risk free rate + Risk Premium
iii Quantitative Risk Analysis

(F) Systematic and Unsystematic Risks
i Market Risk
ii Interest Rate Risk
iii Purchasing Power Risk
2.Unsystematic Risks:
a. Business Risk
b. Financial Risk
Summary
98
Introduction
In this study session, you will be able to understandthe Concept of Capital Market,
Capital Market & Corporate Finance and, Capital Market Efficiency. Also, some
lessons from Capital Market History as well as Return, Risk and the Security
Market Line will be discussed.
Learning Outcomes
1. Explain theConcept of Capital Market.

2. Discuss the Capital Market & Corporate Finance.
3. Explain the Capital Market Efficiency.
4. Discuss the Return, Risk and the Security Market Line.
(A) Capital Market

Capital market is a financial market where buyers and sellers meet to transact on
long-term debt or equity-backed securities. In this market, the wealth of savers is
channeled to companies, governments, etc. who can put it to long-term productive
use.
ITQ: Define a capital market.
ITA: Traditionally, capital market refers to the market for trading long-term debt
instruments (those whose maturity period is more than one year) that is a
market where capital is raised. More recently, capital market is used in a
more general context to refer to the market for stocks, bonds, derivatives
and other instruments.
99
(B) Capital Market Efficiency Theory
Efficiency of a stock market means the ability of a stock market to price stocks
and shares fairly and quickly. An efficient market is therefore one in which the
market price of all securities traded on it, reflect all the available information
(Mayo, 1998). The efficient market hypothesis refers to the proposition that a
particular stock market is an efficient market; at least to a greater or lesser extent.
ITQ: What is capital market efficiency?
ITA: An efficient capital market is a market where the share of price reflects
new information accurately and in time. Capital market efficiency is
judged by its success in incorporating and inducting information,
generally about the base value of securities into the price of securities.
(C) Efficient Market Hypothesis

The efficient market hypothesis argues that the prices of securities reflect all
information available to investors. As soon as any relevant information is
discovered, it is quickly distributed to all participants in the market and the
security prices immediately adjust to take account of its market. The theory is
concerned with how security prices behave in response to information changes in
the market.
ITQ: What is efficient market hypothesis (EMH)?
ITA: This is an investment theory that states; it is impossible to beat the market because
stock market efficiency causes existing share price to also incorporate and reflect
all relevant information. According to the EMH, stocks always trade at their fair
value in stock exchange, making it impossible for investors to either purchase
undervalued stocks or sell stocks for inflated prices. As such, it should be
impossible to outperform the overall market through expert stock selection or
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market timing, and that the only way an investor can possibly obtain higher
returns is by purchasing riskier investments.
Empirical testing has distinguished the following three classifications of
hypotheses:
iv. The Weak Efficiency Hypothesis:
Under this hypothesis, it is believed that changes in share prices should occur in a
random fashion when new information arrives unexpectedly. Information
available is restricted to the details of past share prices, returns and trading
volumes.
v. Semi Strong Efficiency Hypothesis:
This hypothesis advocates that share prices should reflect all relevant information
about past price movements and their implications and, also, should reflect all
knowledge relevant to the valuation of the share, which is available publicly.
vi. Strong Efficiency Hypothesis:
This class/form of efficient market hypothesis concludes that share prices should
reflect all information available as from the past price changes, from public
knowledge/anticipation, and form the insider knowledge available to specialists or
experts e.g., investment managers.
ITQ: What are the classifications of hypothesis that empirical testing has distinguished?
ITA: (a) The weak efficient hypothesis (b) Semi strong efficiency hypothesis (c) Strong
efficiency hypothesis.
(D) Capital Market Instruments

These are securities traded in the capital market. They include debt securities,
preference shares (preferred stock), ordinary shares (common stock), and
convertible securities.
ITQ: What are capital market instrument?
ITA: Capital market instrument are referred to as the securities traded in the capital
market such as stocks, shares and convertible securities.
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(E) Risk and Return
Return is an income received on an investment and any change in market price,

usually stated as a percentage of the beginning market price of the investment. In
other words, it is a reward from holding an investment for some period, say, a
year. It is any cash payment received due to ownership, plus the change in market
price, divided by the beginning price.
Arithmetically, returns can be calculated as follows:
Return=
X 100
Example: If you made an investment in the shares of a company in 2005 which
were selling for N50 per unit and decided to sell the shares at the rate of N60 per
unit in 2006. Assuming you received a dividend of N5 per unit, what is your rate
of return?
Return = EPp - BPp X 100

BPp
Return= N60 - N50 x 100 = 20%
N50
Risk is a measure of the uncertainty surrounding the return that an investment will
earn. Investments whose returns are more uncertain are generally considered as
being riskier. In other words, risks on investment are referred to as the variability
of returns associated with a given asset.
ITQ: What is the difference between return and risk?
ITA:Return is an income received on an investment and any change in market price,

usually stated as a percentage of the beginning market price of the investment.
Risk is a measure of uncertainty. 102
Every investment decision is guided by an assessment of risk and the return
expected. Financial managers generally prefer having higher returns and lower
risks on their investments. Because of this desire, they try at any point in time to
strike a balance between risk and expected return. The higher the level of risk
associated with a given investment, the higher the expected return. That is to say,
there is a trade-off between risk and expected return. But that does not prevent one
from investing in risky assets over the long-term in the hope of benefiting from
this trade-off.
The Risk-averse financial managers (those afraid of risks) tend to invest in less
risky stocks while the Risk-seekers or lovers invest in highly risky securities
because of their desire for higher returns. This explains why some investors
speculate on higher risks ventures, but the rational investor will always try to
determine the level of risk associated with a given investment before he commits
his funds into it.
Risk-Return Trade-off
Investment decisions involve varying degree of risk. If an Investor makes an
investment in government securities, the risk of the investment is minimal because
the likelihood of default on the investment might not be there. However, the rate
of return (interest) on such securities will be smaller due to the low level of risks
involved. Generally, we can expect lower returns and lower risks on government
securities, and higher returns with higher risks on the shares of private companies.
Risk and Return move in the same direction (direct relationship).The greater the
risk, the greater the return. The relationship between risk and return can be
expressed in the following equation:
103
Return = Risk free rate + Risk Premium
Risk-free rate is the rate applicable to government securities, while the risk
premium is the additional risk over and above the risk-free rate which is added to
the risk-free rate to get the expected return. Therefore, in government securities,
return = risk free rate, while in other investments, return = risk free rate + risk
premium. The graph below illustrates the relationship between risk and return:
Expected
Return
Risk Premium
Risk-Free Rate
Risk
Figure: Risk-Return Trade-off
ITQ: What is the direct relationship between risk and return?
ITA: The higher the level of risk associated with a given investment, the higher
the expected return.
Quantitative Risk Analysis
Understanding the nature of risk is not adequate enough unless the investor or the
analyst is able to express this risk in quantitative terms. Expressing the risk of an
investment in quantitative terms makes it possible to compare or rate such
104
investment with other investments. The statistical tool often used to measure risk
is the standard deviation.
Example
Let us look at two companies, X and Y, whose returns and associated probabilities
are as follows:
COMPANY X COMPANY Y
R P R P
6 0.10 4 0.10
7 0.25 6 0.20
8 0.30 8 0.40
9 0.25 10 0.20
10 0.10 12 0.10
If (r) represents the required rate of return from each investment and (p) is the
associated probability of a given return occurring, we can therefore estimate the
level of risks of the two companies X and Y above as follows:
105
SOLUTION
COMPANY X
R P (r)(p) (r–r) ( r –r )2 (r –r)2p

