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MF-702: Corporate Finance

Presentation on-
1. Role of Corporate Finance in Business
2. Corporate Financial Planning and Business Development
3. Mergers and acquisitions- Definition, Types, Reasons, Process
4. Share valuation- Definitions, Approach, Methods
5. Bond valuation- Definitions, Features, Bond pricing

Date: 05.02.2021

Presented To- Presented By-


Mrs. Fahmida Ahmed Kazi Md. Muhaiminul Islam
Assistant Professor ID-561 EMBA (for Engineers)
FBA, USTC 23rd Batch, Final Semester
FBA, USTC
 
Role of Corporate
Finance in Business
Topic: 1
Corporate Finance

 The area of finance dealing with the sources of funding and the capital
structure of corporations.
 Every decision that a business makes has financial implications and many
decision which affect the finance of a business is a corporate finance decision
 The primary goal is to maximize or increase shareholder value
Corporate Finance

The financial Information for Assessing and Financial


analysis of pricing making better increasing the Assessing the consequences of
and product financial decisions financial value of financial payoff to production and
strategies. Human capital create and operating
Accounting and IS
Marketing OB augmenting decisions
barriers to entry
Production and
Corporate operation
Strategy management
Fundamental Rules of Corporate Finance

Corporate finance is based on two fundamental rules. All tools and techniques of
corporate finance are mere ways and means of implementing these rules.
 Rule # 1: Money today is worth more than money tomorrow
Things to consider
Inflation, Opportunity Costs
 Rule # 2: Risk free money is worth more than risky money
Things to consider
Return of risky Capital
Return on less risky Capital
 Raising capital
 Managing risk
Role of  Decision making
Research and development
Corporate

 Effective functioning
Finance in  Growth and diversification
Business  Meeting contingencies
 Short-term and long-term goals
 Replacement of assets
Raising Capital

There are several ways to raise capital. But all comes at a certain cost.
Several options for organizations to raises capital from-
 Debt Capital
 Equity capital
 Preferred stock
Decision Functions of Corporate
Finance
 Financing Decision
Decision to select the source of the fund and determine the capital structure
 Investment Decision
Decision is to deploy the funds in a manner that it yields the maximum returns for its
shareholders
 Dividend decision
Relate to the distribution of profits earned by the organization.
 Liquidity decision
Current assets management that affects a firm’s liquidity is yet another important
finances function
Focus of Corporate Finance: Maximizing the value of a Business
Agency Problem
Agency problem is a conflict of interest inherent in any relationship
where one party is expected to act in the best interest of another.

Agency problem can be categorized in the following way:


 Managers Vs Owners
 Senior  management Vs Junior management
 Creditors Vs Owners
 Owners Vs Other parties
Solving Agency Problem
 Agency problem arises when incentives or motivations present
themselves to an agent to not act in the full best interest of a
principal.
 Through regulations or by incentivizing an agent to act in accordance
with the principal's best interests, agency problems can be reduced.
 Two factors – marker forces and agency costs- serve to prevent
minimize agency problem..
 Agency Costs
 Market Force
Corporate Financial
Planning and Business
Development
Topic: 2
FINANCIAL PLANNING

 Financial planning is a process consisting of:


 Analyzing the investment and financing choices available to the business.
 Projecting the future consequences of current decisions under varying scenarios.
 Deciding which alternative to undertake.
 Later, measuring performance or results with the goals of the financial plan—the
planning and control cycle.
Financial Planning Objectives: Focusing on the Big
Picture

 Ensuring availability of funds


 Estimating the time and source of funds
 Generating capital structure
 Avoiding unnecessary funds
Financial Planning Model Elements

Elements used to form a planning model include:


 Sales forecasts
 Pro forma financial statements
 List of asset requirements
 Financial requirements
 Plug value
 Economic assumptions
Components of a Financial Planning Model

Current financial statements


Inputs • Forecasts of key variables such as sales and interest rates.

