Corporate Finance :

Opportunities & Threats

Abhishek Mani
5th March 2010
New Delhi
 Corporate Finance in Modern Business

When contemplating all business decisions,

managers should ask:

Does this action create value for the

firm’s shareholders?

• By taking actions that generate benefits in

excess of costs, firms generate wealth for their
investors.

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 Corporate Finance Functions

External Financing

Capital Budgeting

Corporate
Finance Financial Management

Functions
Corporate Governance

Risk Management
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 The Capital Budgeting Function

Capital Budgeting – selecting the

best projects in which to invest
the resources of the firm, based
on each project’s perceived risk
and expected return.

Select investments for which the marginal benefits exceed

the marginal costs.
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 Overall Aim Of Capital Budgeting
To maximise shareholders wealth..

Projects should give a return over and above the marginal

weighted average cost of capital.

Projects can be;

• Mutually exclusive
• Independent
• Contingent

Process of Choice

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 Practical Issues with Capital Budgeting

• Projecting the cash flows

• Selection of method of capital budgeting
• Discount factor to use
• Other Issues
– Scale
– Project Live

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 Discussion: Cash Flow Issues

• Cash flows should be incremental

- include all incidental effects (redundancy)
- Do not forget working capital
- Do forget sunk costs!
- Be careful with allocated overheads

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 Discussion: Cash Flow Issues

• Uncertainty means more things can happen than

will happen.
• How do we obtain a feel for what the cash flows
are most likely to be?
• - Sensitivity Analysis
• - Scenario Analysis
• - Break Even Analysis
• - Simulation

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 Discussion: Discount Factor issues

WACC is appropriate discount factor when:

– The new project has the same risk profile as the firm
as a whole
– The new project uses the same financial structure as
the firm as a whole
• No special financing connected to the project
• Financing for the project is taxed the same way as
all other financing for the firm

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 Ideal Selection Method

Will
• Select the project that maximises shareholders
wealth
• Consider all cash flows
• Discount the cash flows at the appropriate
market determined opportunity cost of capital
• Will allow managers to consider each project
independently from all others

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 Selection Methods

• Payback

• Net Present Value (NPV)

• Internal Rate of Return (IRR)

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 Discussion: Payback Issues

• Ignores overall return

• Ignores impact of large flows

• Ignores timing of flows

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 Comparison of NPV vs. IRR

1. NPV accepts all projects with NPV > 0.

Ranking of projects is by value of NPV.
2. IRR finds the value of the discount rate that
makes NPV = 0. Project will be accepted if
IRR > k (cost of capital)
The big Q?
Will the two methods always give the same
answer?
No, unfortunately not

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 Multiple Rates of Return

• Multiple Rates of Return

NPV
400

200 IRR 15%

Discount Rate
0
IRR – 12%
- 200

- 400

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 NPV Vs IRR

Conclusion

NPV is the correct method to use

But - there are some additional issues

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 Other Issues : Scale

• How do we evaluate between projects of

different scale? If we have plenty of capital then
it is not a problem.
• Work out the Profitability Index
Present Value = PI
Cost

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 Other Issues : Project Lives

• What if projects take place over different time

scales?

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 Thank You

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