Basics of Financial Management

Session 1: Introduction to Corporate Finance

Autumn Semester

Prof. Rohan Chinchwadkar

Shailesh J. Mehta School of Management
Is Finance a Social Science?

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What is the difference between these equations?

Newton’s Law 𝑚$ 𝑚%
of Universal 𝐹=𝐺
Gravitation 𝑟%

CAPM 𝑅! = 𝑅" + 𝛽! ∗ 𝑅# − 𝑅" + 𝜀

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Is Finance a Social Science?

Common reasons why people think finance is not a social science:

▪ Quantification: It is all about numbers and calculations

▪ Tools: It is all about excel sheets

However, at its core, finance is a social science because:

▪ People: It is a study of how people behave, think, make decisions

▪ Negotiation: People have to agree on numbers and calculations

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Finance is a social science

▪ Not a natural science: Generalizability, Falsification

▪ Models: Each model has assumptions, some are critical

▪ Pluralism: Explore multiple schools of thought

▪ Application: End-user should select relevant models

“Economics is a science of thinking in terms of models joined to the art of

choosing models which are relevant…”

Keynes (1938)

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Questions?

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About the course

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Pedagogy

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Course reading: Textbook

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Course reading: Reference Books

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Session plan (1/2)

No. Session Theme Session Title

1 Introduction to Corporate Finance

2 The Objective in Decision Making

3 Financial System: Markets and Institutions

4 Corporate Finance Investment Decision: Hurdle Rates

5 Investment Decision: Hurdle Rates

6 Investment Decision: Hurdle Rates

7 Inv Decision: Measuring Investment Returns

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Session plan (2/2)

No. Session Theme Session Title

8 Inv Decision: Measuring Investment Returns

9 Inv Decision: Measuring Investment Returns

10 Corporate Finance Financing Decision: Capital Structure

11 Dividend Decision: How much cash to return

12 Introduction to Valuation

Other Areas in
13 Understanding Money
Finance

14 Wrap Up Wrap Up and Doubt Solving

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Tentative Course Evaluation (Finance – 50 marks)

No. Component Weightage

1 End-term exam 40%

2 Individual Project 40%

3 Course Participation 20%

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Plagiarism

▪ Plagiarism in project report will attract severe penalty

and will be reported to relevant authorities

▪ To learn more about plagiarism and how to avoid it,

please visit:

https://integrity.mit.edu/handbook/what-plagiarism

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Some important things

▪ Platforms: Moodle for sharing material and announcements

▪ Unanswered Questions and Advanced Content: If some

questions remain unanswered in the session due to lack of
time or you would like to discuss advanced topics, please
email them to me at rohan@som.iitb.ac.in with the title “IITB
BTech Finance 2023 – Session # – Questions”

▪ Class Rep: Sabhya Sanchi (190020098@iitb.ac.in)

▪ Teaching Assistant: Vidit Mohan (mohan.vidit@sjmsom.in)

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Questions?

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Let our study be enlightening

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Different areas of finance

Corporate Finance

Personal Finance
Public Finance

Entrepreneurial Finance
International Finance

Behavioural Finance

Financial Institutions
Financial Markets

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Corporate Finance: First Principles

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Money makes the world go round…

▪ The old saying that it is always about the money sounds crass but in
business, it is almost always true

▪ No matter what aspect of business or investing you are talking about or in,
no matter how fuzzy or qualitative, the ultimate effect is in earnings and
cash flows

▪ Finance is therefore not just another function of business, but is the

measuring rod for all of business

▪ Finance is forward looking, not backward looking (like accounting)

Source: “Foundations of Finance” by Aswath Damodaran. | 20

 wsThe
generated
Firm: by Financial
the assets, with a limited or
Balance no role(Market
Sheet in the day-to-day
Value) running of the busine
e categorize this type of financing to be debt. Alternatively, it can offer a residual claim on t
sh flows (i.e., investors can get what is left over after the interest payments have been made) an
▪ The Firm (unit of analysis): generic term to refer to any business, large or small,
uch greater role in the operation of the business. We call this equity. Note that these definitions a
manufacturing
neral enough or service,
to cover both private private or public
firms, where debt may take the form of bank loans and equ
he owner’s own money, as well as publicly traded companies, where the firm may issue bonds
▪ Assets in accounting statements: Fixed (long-term), Current (Short-term)
se debt) and common stock (to raise equity).
Thus,
▪ atLiabilities
this stage,inweaccounting
can lay outstatements:
the financialLong-term,
balance sheet of a firm
Current, as follows:
Owner’s Equity