Planning Equations specifying key relationships


Model • Includes the cost of producing the forecasted sales and asset investment

Projected financial statements


Outputs Financial ratios can be derived
Financial
Planning Process
 There are 6 steps for the
financial planning process
 Collection of Optimum Funds
 Fixing the Most Appropriate Capital Structure
Importance of  Financing in Right Projects

Financial  Operational Activities


 Financial Control
Planning for  Proper Utilization of Finance
Business  Avoiding Business Shocks and Surprises
 Linking between Investment and Financing Decisions
 Coordination
 Linking Present with Future
Top 10 Types of Financial Models

 Three Statement Model


 Discounted Cash Flow (DCF) Model
 Merger Model (M&A)
 Initial Public Offering (IPO) Model
 Leveraged Buyout (LBO) Model
 Sum of the Parts Model
 Consolidation Model
 Budget Model
 Forecasting Model
 Option Pricing Model
Financial Forecasting: Percentage of
Sales Method
 A financial forecasting method that businesses use to predict their sales
growth on an annual basis. And this information to predict the amount of
financing they need to acquire to help accomplish their goal
 Once the sales growth has been determined, the company can prepare pro-
forma, or forecasted financial statements
 The two main financial statements used in this approach are the balance
sheet and the income statement.
External Financing and Growth


  The faster the firm grows external financing will be needed. The extent of
external financing will be related to the asset intensity of the firm, the
profitability of the firm and the debt/equity and dividend policies of the firm.

= New investments – Retained earnings


= Growth rates x assets – retained earnings
Mergers and Acquisitions-

Definition
Types
Reasons
Process
Topic: 3
A merger is the combination of two companies
into one where one is being absorbed by the
other. In other words, when two or more
companies are consolidated into one company.
Definition of
Merger In Finance, Merger is an act or process of
purchasing equity shares (ownership shares) of
one or more companies by a single existing
company.
Acquisition
 Acquisition is the process through which one company takes over the
controlling of another company.
 In an acquisition, a company takes at least 50% ownership of another
company, and takes controls over it.
 The company under consideration by another organization for an
acquisition is sometimes referred to as the target.
 As part of the exchange, the acquiring company often purchases the
target company's stock and other assets, which allows the acquiring
company to make decisions regarding the newly acquired assets
without the approval of the target company’s shareholders.
 Acquisitions can be paid for in cash, in the acquiring company's stock
or a combination of both.
Merger vs. Acquisition
Ways of Mergers & Acquisitions

 by purchasing assets
 by purchasing common shares
 by exchange of shares for assets
 by exchanging shares for shares
Types of Merger

Merger and
Acquisition

Market Product
Horizontal Vertical Conglomerate
extension extension
Horizontal Merger

 Merger happens between two companies with similar products,


customer and target markets
 Typically, this type of merger is done between direct competitors.
 As competition tends to be higher and the synergies and potential
gains in market share are much greater for merging firms in such an
industry.
 Examples of horizontal merger: Reebok and Adidas, the second and
third largest sports shoes makers merged in order to cut production
and distribution costs by combining their operations. Another
example would be the merge between Confinity and X.com to become
Paypal.
Vertical Merger

 A vertical merger is when one company merges with a company that


is better at one step of their process.
 A vertical merger occurs when two or more firms, operating at
different levels within an industry's supply chain, merge operations.
 The logic behind the merger is to increase synergies created by
merging firms that would be more efficient operating as one.
 Example: Shell Oil which owned more oil and gas refineries, joined
with Texaco, which owned more gas refueling stations.
Market Acquisition Merger

 A market-extension merger is a merger between companies that sell the same


products or services but that operate in different markets.
 The goal of a market-extension merger is to gain access to a larger market
and thus a bigger client or customer base.
 As for example, Facebook’s acquisition of Whatsapp for messaging service is a
type of market extension merger.
Product Acquisition Merger

 A product-extension merger is a merger between companies that sell


related products or services and that operate in the same market.
 The aim is to utilize similar distribution channels and common, or
related, production processions or supply chains.
 The merger of Pizza Hut and PepsiCo in 1977 was a Product Extension
Merger. Pizza & Soft Drink, like Pepsi, are not the same products but
cater to the same industry.
Conglomerate

 A merger between two businesses that are not related to each other.
The two companies are in completely different industries or in
different geographical areas.
 Conglomerate merger is helpful for companies to extend their
corporate territories, to gain synergy, expand their product range,
etc.
 This type of merger is mostly seen in large corporation
 In 1995, Disney purchased American Broadcasting Company (ABC),
gaining entry into ABC’s national television realm, as well as ESPN’s
extensive sports coverage.
 Economies of Scale
 Synergy
 Operating Economics