6 0.1 0.6 -2 4 0.4
7 0.25 1.75 -1 1 0.25
8 0.3 2.4 0 0 0
9 0.25 2.25 1 1 0.25
10 0.1 1 2 4 0.4
∑(r)(p) or r=8.00 ∑(r–r)2p=1.3
Variance (σ) = ∑(r –r)2p=1.3
Standard Deviation (σ) = √∑(r –r)2p
(σ) = =1.14
COMPANY Y
( r –r
R P (r)(p) ( r –r ) 2 (r –r)2p
)
4 0.1 0.4 -4 16 1.6
6 0.2 1.2 -2 4 0.8
8 0.4 3.2 0 0 0
10 0.2 2 2 4 0.8
12 0.1 1.2 4 16 1.6
∑(r)(p) or r= 8.00 ∑(r –r)2p=4.8
Variance (σ) = ∑(r –r)2p=4.8
Standard Deviation (σ) = √∑(r –r)2p
(σ) =2.19 = 2.2
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Decision: Because the Expected Return from either investment is the same,
the Investor will prefer Company X because its risk is lower than that of
Company Y. However, if the Expected Returns were different, Speculator
will not mind to shoulder higher risks for higher returns.
ITQ: What is the difference between risk free rate and risk premium?
ITA: Risk-free rate is the rate applicable to government securities, while the risk
premium is the additional risk over and above the risk-free rate which is
added to the risk-free rate to get the expected return.
(F) Systematic and Unsystematic Risks

Risks can be grouped into two component parts, systematic and unsystematic risks
1. Systematic Risks: These are risks caused by factors external to the business,
and therefore cannot be controlled by the business or the investor. These risks
affect the entire market and neither the company nor the investor can prevent
their occurrence. Systematic risks can be sub-divided into:
 Market Risk: This is a risk that arises due to changes in the market
behaviour of the capital. The market may experience a decline in the prices
of stocks due to factors such as unstable political climate, government
policy changes, war, economic meltdown, religious and other ethnic crises.
A stock market situation where the prices of stocks are continuously rising
for a given period is called the Bull market, and the market situation where
the prices of stocks are continuously declining is called the Bear market. In
Nigeria, we experienced the Bull market from late 90s up to around 2005.
The bearish market began from around 2006.
 Interest Rate Risk: The rise or fall in interest rates affects the availability
of funds in the hand of the investors, especially the Speculators. If the cost
107
of borrowing is low, people will borrow money from the banks to invest in
stocks with the expectation of making higher returns. High cost of
borrowing on the other hand implies low money in the hand of investors for
stock purchases. The decline in purchase of stocks will inadvertently lead to
a decline in their prices. Fluctuation in interest rates does not only affect the
investors or the stock market, it also affects the companies who carry out
their activities with borrowed funds.
 Purchasing Power Risk: Generally, inflation in the economy leads to
reduction in purchasing power of consumers, and variations in the expected
returns from investments are caused by loss in purchasing power. The
increase in the cost of raw materials, labour and equipment will lead to
increase in the cost of production and hence, increase in the prices of goods
and services. If the manufacturer cannot pass on the increased costs to the
consumer, it means there will be reduction in the profitability of the
business. Reduction in profitability leads to lower returns.
ITQ: What are the two types of risk?
ITA: Systematic and unsystematic risk.
2.Unsystematic Risks: These are risks which are unique and peculiar to the
business, and can therefore be controlled by the business. Unsystematic risks
can arise due to managerial inefficiency, poor machinery, liquidity (finance)
problem, disruption in the production system, labour problems, unavailability
of raw materials, change in consumer preference, etc. Unsystematic risk can be
broadly classified into:
108
a. Business Risk: an aspect of the unsystematic risks which is caused by the
business operating environment.
b. Financial Risk: an aspect of the unsystematic risk caused by the variability

of income due to capital structure of the company. The capital structure of
the company consists of equity and borrowed funds. The presence of debt
funds in the capital structure of the company can affect the payments of
dividend to be made to equity holders.
Regardless of whether a risk is systematic or unsystematic, the possible risks that

can occur in the business environments may include Finance risk, Capital risk,
Country risk, Default risk, Delivery risk, Economic risk, Exchange rate risk,
Interest rate risk, Liquidity risk, Operations risk, Payment system risk, Political
risk, Refinancing risk, Reinvestment risk, Settlement risk, Sovereign risk, and
Underwriting risk, etc.
ITQ: What is systematic risk? What are the types of systematic risk?
ITA: Systematic risks are risks caused by factors external to the business, and therefore
cannot be controlled by the business or the investor. The types of systematic risks
are: Market risk, interest rate risk and purchasing power risk.
ITQ: What is unsystematic risk? What are the types of unsystematic risk?
ITA: Unsystematic risks are risks which are unique and peculiar to the business, and can
therefore be controlled by the business. The types of unsystematic risks are:
Business risk and financial risk.
Summary
In this study session, we have discussed the concepts of Capital Market, Capital
Market & Corporate Finance and Capital Market Efficiency. Also, some lessons
109
from Capital Market History as well as Return, Risk and the Security Market Line
were discussed.

1. In capital market operation, explain capital gain and capital loss in relation
to the computation of return.
2. What do you understand by efficient market hypothesis?
3. Discuss the three forms of capital market efficiency.
4. Identify and explain the financial instruments of capital market.
5. In relation to capital market operation, explain the primary and secondary
markets.
6. What are the lessons learnt from the history of capital market?
7. How are the risk and return determined under capital market operation?
8. Define option and explain its main types.
9. What are the factors that determine option value?
10. Binomial and Black-Scholes models are used in option valuation. Explain
them, thereby bringing out clearly their similarities and differences.
11. Discuss the current problems and issues affecting the development of
capital market.
12. Analyse the relationship between risk and return.
110
References

Limited ISBN-978-81-203-3022-1.


ISBN 978-0-07-353062-8.

5. Weston, J. Fred & Brigham, F. Eugene (2002). Managerial Finance

6. Berk, J. &Demarzo, P. (2011). Corporate Finance (2th Edition). India:


8. Emery, D. R., Finnery, J. D. & Stowe, J. D. (2007). Corporate

111
9. Lawrence, J. Gitman (2000). Principle of Managerial Finance. Harper
10. Vanhorne, J. C. & John, M. Machowicz (2004). Fundamental of


The Dryden Press.

13. Ross, S.A., Wesrerfield, R.W. & Jeffrey, J (2002). Corporate Finance

15. Bodie, Z., Kane, A. & Marcus A. J. (1998). Essentials of Investment

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9.3 MODULE 3:
Financial Management Issues in Financing Decisions
Introduction
At this juncture, you are adequately exposed to the conceptual issues in corporate
finance and financial reporting. You are also acquainted with the topical issues in
the areas of investment and dividend decision of a corporate organisation. Now,
how can the organisation raise finance to invest? This Module is structured to
educate you on the financial management issues in financing decisions of
corporate organisations. Financing decision is a decision that concerns the
liabilities and stockholders’ stake in the organisation. It can also be defined as a
judgment made concerning the method of raising funds in terms of their
effectiveness, efficiency, and economy.
The Module is divided into topical issues surrounding the financing decision of
corporate organisation. We will start with structuring the capital of and the
methods of raising finance for organisation. We will look extensively on the
theories on capital structure, financial leverage and the attainment of optimal level
of capital structure by an organisation. Other issues like valuation of bonds,
shares, and investment portfolio are also covered. Globalisation has led to
businesses operating without boarder, across the globe including the issue of
finance.
Corporate organisations look for funds to finance their operations, not necessarily
within their operating environment. This is called international finance and
accords the organisations unlimited opportunities to raise finance. There are
certain issues of concern, however, including risks and other militating factors that
could make or mar an organisation’s access to the benefits of international finance.
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This Module also delves into the issue of international finance and how best to use
it for financing purposes.
9.3.1 Objectives
At the completion of this Module, you should have the capacity to:
 Determine the effective combination of debt and equity.
 Compute the value bonds, shares, and portfolio of investment.
 Understand the international financial environment, its evolution, and
methods used to manage risk in global markets.
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STUDY SESSIONS
9.3.2.1 STUDY SESSION 7: Corporate Finance and Capital Structure
Introduction
Learning Outcomes
(A) Capital Structure

(B) Theories on Capital Structure
i Net Income Theory
ii Net Operating Income Theory
iii Traditional Theory
iv Modigliani-MillerTheorem
v Pecking Order Theory
Summary

Introduction
You are welcome to this study session. In this session you will be introduced to
the Concept& Composition of Capital Structure of a Corporation, Financial
&Operating Leverage and Theory & Practice of Capital Structure.
Learning Outcomes
At the end of this study session, you should be able to:
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1. Define the Concept& Composition of Capital Structure of a
Corporation.
2. Know the Financial & Operating Leverage.
3. Discuss the Theory & Practice of Capital Structure.
(A) Capital Structure