Assets Liabilities

Existing investments Assets Debt Fixed claim on cash flows

Generate cash flows today in Place Little or no role in
Includes long-lived (fixed) and management
short-lived (working capital) Fixed maturity
assets Tax-deductible

Expected value that will be Growth Equity Residual claim on cash flows
created by future investments Assets Significant role in
management
Perpetual lives

Source: “Applied Corporate Finance” by Aswath Damodaran, John Wiley & Sons. | 21
e will return to this framework repeatedly through this book.
 Risk,
Risk, in
in traditional
traditional terms,
terms, is
is viewed
viewed asas a
a negative
negative and
and something
something toto be
be avoided.
avoided. Webster’s
Webster’s
The main objective and three key decisions of the firm
dictionary,
dictionary, for instance, defines risk as “exposing to danger or hazard.” The Chinese symbols
for instance, defines risk as “exposing to danger or hazard.” The Chinese symbols
for
for risk,
risk, reproduced
reproduced below,
below, give
give aa much
much better
better description
description of
of risk:
risk:

M
MAXIMIZE THE VALUE OF THE
AXIMIZE THE VALUE OF THE
B USINESS (FIRM)
BUSINESS (FIRM)

The
The Investment
Investment Decision
Decision The
The Financing
Financing Decision
Decision The
The Dividend
Dividend Decision
Decision
Invest in assets that Find the right kind of debt If you cannot find
Invest in assets that Find the right kind of debt If you cannot find
earn for
for your
your firm
firm and
and the
the right investments
investments that
that make
make your
earn a a return
return greater
greater than
than right your
the minimum acceptable mix
mix of debt and equity to
of debt and equity to minimum acceptable rate,
minimum acceptable rate,
the minimum acceptable
hurdle rate fund
fund your
your operations
operations return
return the
the cash
cash to
to owners
owners
hurdle rate
of your business
of your business

The hurdle
The hurdle rate
rate The return
The return The optimal
The optimal The right
The right How
How much
much How
How you
you
should reflect should
should reflect
reflect mix of debt kind
kind of debt
of debt cash
cash you can
you can choose
choose toto
should reflect mix of debt
the riskiness of the magnitude and equity matches the return depends return cash to
the riskiness of the magnitude and equity matches the return depends return cash to
the investment and the timing maximizes
maximizes tenor of your on current the owners
the investment and the timing tenor of your on current the owners
and the mix of the cash firm value assets
assets and potential will depend
and the mix of the cash firm value and potential will depend
of debt and flows as well as investment
investment on whether
of debt and flows as well as on whether
equity
equity used
used all
all side
side effects
effects opportunities
opportunities they
they prefer
prefer
to fund it dividends or
to fund it dividends or
buybacks
buybacks

Source: “Applied Corporate Finance” by Aswath Damodaran, John Wiley & Sons. | 22
Fundamental Propositions about Corporate Finance

▪ Corporate finance has an internal consistency that flows from its choice of
maximizing firm value as the only objective function
– Principles: Risk has to be rewarded, cash flows matter more than accounting income,
markets are not easily fooled, and every decision a firm makes has an effect on its value

▪ Corporate finance must be viewed as an integrated whole, not a collection

of decisions. Investment, financing, dividend decisions affect each other.
– e.g. A firm that takes poor investments will have dividend problems (insufficient funds)
and financing problems (drop in earnings makes it difficult to meet interest expenses)

▪ Corporate finance matters to everybody. There is a corporate finance

aspect to almost every decision made by a business
– Entrepreneurs, marketing managers, corporate strategists, HR managers, IT managers
all make corporate finance decisions every day and often do not realize it
– An understanding of corporate finance will help them make better decisions

Source: “Applied Corporate Finance” by Aswath Damodaran, John Wiley & Sons. | 23
Questions?