Reasons for  Diversification of products and services


 Growth
Merger and  Eliminations of Competition
Acquisition  Better Financial Planning
 Tax benefits
 Increase in value
 Economic necessity
Search for
Develop an Begin Perform
Set the M&A potential
acquisition acquisition valuation
search criteria  acquisition
strategy  planning  analysis 
targets 

Financing Closing and


M&A due Purchase and
Negotiation strategy for the integration of
diligence  sale contract 
acquisition  the acquisition 

Typical 10-step M&A deal process


Share valuation-

Definitions
Approach
Methods
Topic: 4
What is Share valuation

 Share Valuation means to find the intrinsic or true value of an


investment based only on dividends, cash flow and growth rate for a
single company. Shares are ownership in a corporation.
When is share valuation required

The valuation of shares is usually required in the following situations –


 When a business is being sold to another business;
 When a business offers its shares as security to get a loan;
 When companies undergoes mergers, demergers, acquisitions or
reconstruction;
 When a company is implementing an Employee Stock Option Plan
(ESOP); and/or
 When a company plans to convert its shares from preference to equity
shares.
Approach to Share Valuation

 Asset approach
 Income approach
 Market approach
Types of Share valuation methods


  Asset based

Value per share=

 Income based
Types of Share valuation methods
(Contd)

  Market based
 Earning yield
 Expected rate of earning = x 100
 Value per share = paid up equity capital
 Dividend yield
 Expected rate of dividend = x 100
 Demand and supply
 Bank rate
 Market players
 Dividend announcements
Factors  Management profile

affecting the  Trade cycle


 Speculation
valuation of  Political factors

share  Industrial relations


 Stability of government
 General market sentiments
 Actions of institutional investors
 Availability of credit
 Effective regulation
 Pay regular fixed dividend and ownership of
the company. It has a preference regarding
both the dividend and capital.
Preference
share &
Valuation
Stock / Common stock

Single period valuation model


Redeemable Share valuation Multi-period valuation model

Irredeemable Share Dividend Discount Model (DDM)


valuation
Redeemable Share Valuation

Single period
Valuation

Multi Period
Valuation
 Dividend Discount Model (DDM)
 Dividend discount model (Zero growth)

Irredeemable Dividend discount model (unlimited



constant growth)
Share Valuation  Dividend discount model (Limited
constant growth)
 Dividend discount model (Mixed
growth)
DDM- Zero growth

 Cash flow pattern of zero growth stock is like perpetuity. If we assume that
the dividend payments will remain constant then the formula could be
written as:
DDM- (Unlimited
constant growth)

 This model assumes that the


dividend payments are growing
each year at a constant rate of
“g” forever:
DDM- Limited Constant Growth

 This model assumes that the dividend payments are growing each year at a
constant rate of “g” for limited time
DDM- Mixed Growth

 This model assumes that the company and its dividend payments grow much
faster than the economy for a certain period at the beginning and then settles
to a constant growth rate.
 Example: Suppose that Sun Corporation’s dividends this year is Rs. 1.20 per
share and that dividends will grow at 10% per year for the next three years,
followed by a 6% annual growth rate.  The appropriate discount rate for
Corporation’s common stock is 12%. 
DDM- Mixed Growth
Bond valuation-

Definitions
Features
Bond pricing
Topic: 5
What are Bonds?

 A bond is a debt instrument that provides a periodic stream of interest payments to


investors while repaying the principal sum on a specified maturity date. A bond’s
terms and conditions are contained in a legal contract between the buyer and the
seller, known as the indenture.
 Bonds are units of corporate debt issued by companies and securitized as tradeable
assets.
 A bond is referred to as a fixed income instrument since bonds traditionally paid a
fixed interest rate (coupon) to debtholders. Variable or floating interest rates are
also now quite common.
 Bond prices are inversely correlated with interest rates: when rates go up, bond
prices fall and vice-versa.
 Bonds have maturity dates at which point the principal amount must be paid back in
full or risk default.
Main Credit Quality

Features of
Bond Time to Maturity
Each bond can be characterized by several
factors.  These include:
 Face Value
Characteristics of  Coupon Rate

Bond  Coupon
 Maturity
 Call Provisions
 Put Provisions
 Sinking Fund Provisions
Face Value

 The money amount the bond will be worth at maturity


 Also the reference amount the bond issuer uses when calculating
interest payments
Coupon Rate and Coupon

 The rate of interest the bond issuer will pay on the face value of the
bond, expressed as a percentage.
 A bond’s coupon is the dollar value of the periodic interest payment
promised to bondholders; this equals the coupon rate times the face
value of the bond.