This refers to the way an organisation is financed in terms of the combination of
debt and equity. Capital structure is defined as the mix of an organisation’s long-
term debt, common equity and preferred stock. In other words, it is how an
organisation finances its overall operations and growth by using different sources
of funds.
ITQ: What is capital structure?
ITA: This is the financing of an organisation by the combination of debt and equity.
(B) Theories on Capital Structure

a. Net Income Theory: This theory is built on the idea of increasing market
value of a firm and decreasing overall cost of capital. It advocates that debt
is cheap than equity and the capital structure of a firm should be chosen to
have more debt than equity. The argument further states that, it will be
helpful to increase the market value of a firm and decrease the overall cost
of capital, when more debt is used to finance a firm.
b. Net Operating Income Theory: This theory rejects the idea of increasing
leverage as suggested under Net Income Theory. The theory advocates that
at each and every level of capital structure, market value of a firm will be
same. The belief is that a change in capital structure does not affect the
overall cost of capital and market value of a firm.
c. Traditional Theory: This theory combines the Net Income and Net
Operating Income theories. It advocates that as more debt are used to
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finance a firm, the cost of capital will continue to decline until an optimal
level of capital structure with the least cost of capital is attained, after
which additional debt will increase the overall cost of capital.
d. Modigliani-MillerTheorem (M&M): This is a financial theory given by
Modigliani and Miller which claims that a firm's market value depends on
its future earning power, and risk of underlying assets and not on financing
decisions and dividend declaration.
e. Pecking Order Theory: This theory states that companies prioritise their
sources of financing in accordance with the law of least effort or least
resistance and preferring to raise equity as a financing means of last resort.
ITQ: Mention the theories on capital structure.
ITA: (a) Net income theory (b) Net operating theory (c) Tradition theory (d) Modigliani-
Miller theorem (M&M) (e) Pecking Order Theory.
Summary
In this study session, we have discussed the Concept &Composition of Capital

Structure of a Corporation, Financial & Operating Leverage as well as the Theory
& Practice of Capital Structure.

1. Define capital structure and explain its composition.
2. Discuss the relevance and irrelevance theories of capital structure.
3. What is financial leverage? How can it be measured?
4. What is the relationship between financial leverage and shareholders’ risk
and return?
5. What is trade-off theory under capital structure?
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6. Explain Pecking Order theory.
7. Discuss the elements of capital structure.
8. How can the Weighted Average Cost of Capital (WACC) be computed?
9. What is the relationship between beta, cost of capital and capital structure?
10. What is the difference between offer for sale and offer for subscription?
11. What are the procedures in selling securities to the public?
12. What are the costs of issuing securities?
13. Explain the terms; rights issue, Initial Public Offering (IPO), and
underwriting as they relate to raising capital.
14. Discuss the risk in having high operating leverage.
15. What is the theoretical conception of optimal capital structure?
References

Limited ISBN-978-81-203-3022-1.

118
ISBN 978-0-07-353062-8.








The Dryden Press.
119


120
Corporate Finance and Valuation
Introduction
Learning Outcomes
(A) Company Valuation
(B) Interest Rates and Bond Valuation
(C) Types of Bonds
i Secured/Unsecured Bonds
ii Perpetual/Redeemable Bonds
iii Fixed Interest Bonds/Floating Interest Bonds:
iv Zero Coupon Bonds
(D) Bond Valuation

(E) Stock Valuation
I. Valuation of Shares through Price-earnings (P/E) Ratio
II. Valuation of Stock through Dividend discounting method
a) Single Period Valuation
b) Multiple Period Valuations
III. Constant Growth Rate of Dividend
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(F) Investment Portfolio
(G) Portfolio Theory
Summary
(H) Discussion Questions
Introduction
You are welcome to this study session. In this study session, you will get to
understand the concept of Value & Return, Valuation of Bonds & Shares as well as
the Portfolio Theory and Assets Pricing Models. Also, Beta Estimation and the
Cost of Equity will be discussed.
Learning Outcomes
At the end of this study session, you should be able to:
1. Understand the concept ofValue & Return.

2. Explain the Valuation of Bonds & Shares.
3. Discuss the Portfolio Theory and Assets Pricing Models.
4. Explain Beta Estimation and the Cost of Equity.
(A) Company Valuation

The process of determining the value of an asset is called valuation. There are
various processes for doing the same thing when it applies to the valuation of a
company or business. It refers to the process and a set of procedures that are used
to estimate the economic value of the business owners’ interest in the business.
The concept is usually used by financial market participants to determine the price
they are willing to pay or receive, effect a sale of a business and to resolve
disputes.
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ITQ: What is the meaning of valuation?
ITA: Valuation is when you ascertain the value of an asset.
(B) Interest Rates and Bond Valuation

Interest rate is a value charged by lenders as compensation for the loss of the
asset’s use. But in the case of money lent, it is a value gained by the lender of such
money to others as against what he ought to have earned himself if he were to
invest the funds instead of lending them out. In other words, the allocation of
funds in an economy happens primarily on the basis of price, expressed in terms
of expected return.
It is compensation that a supplier of funds expects and a user of funds must pay in
return. Interest rates are normally applied to debt instruments such as bonds and
bank loan facilities.
Bonds are debt obligations with long-term maturities issued by governments and
large corporations. They are securities that pay a stated amount of interest to the
investor, period after period, until it is finally retired by the issuer. Bond valuation
can be compared to the valuation of capital budgeting project, businesses and/or
real estate.
A bond has some basic features, namely: a face value, maturity period, fixed
interest (known as coupon payment) and a redemption value. An important thing
to note about a bond is that, its value depends largely on the prevailing rate of
interest in the economy. Bonds and interest rates have an inverse relationship:a
rise in interest rate will force the value of the bond to decline, while a reduction in
interest rate has the consequence of making the value of the bond to rise.
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To demonstrate the reason behind the inverse relationship, you will need to
understand the concept of yield. Bond yield is the amount of return that an
investor will realise on a bond. It is important to remember that a bond yield to
maturity is inverse to its price. As the bond's price increases, its yield to maturity
falls.
For example, if you purchased a bond with a par (face) value of N100, and a 10
percent annual coupon rate, its yield would be the coupon rate divided by the par
value (10/100 = 0.10), or 10 percent. If the bond price falls to N90, the yield
would become (10/90 = 0.11) or 11 percent. The bond holder would still receive
the same amount of interest, because the coupon rate is based on the bond’s par
value. As you can see, the yield increased because the bond's price fell.
ITQ: What is a bond?
ITA:Bonds are debt obligations with long-term maturities issued by governments and
large corporations.
(C) Types of Bonds
a) Secured/Unsecured Bonds: A secured bond is when the bond is secured on

the real asset of the issuer. Unsecured bond on the other hand is when the
bond is issued mainly on the name and fame of the issuer without any
backing for the fall back option of the investor.
b) Perpetual/Redeemable Bonds: Bonds that do not or never mature at all are
called perpetual bonds. The only advantage to the investor is that, perpetual
bonds carry high interest rate which makes them attractive to investors.
Redeemable bonds on the other hand are bonds that are expected to be
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repaid (redeemed) after a specified period of time. They are the opposite of
perpetual bonds.
c) Fixed Interest Bonds/Floating Interest Bonds: Fixed interest bonds do
carry fixed interest on their face value and investors must be paid the fixed
interest on the bonds regardless of the financial standing of the issuer.
Floating interest bonds on the other hand are bonds issued with the
understanding that interest will not be fixed, and can be up or down
depending on the financial disposition of the issuer or the prevailing interest
rate in the economy.
d) Zero Coupon Bonds: These bonds do not carry or bear interest but are sold
at a discount initially and at maturity, the investor is paid the full face value
of the bond.
ITQ: Mention the types of bonds.
ITA: (a) secured/unsecured bonds (b) perpetual/redeemable bonds (c) fixed

interest rate/floating bonds (d) zero coupon bonds.
(D) Bond Valuation
If an investor buys a Bond and sells it after holding it for a period, the Return from
that Bond can be calculated as follows:
Holding period return = x 100
Note: Price gain is the difference between the selling price of the Bond and the
initial purchase price. The Coupon payment is the amount paid as interest.
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Example
Supposed an investor invested in a bond of N9,000 face-value with coupon

payment of N1,000 per annum, and decided to sell the bond at the rate of N10,000
at the end of the year, what is the holding period return for this bond?
126
Solution
Price of Bond = N9,000

Price Sold = N1,0000
Price Gained = 10,000 – 9,000 = 1,000
Coupon Payment = 1,000
= x 100 = 0.22 x 100

Holding period return = 22%
If on the other hand as in the previous example, the Bond was sold for N7,500,
what is the Holding period Return?

