Corporate Finance

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 This lecture

What is finance?
Corporate financial decision making
Flow of funds and corporate finance
Four absolutely critical concepts
What is Finance?

Financial Assets &

Capital Markets
 What is a Financial Asset or ‘Security’?

Claim to a series of cashflows against

some other economic unit
examples
share = claim against a company
treasury bond = claim against the government
bank account = claim against a bank
 What is a Capital Market?

Medium for issue and exchange of

financial assets
eg. a bank, the Stock Exchange, the
bond market

Means of exchanging current for future

consumption
 Corporate Financial
Decision Making

Corporate Investment Decision &

Corporate Financing Decision
 Corporate Investment Decision

Concerned with what ‘real assets’ a

company should acquire
ie. ‘Projects’ a company should
undertake
involves
Asset Valuation
Capital Budgeting
 Corporate Financing Decision

Concerned with how funds should be

raised to acquire real assets
Involves
Capital structure decision
Dividend Policy
The Flow of Funds and Corporate Finance

INVESTORS

consumption
investment
decision

MARKET
CAPITAL
The Flow of Funds and Corporate Finance

INVESTORS

consumption
investment
decision

capital
structure
MARKET decision
CAPITAL financial
CORPORATIONS
asset
valuation
The Flow of Funds and Corporate Finance

INVESTORS REAL
ASSETS

consumption
investment
decision investment
decision

capital
structure
MARKET decision
CAPITAL financial
CORPORATIONS
asset
valuation
The Flow of Funds and Corporate Finance

INVESTORS REAL
ASSETS

dividend
consumption decision
investment
decision investment
decision

capital
structure
MARKET decision
CAPITAL financial
CORPORATIONS
asset
valuation
 Four Absolutely Critical Concepts

1. Objective of corporate financial decision

making
2. Asset valuation
3. Rates of return
4. ‘Markets’ section of the financial press
 1. Objective of Corporate Financial
Decision Making
maximise value of the firm
or
maximise (shareholder + debtholder)
wealth
Shareholder wealth
= Market capitalisation of shares
= issued shares x share price
 Example: Market Capitalisation of
NEWSCORP on 15 April 1998
Shares No Issued Closing Market
(m) Price Capitalisation
($) ($b)
Ordinary 1,951 10.88 21.2

Preferred 1,534 9.39 14.4

Converting 25 22.30 0.6

Total 36.2
 Concepts of Owner Wealth

Remuneration incentive schemes

Shareholder votes
Management ownership
‘agency’ problems
 2. Asset Valuation - Determining Price

Say I offered you a share and

guaranteed to buy it back from you in 1
year at $105
Say HSBC was offering 5% p.a.
What is the appropriate price (value) of
the share?
 Would you buy the share for ...

$105?
$97?
$90?
$100
= INTRINSIC VALUE
EFFECT OF RISK?
eg. 50% probability I would pay you $105
 Generalising

Future Price = Current Price x

(1+Interest Rate)

re-arranging:
Future Price
Current Price =
1+Interest Rate
 ‘Interest Rate’ also known as ...

discount rate
hurdle rate
opportunity cost of capital
required rate of return
 Asset Price Versus Value

Value = Intrinsic value of an asset

Price = amount of money an asset
changes hands for in the marketplace
Price not necessarily equal to value
 ‘Perfect Capital Markets’
- Price and Value
Needed for price = value
Key requirements
No transaction costs
but brokerage
Information free & available
but insider trading
All participants are price takers
but large trades move prices
No taxes
but stamp duty on share trades exists
 3. Rate of Return

definition:

Net Gain From Asset

Invested Capital
 Example of Return Calculation:

on Opening Closing
16 April 1998 Price Price
NCP 10.756 10.82

All Ords 2870.5 2881.4

 Calculations

NCP = (10.82-10.756)/10.756 = 0.6%

All Ords = (2881.4-2870.5)/2870.5 =
0.4%
Abnormal Return NCP = 0.2%
4. Reading the ‘Companies’ Section of a
Major Newspaper
Should be able to work out the
following:
price at which stock last traded
number of shares traded
highest price traded in last 52 weeks
lowest price traded in last 52 weeks
value of the Share Price Index
A Last Word: To Get Interested in Finance -
BUY SOME SHARES!