 For example, a 5% coupon rate means that bondholders will receive


5% x $1000 face value = $50 every year. Here 5% is the coupon rate
and $50 is the coupn.
Maturity

 A bond’s maturity is the length of time until the principal is scheduled


to be repaid. 
 Occasionally a bond is issued with a much longer maturity; for
example, the Walt Disney Company issued a 100-year bond in 1993. 
 There have also been a few instances of bonds with an infinite
maturity; these bonds are known as consols. With a consol, interest is
paid forever, but the principal is never repaid.
Call and Put Provisions

 Many bonds contain a provision that enables the issuer to buy the
bond back from the bondholder at a pre-specified price prior to
maturity. This price is known as the call price.  A bond containing a
call provision is said to be callable.
 Some bonds contain a provision that enables the buyer to sell the
bond back to the issuer at a pre-specified price prior to maturity. This
price is known as the put price. A bond containing such a provision is
said to be putable.
Sinking Fund Provisions

 Some bonds are issued with a provision that requires the issuer to
repurchase a fixed percentage of the outstanding bonds each year,
regardless of the level of interest rates.
 A sinking fund reduces the possibility of default; default occurs when
a bond issuer is unable to make promised payments in a timely
manner. 
 A sinking fund reduces credit risk to bond holders.
Bond Pricing

 A bond’s price equals the present value of its expected future cash


flows. The rate of interest used to discount the bond’s cash flows is
known as the yield to maturity (YTM.)
 Pricing can be adjusted into the following categories-
A. Pricing Coupon Bonds
B. Adjusting for Semi-Annual Coupons
C. Pricing Zero Coupon Bond
A coupon-bearing bond may be priced with
the following formula:

  𝑇
𝐶 𝐹
𝑃=∑ +
𝑡 =1 (1+ 𝑦 ) ( 1+ 𝑦 )𝑇
𝑡

Pricing Coupon Where,


Bonds C = the periodic coupon payment
y = the yield to maturity (YTM)
F = the bond’s par or face value
t = time
T = the number of periods until the bond’s
maturity date
Pricing Coupon
Bonds (Contd’)
 This formula shows that the price
of a bond is the present value of
its promised cash flows.  As an
example, suppose that a bond
has a face value of $1,000, a
coupon rate of 4% and a maturity
of four years.  The bond makes
annual coupon payments.  If the
yield to maturity is 4%, the
bond’s price is determined as
follows:
Pricing Coupon Bonds (Contd’)

 These results show the following important relationship:


if y > coupon rate, P < face value
if y = coupon rate, P = face value
if y < coupon rate, P > face value
 These results also demonstrate that there is an inverse
relationship between yields and bond prices:
when yields rise, bond prices fall
when yields fall, bond prices rise
Adjusting for Semi-Annual Coupons

 For a bond that makes semi-annual coupon payments, the following


adjustments must be made to the pricing formula:
 the coupon payment is cut in half
 the yield is cut in half
 the number of periods is doubled
Adjusting for Semi-
Annual Coupons

 As an example, suppose that a


bond has a face value of $1,000,
a coupon rate of 8% and a
maturity of two years.  The bond
makes semi-annual coupon
payments, and the yield to
maturity is 6%.  The semi-annual
coupon is $40, the semi-annual
yield is 3%, and the number of
semi-annual periods is four.  The
bond’s price is determined as
follows:
Pricing Zero Coupon Bond


  A zero-coupon bond does not make any coupon payments; instead, it
is sold to investors at a discount from face value. The difference
between the price paid for the bond and the face value, known as
a capital gain, is the return to the investor.
 The pricing formula for a zero coupon bond is:
P=
 In order to be consistent with coupon-bearing bonds, where coupons
are typically made on a semi-annual basis, the yield will be divided by
2, and the number of periods will be multiplied by 2.
Pricing Zero Coupon Bond (Contd.)


  As an example, suppose that a one-year zero-coupon bond is issued
with a face value of $1,000. The discount rate for this bond is 8%.
What is the market price of this bond?  Coupons are made on a semi-
annual basis.

=$924.56

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