Holding period return =1,500 + 1.000 X 100
9,000
= 500 X 100 = 5.5%
9,000
The Return on the Bond is now 5.5%
Note: the Holding Period Return for the Bond is the effective Yield, while current
yield is calculated as follows:
Current Yield = Annual Coupon Payment

Current Market Price
Current Yield = 1,000= 10%
10,000
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Yield to Maturity of a Bond:
The present value method can be used to find the Yield to maturity of a Bond. This
can be done with the help of the following formula:
PVB = + + +……
(E) Stock Valuation

Investors do conduct valuations of stocks when making investment decisions
whether on common or preferred stocks. They usually consider investing in
undervalued stocks and selling their holdings of stocks that they consider to be
overvalued.
There are different methods of stock valuation such as; price-earnings (PE)
method, dividend discount model, free cash flow model, capital asset pricing
model, and arbitrage pricing model. Some of the methods of valuing stocks will
be illustrated below:
IV. Valuation of Shares through Price-earnings (P/E) Ratio

Price-earnings (P/E) ratio can also be a useful tool for valuing shares of a
company. The P/E ratio describes the relationship between the share price of a
company and its earnings per share, and can be calculated by dividing the share
price of the company by its earnings per share.
Formula:
Price-earnings (P/E) Ratio = Market Price per Share

Earnings per Share
Earnings per Share =Net Profit

Number of Shares
128
The P/E ratio is an important tool and also a more commonly used method of
valuing the shares of a company at the Stock Exchange. The method has the
relative advantage of analysing stocks quickly and compares their prices than the
Discounting model. Stock Analysts rely more on the P/E ratio to assess the earning
power of a stock at the stock market.
Example:
Supposed the following data were extracted from the audited financial Statement
of ABU Departmental Store for year ended 31st December, 2013.
Price of Ordinary shares per unit 60K
Net Profit for the year ended 31st Dec.13, N2.5Million
Number of shares issued 5Million
You are required to calculate the:
(i) Earnings per Share

(ii) Price-earnings (P/E) Ratio
(i) Earnings per Share =Net Profit
Number of Shares
N2, 500,000
= 5,000,000
Earnings per Share = 50K

(ii) Price-earnings (P/E) Ratio = Market Price per Share
Earnings per Share
= 60K
50K
Price-earnings (P/E) Ratio = 1.2
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The above shows a good P/E ratio for ABU Departmental Store because the
earnings are well over 80% of the price of the share, i.e. 50/60 × 100 = 83-3%.
V. Valuation of Stock through Dividend discounting method

The valuation of ordinary or equity shares can also be done on the basis of
dividend discounting. To do this, we need to consider whether the shares are held
by the investor for one single period or a multiple period.
c) Single Period Valuation

In the single period valuation, the investor is assumed to buy shares and hold same
for a single period of one year, and will sell the share at the end of the first year.
During this period, the investor will receive dividend for one year (D1), and can
also sell the shares at the end of the year possibly at a price (P1). In this respect,
the value of that share can be determined as follows:
P0 = D 1 + P1
(1 + r) (1 + r)
If we factor out 1 from the above, we have:
(1+r)
P0 =
Where P0 = Present value of the Stock
P1 = End Period Price
D1 = Dividend one period
r = Required Rate of Return
Example
Let us assume that Jameelah intends to buy shares of a company to hold for a
single period of one year. Assuming that she expects a dividend of N2 per share
130
during the holding period, and can sell the share at an expected price of N21 at the
end of year one. If her required rate of return is 15%, what is the value of the
share?
Solution
P1 = N21 D1 = N2
r= = 0.15
P0 =
P0 = = = 20
P0 = 20
The present value of the share is N20:00
d) Multiple Period Valuations

In the multiple period valuation approach, the investor is expected to buy shares
and hold them for a fairly long period of time – two or more years – and will sell
the shares at his own desired time. During the period of holding the shares, he will
be receiving dividend for each year, and at the end, can sell the shares at a given
price. In this respect, the value of the share under multi-period holding can be
determined as follows:
P0 = + + ...... +
Or P0 =
Where:
Di= Dividend for any period

131
R= Required Rate of Return
Pn= Price of Share at the end of the period
Example 1
Supposed a company has made an investment in a stock which it expected to hold

for the next five years. The expected dividend from the stock for the five-year
period is:
Year 1 2 3 4 5
Dividend 2 2.10 2.21 2.32 2.43

N’
If the company expects to sell this stock at the rate of N25.53 at the end of year
five, what is the present value assuming the required rate of return is 15%
Solution:
P0 = + + ...... +
P0 = + + + +
P0 = 1.74 + 1.59 + 1.45 + 1.33 + 1.21 + 12.70 = 20.02
P0 = N20.02
132
Example 2
A company invested in stock A which it expected to hold for a period of three

years. If dividend on the stock will be paid at the rate of N4 per unit annually for
three years, what will be the value of the stock if the required rate of return is
10%? Assume that the share can be sold at the rate of N60 at the end of year 3.
Solution:
P0 = + + +
P0 = + +
P0 = 3.64 + 3.31 + 3.01 + 45.08 = 55.04
P0 = N55
VI. Constant Growth Rate of Dividend

Where the dividend on the share of a company is expected to grow at a constant
rate into an indefinite future, the value of the share of such company can be
determined by the following formula:
P0 =
Where D1 = Dividend
r = rate of return
g = Growth rate
Example
Let us assume an investor who invested in a stock which will pay a

dividend of N3.50 per share at the end of the year. The dividend in
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subsequent years is expected to grow at the rate of 10% per annum. If the
required rate of return is 15%, what is the present value of the share?
Solution:
P0 =
P0 = =
P0 = N70
Valuation of Preference shares
Preference shares can be issued with maturity or without maturity period. The
holders of preference shares receive fixed interest income on their investments and
also have priority of claim over equity stock holders.
For preference shares with maturity period, the value of the shares is determined
by the following formula:
Pf0 = PD1 + PD2 + PD3 + PD4 ... + PDn+ Pfn

(1+r)1 (1+r)2(1+r)3 (1+r)4(1+ r)n
The above can be reduced to:

n
Pf0 = ∑ PDi
i=1 (1+r)n
Where:
Pf0 = Present Value of Preferred Stock
134
PDi = Preferred Dividend at any one period
Pfn = Price of Preferred Stock at maturity
r = Required Rate of Return
n = Number of periods
If on the other hand, a Preferred stock does not have maturity period, its value can
be calculated as follows:
Pf0 = PDi
Example
Assuming that Hotel Seventeen Limited is considering the purchase of a 5-year

preference shares with a par value of N40 per share and a dividend pay-out rate of
10% per annum. If the redemption value of the shares at the end of five years is
N60 and Hotel Seventeen requires 15% return on its investment, determine the
present value of the preference share:
The present value of the preference share can be calculated as follows:
Dividend on preference share will be N4 per annum, i.e., 10% of the par value of
N40.
Rate= 15%
n = 5 years
Pfn = N60
Pf0 =
Pf0 = PD1 + PD2 + PD3 + PD4 + PD5
(1+r)1 (1+r)2 (1+r)3 (1+r)4 ( 1+ r )5
Pf0 = 4 + 4 + 4 + 4 + 4
135
(1+0.15)1 (1+0.15)2 (1+0.15)3 (1+0.15)4 (1+0.15)5
Pf0 = 4 + 4 + 4 + 4 + 4
(1.15) (1.32) (1.52) (1.75) (2.01)
Pf0=3.45+ 3.03 +2.63 + 2.29 + 1.99
Pf0 = N13.39
Messrs Hotel Seventeen should pay N13.39 per unit of the Preference shares.
Example
If we are told that the Preference shares in the above example are without maturity
period, what will be the present value of the share?
Pf0 = PDi
r
Pf0 = 4
0.15
Pf0 = N26.67
If the preference shares have no maturity period, Hotel Seventeen will pay N26.67
per unit of preference shares now.
ITQ: What are the different methods used in stock valuation?
ITA:There are different methods of stock valuation such as: price-earnings (PE)
method, dividend discount model, free cash flow model, capital asset pricing
model, and arbitrage pricing model.
136
(F) Investment Portfolio
The word portfolio is a term used in finance to mean a collection of investment
held by an investing organisation or individual. Investment portfolio, however,
refers to investment in an assortment or range of financial assets/securities, or
other types of investment vehicles, in order to spread the risk of possible loss due
to below-expectation performance of one or a few of them. It is a strategy aimed
at reducing the possible risk of losing certain amount investment on only one
security/financial asset by spreading the investment amount on a list of financial
assets or securities.
ITQ: What is portfolio in finance?
ITA: In finance, a portfolio is a collection of investments held by Investment Company,

(G) Portfolio Theory
hedge fund, financial institution or individual.
This is considered as part of modern portfolio theory and its main assumption is
that investors fanatically try to minimise risk, while striving for the highest return
possible. It is normally called optimal portfolio theory which states that,
investors will act rationally in terms of always making decisions that are aimed at
maximising their return for their acceptable level of risk. Optimal portfolio theory
was first used by Harry Markowitz in his article “Portfolio Selection” published in
the Journal of Financein 1952, where heintroduced the analysis of the portfolios
of investments. The new approach presented in this article included portfolio
formation by considering the expected rate of return and risk of individual stocks
and, crucially, their interrelationship as measured by correlation.
137
Prior to this, investor would examine investments individually, build up portfolios
of attractive stocks, and not consider how they related to each other. Markowitz
showed how it might be possible to better off these simplistic portfolios by taking
into account the correlation between the returns on these stocks. The
diversification plays a very important role in the modern portfolio theory.
Markowitz approach is viewed as a single period approach: at the beginning of the
period the investor must make a decision in what particular securities to invest and
hold these securities until the end of the period. Because a portfolio is a collection
of securities, this decision is equivalent to selecting an optimal portfolio from a set
of possible portfolios.
ITQ: What is the meaning of optimal portfolio?
ITA: Optimal portfolio was used by Harry Markowitz in 1952 and it shows that it is
possible for different portfolios to have varying levels of risk and return.
The term portfolio refers to combinations of securities. Portfolio theory is a theory

of finance that attempt to maximise portfolio expected return for a given amount
of risk or minimise risk for a given amount of expected return by carefully
choosing the proportions or weights of various assets. The theory assumes that,
investors are rational and financial markets are efficient. And since assets prices
are normally distributed, it defined risk as a standard deviation assets return.
138
Despite the importance of the theory in explaining investor behaviour, in recent
years, the basic assumptions of the theory has been widely criticised.
Modern portfolio theory is a mathematical formulation of a concept of

diversification in investing with the hope of selecting a collection of investment
assets that has collectively lower risk than any individually asset. By intuition, this
is possible because different types of asset usually change in value in opposite
direction.
Fundamentally, the concept of portfolio theory stresses that assets should not be
selected individually on its own merit; rather it should be on the basis of how each
asset changes in price relative to how every other asset in the portfolio changes in
prices. Investing is a trade-off between risk and expected return. The theory
explains how to select up portfolios with the highest possible expected return. The
theory is seen as a concept of diversification. It explains the best way to come up
with the best diversifying strategy. Diversification is a concept that essentially
reduces investor's exposure to individual asset risks. That is, an investor can
reduce portfolio risk of assets simply by holding combination of assets that are not
positively correlated.
Portfolio analysis is an effort to determine the future risk and return in holding
various blends of individual securities. In investment term, a portfolio can be
defined as a combination of individual securities held by an individual or
institution. It is a combination of securities in various assets. Prof. Markowitz
illustrated that when individual investment securities such as fixed income
securities and equities are combined in a portfolio,it is accurately possible to
reduce the total risk (also known as volatility) of such portfolio to a point lower
than the risk of individual investments. Markowitz found that, the variance of the
139
return on a portfolio is in actual facts a function not only of the variances but also
the co-variances between individual investments instruments and their weights in
a portfolio.

Portfolio Return
The return on a portfolio of assets is the weighted average return.
Weight for asset and is the return for asset
Note: the weight must sum to 1.
The portfolio weight for stock , denoted by is the fraction of portfolio’s wealth
held in stock that is:
Example
Musa has a portfolio of four common stock with the following expected market
values and returns:
Investment in Stocks Market Value Weight Return in %
First Bank 40,000 0.1666 8
Nestle 50,000 0.2083 20
Emcon 20,000 0.0833 15
Global Oil and Gas 100,000 0.4166 9
GTB 30,000 0.1250 12
Total 240,000 1

140
0.1666 8 0.2083 20 0.0833 15 0.4166 9 0.1250 12
11.999%
Standard Deviation: Two Asset Case

2
√ 2
Standard Deviation: Three Asset Case

√ 2 2 2
Note: Variance-covariance matrix can be used to extend the formula to N number

of assets.
Covariance for asset i and j can be computed using the formula:
Covariance and correlation measure the degree to which a pair of return tends to
move together. A positive covariance or correlation between two returns means
that the two returns tend to move together, while a negative covariance or
correlation means that the returns tend to move in opposite direction.
141
Computing portfolio return
Example
A N10,000,000 portfolio consists of N3,000,000 of GTB stock and N7,000,000 of
Nestle stock. If GTB has a return of 15 percent and Nestle has a return of 5
percent, determine the portfolio return using ratio method and portfolio weighted
average method.
Using the ratio method

P D P
Total Return
P
Return on GTB = 3,450,000
Return on Nestle = 7,350,000
The portfolio end of the period value is N10,800,000
10,800,000 10,000,000
Total Return
10,000,000
800,000
Return 8%
10,000,000
Return on GTB = 3,450,000

Return on Nestle = 7,350,000
The portfolio end of the period value is N10,800,000
That is 8%
142
Using the weighted average method
0.3 0.15 0.7 0.05 %
Summary
In this study session, we have discussed the concepts of Value & Return, Valuation
of Bonds & Shares as well as the Portfolio Theory and Assets Pricing Models.
Also, Beta Estimation and the Cost of Equity have been discussed.
(H) Discussion Questions

1. What do you understand by the concept of value and return in corporate
financing?
2. How can the future value of a financing source be determined?
3. How can the present value of financial arrangement be determined?
4. What are the procedures for valuing bonds?
5. What are the procedures for valuing shares?
6. Explain portfolio theory.
7. How can the risk and return of a portfolio be determined?
8. What is an optimal or efficient portfolio?
9. How can a beta of a portfolio be determined?
10. Discuss CAPM as applied in portfolio analysis.
11. Discuss the relationship between value and return of common stocks.
12. What are the issues in estimating the cost of capital?
13. What is the best method to determine the cost of equity of firms? Discuss.
14. Analyse the financial problems facing business organisations.
15. Discuss the issues in beta estimation.
143
References

Limited ISBN-978-81-203-3022-1.


ISBN 978-0-07-353062-8.



144




The Dryden Press.



145
Corporate Restructuring and Combination
Introduction
Learning Outcomes
(A) Corporate restructuring

(B) Ownership Restructuring:
(C) Business Restructuring:
(D) Asset Restructuring:
Summary
(D) Discussion Questions

Introduction
You are welcome to another study session. In this study session you will be
introduced to the concept of Business Restructuring & Combination, Value
Creation through Mergers & Acquisitions as well as Tender Offer and Hostile
Takeover.
Learning Outcomes
In this study session, you should be able to:
1. Define the concept of Business Restructuring & Combination.

2. Discuss theValue Creation through Mergers & Acquisitions.
3. Explain Tender Offer and Hostile Takeover.
146
(A) Corporate restructuring
Corporate restructuring refers to the changes in ownership, business mix, asset
mix, and alliance with a view to enhance the shareholder value. A company
should continuously evaluate its portfolio of businesses, capital mix and
ownership and asset arrangement to find opportunities for increasing the
shareholder value.
However, it should focus on asset utilisation and profitable investment

opportunities, and recognize a divest less profitable or los making businesses/
products. The company may however enhance value through capital restructuring,
design innovative securities that help to reduce cost of capital.
Corporate restructuring may involve the following:
(i) Ownership Restructuring: A company can affect ownership

restructuring through mergers and acquisitions, leveraged buyouts,
buyback of shares, spin offs, joint ventures and strategic alliances.
(ii) Business Restructuring: This involves the reorganization of
business unit or divisions. It includes diversification into new
business, outsourcing, divestment, brand acquisition etc.
(iii) Asset Restructuring: This involves the acquisition or sale of
assets and their ownership structure. Examples of asset
restructuring are sale and lease back of asset, securitisation of
debt, receivable factoring etc.
ITQ: What is corporate restructuring?
ITA: Corporate restructuring refers to the changes in ownership, business mix,

asset mix, and alliance with a view to enhance the shareholder value
147
However, as earlier mentioned, the basic purpose of corporate
restructuring is to enhance the shareholders’ value. The focus here is on
mergers and acquisitions, leveraged buyouts and divestments.
Mergers and acquisitions (M&A) is a common term used to refer to the

consolidation of companies. A merger is a combination of two companies to
form a new company, while an acquisition is the purchase of one company by
another in which no new company is formed.
Divestures on the other hand is a reduction of some kind in the assets of a

company or outright sale of an existing line of business of a company for the
purpose of raising cash to fund other operations.
A Leveraged Buy-Out (LBO) is the acquisition of another company using

borrowed funds so as to meet the cost of such acquisition. In most LBO cases,
the assets of the company being acquired are used as collateral for the loan
obtained.
ITQ: What are the types of corporate restructuring?
ITA: Ownership restructuring, Business Restructuring and Asset Restructuring.
Summary
In this study session, we have discussed the concepts of corporate Restructuring

with ownership restructuring which has to do with mergers and acquisitions,
leverage buyouts and divestment.
(D) Discussion Questions

1. What is corporate restructuring?
2. What is business combination?
148
3. State and discuss the types of business combination.
4. What do you understand by demerger?
5. What are the motives and benefits of mergers and acquisitions?
6. Discuss the issue of value creation through mergers and acquisitions.
7. Discuss the DCF as an approach to the valuation under mergers and
acquisitions.
8. What are the factors to be considered in financing a merger?
9. Discuss the significance of P/E ratio and EPS analysis in merger
negotiations.
10. What are tender offer and hostile takeover under business combination?
11. "Merger can be a risky business". Discuss this assertion.
12. What are the problems associated with financing a merger?
References
Limited ISBN-978-81-203-3022-1.

Delhi: Vikas Publishing House, India.
149
ISBN 978-0-07-353062-8.







150
The Dryden Press.



151
International Corporate Finance
Introduction
Learning Outcomes
(A) International Finance
(B) Global Market Risks
(C) Derivatives
(D) Foreign Exchange Market
Determinants of Foreign Exchange Rates
Summary
(E) Discussion Questions
Introduction
You are welcome to another study session. In this study session, you will
understand the Concept of International Finance, the Foreign Exchange Market
and International Capital Investment Analysis. Also, Political Risk of Foreign
Investment as well as Financing International Operations will be discussed.
Learning Outcomes
In this study session, you will be able to:
1. Explain the Concept of International Finance.

2. Discuss the Foreign Exchange Market.
152
3. Discuss the International Capital Investment Analysis.
4. Explain the Political Risk of Foreign Investment.
5. Discuss the Financing of International Operations.
(A) International Finance

Gandolfo (2002) defines international finance as a field of financial management
that examines the dynamics of the global financial system, international monetary
systems, balance of payments, exchange rates, foreign direct investment, and how
these topics relate to international trade.
ITQ: What is international finance?
ITA: International finance can be defined as the field of finance which study the
dynamics of financial system globally.
(B) Global Market Risks

Global market risk is defined as the possibility of loss caused by some
unfavourable or undesirable event in international finance.
(C) Derivatives
According to the Office of the Comptroller of the Currency, U.S. Department of
Treasury, a derivative is a financial contract whose value is derived from the
performance of some underlying market factors, such as interest rates, currency
exchange rates, and commodity, credit, or equity prices. The Department further
explained derivative transactions to include an assortment of financial contracts,
including structured debt obligations and deposits, swaps, futures, options, caps,
floors, collars, forwards, and various combinations thereof.
153
ITQ: Define derivatives.
ITA: These are the instruments of financial contract whose value is derived from
another asset which is the underlying assets such as interest rate, currency
exchange rate, commodity, credit or equity prices. Examples of derivative
instruments are forwards, futures, swaps and options, and so on.
(D) Foreign Exchange Market

Different countries have different currencies. International economic transactions
require the exchange of one country’s currency for another. The foreign exchange
(forex) market is the market where the currency of one country is converted for
the currency of another country.
Determinants of Foreign Exchange Rates
 Inflation Rates
 Interest Rates
 Balance of Payment Surpluses and Deficits
 International Reserves
Summary
In this study session, we have discussed the concepts of International Finance and
the Foreign Exchange Market.
(E) Discussion Questions

1. What do you understand by the concept of international finance?
2. How does international finance differ from domestic finance?
3. Identify and discuss key terminologies used in international finance.
4. Discuss the operation of foreign exchange market.
154
5. What do you understand by international parity relationships?
6. What are the risks associated with foreign exchange? How can they be
hedged?
7. What are the issues in and procedures for international capital investment
analysis?
8. Discuss the political risk of foreign investment.
9. How can a corporation finance its international operations?
10. Your company decided to open an overseas branch in Northern Nigeria.
What are the risks associated with that decision and how can they be
hedged?
11. Discuss the issues in international corporate finance.
12. Examine and discuss the international parity relationships.
References

Limited ISBN-978-81-203-3022-1.


ISBN 978-0-07-353062-8.
155







The Dryden Press.

156


157
11.0 FURTHER READINGS

Limited ISBN-978-81-203-3022-1.


ISBN 978-0-07-353062-8.





158


The Dryden Press.



159
12.0 GLOSSARY
Terms Definition/Description
Average Annual The arithmetic mean (average) of the growth of investment
Growth Rate value (portfolio value), over a period of years, to yield a
(AAGR) particular rate that will give growth information at first glance.
Average Annual The percentile metric used to measure historical returns on an
Return (AAR) investment or portfolio and to evaluate the quality of potential
investments.
Abandonment This is the liquidation value of a project. In other words, if the
Value project were to be liquidated at this very instant, at this very
state of progress, the amount earned on its sale is termed as the
abandonment value of the project.
Absolute Return This is an assets result or performance, irrespective of any
comparisons with other assets in the same asset class.
Accounting Noise When the financial situation of a firm is made to look better or
worse than it actually is, by twisting the GAAP (Generally
Accepted Accounting Principles) rules, it is known as
accounting noise.
Across the Board When all the stocks, in all the diverse sectors, move in one
direction together, due to a trend or movement, it is termed as an
across the board bull or bear run.
Active Bond When a bond is traded with a relatively high frequency and in
relatively higher volumes, the bond is known as an active bond.
Active When investments are undertaken with the specific objectives
Management that they should earn higher return than the set benchmark, the
investing process is termed as active management.
Angel Bond Investment grade bonds that pay lower interest rates because the
issuing companies have a high credit rating are termed as angel
bonds.
Annuity Investment that grows at a particular interest and pays out
amortised payments over a certain period after the investment
period are termed annuities.
Bankruptcy The high risk high interest rate financing undertaken by a
Financing company while under a Chapter 11 Bankruptcy process is
160
termed bankruptcy financing.
Bonus Share When a company decides to allot additional shares to already
existing shareholders, instead of a dividend pay-out, it is termed
as a bonus share issue.
Bottom Fisher A bottom fisher is an investor who shops for bargain stocks i.e.,
the stocks that have seen a significant price drop in recent times.
Bracket Creep This is the term used to refer to an increase in income taxes
without any increase in real incomes, because of inflation.
Calculation Agent A calculation agent is the party that calculates the value of a
derivative. In case of a swap agreement the calculation agent
calculates the amount owed. If two or more calculation agents
are sharing responsibility, they are called co-calculation agents.
Call Ratio Back It is a strategic investment plan wherein, various options are
Spread combined in order to have minimum loss potential and mixed
profit potential.
Capital Capital is a vague term that usually refers to the financial
resources and assets of a company including the likes of land
and buildings and plant and machinery.
Capital Note These are the fixed income products that companies issue in lieu
of short-term debt. These are generally unsecured debts and the
company's credit rating helps in backing these notes.
Carried Interest Without contributing any initial funds, the general partners of
private equities and hedge funds receive a share of the profits as
compensation. This amount is known as the carried interest.
Carrying Charge There are certain costs to be incurred while holding a financial
instrument. These charges usually include insurance, storage
costs and other related costs. The cost associated with holding a
financial instrument is known as carrying charge.
Casino Finance Any strategy adopted for investment that is seen to carry high
risk is known as casino finance.
Chastity Bond It is a bond that acts as a discouraging agent for unwanted
takeovers. Immediately after the takeover, the new company will
be forced to pay the bondholders, as the chastity bond matures
when a takeover occurs.
Convertible A debenture that can be converted into any other asset at some
161
Debenture point of time is called a convertible debenture.
Corporate Finance Any activity or task that deals with the financial and monetary
dimension of a company is called corporate finance. Mergers
and acquisitions to procurement of raw materials can all be
included under corporate finance.
Corporate Tax It is a tax or a levy instilled upon a company, and the amount of
the tax will depend on the levels of profit achieved by the firm.
Credit Crunch Credit crunch refers to a financial scenario wherein investment
capital becomes very difficult to obtain. The price of debt
products rises up considerably as the banks and lenders become
very cautious and conservative.
Discounted Cash Discounted Cash Flow is a valuation method used to estimate
Flow (DCF) the profitability of a particular investment option. DCF analysis
uses future free cash flow projections and discounts them, using
weighted average cost of capital, to get the present value used to
analyse the competence of investment.
DDM It is a process to value the price of a stock using estimated
dividends and discounting them back to the current value. The
stock is considered to be undervalued if the DDM value is
higher than the current trading value of the shares. It can be
calculated as: Value of Stock = Dividend Per Share/difference of
Discount Rate and Dividend Growth Rate.
Dead Cat Bounce It means a short-term or temporary recovery from a long time
decline or bear market, after which the market continues to fall.
Death Spiral It is a type of loan given to the company by the investors in
exchange for convertible debt. The original shareholders might
lose the control on the company in this case. Convertible debt is
like convertible bonds that allow investors to convert bonds into
stocks at a rate lower to the current market rate.
Debt Equity Ratio Debt equity ratio is the measurement of the company's financial
position which is calculated by dividing the total liabilities and
the shareholder's equity. It estimates or measures the proportion
of debt and equity the company is using, for financing its assets.
Earnings Retention Setting aside a percentage of net earnings to be reinvested in the
business as opposed to being used to pay out dividends is called
earnings retention.
162
Equity Income Income that is earned through investments in stocks is termed as
equity income. In the mutual funds context, equity incomes are
incomes earned from investments in high quality companies
with a history of rich and reliable dividend distributions.
Equivalent Annual A cost that is used to evaluate projects with different life spans,
Cost equivalent annual cost is the present value of all costs of a
project divided by the annuity factor for the project life.
ESOP Employee Stock Ownership Plans or ESOPs are the employee
benefit plans that offer the employer company's stocks to
employees to keep them focused on their company and generate
an interest in them to keep the company's stock value
appreciating.
Estate Freeze When an estate owner transfers his stock to a company in return
for preferred shares, with the aim to circumvent tax
consequences, the asset management strategy is termed as an
estate freeze.
Exit Strategy These are the strategies or methods to pull out investment from a
certain project.
Fair Market Value The fair price that any asset would fetch in the market place
considering that all parties have reasonable knowledge of the
asset and a reasonable period is taken for the transaction
completion, is termed as that asset's fair market value.
Hedge Hedge means to invest in a low risk investment option so that
the risk of adverse price movement for a high risk asset is
reduced.
Holding Period A holding period refers to the expected amount of time for
which an investor holds on to an investment.
Hot Money Hot money is the money which flows between the financial
markets regularly in the search of the highest short-term interest
rates.
Inflation Inflation is the increase in the prices of goods in a country. It
also represents the fall in the purchasing power of a currency.
Key Rate Duration Key rate duration is the measure of portfolio or security
sensitivity. It basically measures the value of a portfolio or a
security's sensitivity in relation to a 1% change in the yield for a
given maturity, while holding all other maturities constant.
163
M&M - This is a financial theory given by Modigliani and Miller which
Modigliani-Miller claims that a firm's market value depends on its future earning
Theorem power and risk of underlying assets and not on financing
decisions and dividend declaration.
Macaroni Defence This is a defence against takeover attempts in which the
company issues a large number of bonds on the condition of
high value redemption if the company is ever taken over. It is
also known as poison pill.
Macaulay Duration This is a specialised formula used for building up an
immunisation strategy or to measure how sensitive a bond price
is to changes in the interest rates.
Margin of Safety This is an investing principle that states that an investor should
only buy a security if the market price is significantly lower than
its intrinsic value.
Market Arbitrage Theoretically, earning a riskless profit with zero investment, by
simultaneously buying a security in one market and selling the
same in another is termed as a market arbitrage.
Market Risk This serves as the slope of the security market line (SML) and is
Premium the difference between the expected return on market portfolio
and the risk free rate.
Modern Portfolio This is a theory that gives out ways for optimal portfolio
Theory (MPT) construction to give out maximum rewards for a given market
risk level.
Naked Options Naked options are basically, options with no underlying security
positions to support them.
Negative Gearing When money is borrowed to buy an investment asset, with the
investment not making enough money to even cover the interest
expenses and other maintenance costs, it is termed as negative
gearing.
Negotiated Market A secondary market transaction where prices of the securities
traded are negotiated between the buyers and the sellers.
Net Asset Value It gives the fund value, by dividing the total value of all
(NAV) securities in the portfolio (less any liabilities) by the number of
outstanding fund shares.
Net Present Value This is an investment rule that states that, an investment can
164
Rule only be accepted if its net present value (NPV) is greater than 0.
An NPV less than 0 signify that the investment will actually
decrease shareholder's wealth instead of increasing it.
Obligation Bond This is a municipal bond with a face value higher than the value
of the asset whose mortgage it is used to secure.
Optimisation This term is used in technical analysis to signify a trading
system adjustment that makes it more efficient and effective.
Option Chain Quotations for a list of all options on one underlying security,
when bundled together, are called option chains.
Options When an option is dated for a date before the company actually
Backdating grants it, it is called options backdating.
Ordinary Annuity These signify a steady, fixed cash flow stream, at the end of each
period, over a fixed amount of time.
Original Issue The discount on par value (difference between the redemption
Discount Bond price and issue price) at the time of bond issue is termed as an
(OID Bond) original issue discount, and such a bond is called an original
issue discount bond.
OTC Options When options are traded in over-the-counter market, with
participants given the freedom to choose their characteristics,
the options thus traded are called OTC Options.
Overtrading Also known as churning, overtrading is the excessive buying
and selling of securities on an investor's behalf that a broker
does in order to increase the commissions he receives.
Overvalued As a result of an emotional buying push, if a company or stock
is valued more in the market, than the valuation that comes from
its future income earning potential or its P/E ratio, the company
or stock is said to be overvalued.
Participating The type of stock where an additional dividend based on
Preferred Stock predetermined conditions, that is paid along with the normally
specified rate that are to be received by preferred dividends, is
known as participating preferred stock. The additional dividends
are paid only to preferred shareholders, if the common
shareholders receive dividends that exceed a specified per-share
amount. The preferred stock holders also have a right to receive
the stock's purchasing price and also the pro-rata share of any
remaining proceeds that the common shareholders receive in
165
case of liquidation.
Pay-out Ratio The shareholder receiving an earning paid out in dividends is
known as pay-out ratio. The pay-out ratio is used by the
investors to determine what the company does with their
earnings. The pay-out ratio is calculated as: Pay-out Ratio =
Dividends per Share/ Earnings per Share
Perpetual The stock without a maturity date is known as perpetual
Preferred Stock preferred stock. The redemption privileges on such shares are
always provided to the issuers of perpetual stock. The dividends
are paid indefinitely on the issued perpetual preferred stocks.
Puttable Common The option given to investors by the common stock to put the
Stock stock back into the company at a predetermined rate is known as
puttable common stock.
Qualified Dividend This is a type of dividend that applies the capital gains tax rates.
The regular income tax rates are usually higher than these tax
rates.
Quarterly Earnings The quarterly filings by the public companies that include
Report earning reports like net income, earnings per share, earnings
from continuing operations and net sales, to report their
performance. The quarterly earnings report is filed before the
end of each quarter. January, April, July and October are the
months when companies usually file their quarterly earnings
report.
Quarterly Income The limited partnership shares that exist only for the purpose of
Preferred issuing preferred securities and lending the proceeds of the sales
Securities towards the parent company are known as Quarterly Income
Preferred Securities.
Random Walk This is a theory that states that stock price changes have same
Theory distribution and are independent of each other. The past trends
of a stock price or market cannot be applied in prediction of the
future trend of the stock.
Repackaging The purchase of all the public firm common stocks with a
leverage loan into private stocks by a private equity firm is
known as repackaging. The company is 'dressed up' by the
private equity firm before making it public again via an initial
public offering.
166
Return On Average The adapted version of the return on equity (ROE) where the
Equity (ROAE) shareholder's equity is changed to average shareholder's equity
is known as Return on Average Equity (ROAE).
Risk Measures The historical predictors of investment risk and volatility and the
components in the modern portfolio theory (MPT) statistical
measures are known as risk measure.
Reverse Stock Split The increase in par value of stocks or earnings per share by
reduction in the number of a corporation's shares outstanding.
The market value of the total number of shares does not change.
Rights The entitlement of stockholder's to purchase new shares issued
by the corporation at a predetermined price less than the current
market price in proportion to the number of shares already
owned is known as rights. The rights issued have a short validity
period, after which they expire.
Sales per Share The ratio of total revenue earned per share over 12 months. The
total revenue earned in a fiscal year by the weighted average of
shares outstanding for the fiscal year is used to calculate the
sales per share. It is also known as 'revenue per share'. Sales per
Share= (Total Revenue/Sales)/ Average Shares Outstanding.
Secondary The public offering as a part of liquidity when shares are
Liquidity distributed to retail and institutional investors is known as
secondary liquidity. The shares are then sold off to other
interested buyers by these secondary parties.
Securities Fraud The misrepresentation of the investments by a person or
company that help investors make decisions is known as
securities fraud. False information, bad advice, withholding
information, etc. is used to misinterpret information in this type
of white collar crime.
Share Capital The cash or other considerations that help raise funds by issue of
shares is known as share capital. The share capital increases
every time the company sells new shares to public in return for
cash.
Speculative Capital The investors earmarking funds for the purpose of speculation is
known as speculative capital. Extreme volatility and a high
probability of loss is associated with speculative capital.
Split Off The stock of a subsidiary that is exchanged for shares on a
167
parent company in a type of corporate reorganisation is known
as split off.
Stock A security type which can signify the ownership in a capital and
claim on corporation's assets and earnings is known as stocks.
Takeover When a corporate company makes a bid for an acquiree, it is
known as takeover. The acquiring company makes an offer for
the outstanding shares of the targeted company that are publicly
traded.
Technical It is a condition, in which a company or a person that has
Bankruptcy defaulted on financial obligations would be declared bankrupt, if
the creditors move the court.
Tender Offer The offer of purchasing a few or all the shareholder's shares in a
corporation is known as a tender offer. The price offered is
mostly slightly higher than the market price.
Timing Risk The risk taken by an investor in buying or selling a stock based
on future price predictions is known as timing risk. The potential
beneficial movements missed, are explained under timing risk
that may occur due to an error in timing.
Turnover The number of times an asset is replaced during one financial
year is known as turnover in the books of accounting. It is also
the number of shares traded over a period of time, as the total
shares percentage in a portfolio or of an exchange is known as
turnover.
Undercapitalisation A company is said to be in undercapitalisation when it does not
have sufficient cash to conduct its business smoothly. It is also
not in a condition to pay its creditors. When a company goes
through undercapitalisation, the chances of it going bankrupt
increases.
Usury Usury is the illegal practice of lending out money at a rate
higher than that allowed by the law.
Valuation The process of determining the value of an asset is called
valuation. There are various processes for doing the same. These
processes can be subjective as well as objective.
Venture Capital The type of capital that is provided for early-stage, high-
potentialand growth companies is referred to as venture capital.
168
Warrant Coverage Warrant Coverage is an agreement between a company and its
shareholders in which the company issues warrants equal to
some percentage of the dollar amount of the shareholders
investment.
Warrant Premium Warrant premium is the premium paid for the rights associated
with a warrant.
Wasting Asset A wasting asset can be defined as a derivative security that loses
value with time.
Working Capital The difference between a company's assets and liabilities at a
point of time is referred to as the working capital. This amount
gives an idea of the company's financial health at that point of
time.
Yield The income return on an investment that is represented annually
as a percentage based on the investment cost is referred to as the
yield from that investment.
Yield to Call The yield to call is the yield of the bond or note that holds the
security until the call date. This yield remains valid if, and only
if, the security is called prior to maturity.
Zero-Coupon Bond Zero-coupon bond is also referred to as Accrual bond. The debt
security which does not pay any interest, but is traded at a
discount, such that at the maturity of the bond it renders profit.
Source: http://www.buzzle.com/articles/financial-terms-glosary-of-financial-
terms-and-definitions,html
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DISTANCE

BUAD 804: CORPORATEFINANCIAL MANAGEMENT

© 2016 Distance Learning Centre, ABU Zaria, Nigeria

First published 2016 in Nigeria.

Published and printed in Nigeria by:

Ahmadu Bello University Press Ltd.

Ahmadu Bello University,

1.0 COURSE INFORMATION

3.0 COURSE INTRODUCTION

4.0 COURSE OUTCOME AND OBJECTIVES

5.0 ACTIVITIES TO MEET COURSE OBJECTIVES

Group Assignment/Case Study Analyses

1. Study Session Discussion Questions

6.2 Grading Scale

As you work on your research in this course and throughout your

Open education resources

Other sources for open education resources

Individuals (which include OERs)

WEEK/DATE MODULE STUDY SESSIONS ACTIVITY INDIVIDUAL ASSIGNMENTS REMARKS

Visit the DLC website to

Week 8 Study Session5: 1.Study the course material of

1.Study the course material of 1. Analyse the mini case of

Week 11 1.Study the course material of 1. Select two companies from

MODULE 1– Overview and Nature of Corporate Finance, Financial

MODULE 2 – Financial Management Issues in Corporate Investment and

MODULE 3 – Financial Management Issues in FinancingDecisions

8.0 DISCUSSION FORUM

8.1 Topical Discussions

8.2 Discussion Questions

9.1 MODULE 1: Overview and Nature of Corporate Finance, Financial

Section and Subsection Headings

(A) Financial Management

ii The Modern Phase (1980s-Date):

(C) Fields of Finance

ii Securities and Investment Analysis

iii International Finance

(D) Corporate Finance and Financial Manager

(G) Scope of Finance

(H) Financial Management Functions

(I) Discussion Questions

At the end of this study session you should be able to:

1. Explain theNature of Corporate Finance and Financial Management.

Pandy (2005) defines financial management as that managerial activity which

Weston & Copeland (1998) see financial management as the aspect of

 Main Features of Financial Management

(B) Evolution of Finance

 The Transitional Phase (1940-1970s):Here, focus was on the tools of

ii. Securities and Investment Analysis: This field of finance is used by

iii. International Finance: This field of finance studies economic transactions

iv. Institutional Finance: This field of finance examines financial institutions

v. Financial Management: This field of finance deals with financial

ITQ: Finance as an academic discipline can be viewed as being made up of

ITA: Public finance, Securities and investment analysis, International Finance,

(D) Corporate Finance and Financial Manager

ITQ: Define financial management.

ITA: Financial management can be defined as the effective and efficient

management of organisational resources.

(E) Forms of Business Organisations

The three basics forms of business organisations are:

Merits of Sole Proprietorship

- Large expenses in the process of incorporation.

(G) Scope of Finance

The three most important finance activities of a business firm are:

(H) Financial Management Functions