LECTURE 1 – SFAD

INTRODUCTION
What is finance?
 Corporate finance is an area of finance dealing with
financial decisions business enterprises make and the
tools and analysis used to make these decisions
(wikipedia.com)
 Corporate Financial Management deals with the
decisions of a firm related to investment, financing and
dividend (Veshvanath)
 To carry on business, a firm invests in tangible assets
like plant and machinery, buildings, and intangible
assets like goodwill and patents. This comprises the
investment decision
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 These assets don’t come free; one has to pay for
them, so a company needs to tap various sources of
funds including shares, bonds, bank loans. This
forms the financing decision
 The investment in assets generates revenues and
cash flows for a specific period of time. The
managers of the company can either retain cash
with the company for further investment or
distribute to the owners of the company—the
shareholders. This constitutes the dividend decision
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 In short, a finance manager will be concerned with such
financial decisions as:
 Which investment/s should the company accept and what are
the financial implications of undertaking the same?

 How should the company finance those investments? What

should be the mix of owners’ contribution— equity and
borrowed funds, i.e., debt at any given point in time?

 How much of the income generated from operations should be

returned to shareholders in the form of dividends and how much
is to be retained for further investment?
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What is strategic financial management

 The identification of the possible strategies capable

of maximizing an organization's net present
value or share holder’s wealth, the allocation of
scarce capital resources among the competing
opportunities, and the implementation and
monitoring of the chosen strategy so as to achieve
stated objectives.
 Devise Strategy
 Implementation
 Monitoring
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Financial decisions: Time
perspective
 Capital investment decisions are long-term choices
about which projects receive investment, whether to
finance that investment with equity or debt, and
when or whether to pay dividends to shareholders
 On the other hand, the short term decisions can be
grouped under the heading "Working capital
management".
 This subject deals with the short-term balance of
current assets and current liabilities;

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 The focus here is on managing cash,
inventories, and short-term borrowing and
lending (such as the terms on credit extended
to customers).

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Objective of financial managers
 Corporate Finance theoreticians generally agree
that the objective of a firm is to maximize wealth
 Whose wealth? whether it should be the wealth of
shareholders or the wealth of the firm, which
includes bondholders and preferred stockholders

 Shareholder wealth maximization rule requires

managers to work towards a sustainable increase in
the price of the firm’s stock
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 Alternative to the above rule is to maximize profit,
social value, or growth of the firm
 The underlying assumption is that, an increase in
any of these proxies results in an increase in the
value of the firm (alternatively, shareholder value)

 Maximize Profit? Increase sales, suppress

expenses, extract the last rupee from the customer,
pay the lowest possible price to suppliers, pay less
salaries to employees,
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 Can social responsibility be an objective?
 Businessmen are supposed to be socially
responsible
 But social welfare activities have conceptual
propblems? What is right or wrong, how much to
spend on social responsibility? Moreover, what was
considered moral 30 years ago could be immoral
now?

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 Can growth be an objective of a firm?
 Business in pakistan, india and south Korea are
dominated by family groups, and conglomerates.
 Businesses groups in south Korea are called
chaebol, typically own 30—50 companies in all
key business areas; and the big five—Daewoo,
Samsung, Hyundai, LG, and SK—account for 20
percent of all borrowing and contribute to almost
50 percent of GDP

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 When earnings fall due to recession, competition,
or some such thing, these companies will default on
borrowings
 To summarize, growth, though important, need not
necessarily lead to an increase in shareholder value

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 Do Firms Pursue Multiple Objectives?
 In a survey of management views on alternative
objectives, Porwal5 found in his sample that in 67
percent companies—with high profitability—the
first preference is given to the objective of
maximizing percent ROI and, in 33 percent
companies, the first preference is given to the
objective of maximizing aggregate earnings

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Impediments to shareholder wealth maximization

 There could be potential conflict of interest

between shareholders and bondholders, managers
and shareholders, majority and minority
shareholders. So, maximizing wealth of one group
could be achieved at the expense of other groups
 Shareholders vs Bondholders
 Managers vs Shareholders
 Shareholder vs Shareholder

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Sources & Uses of Finance
 The sources of business finance are retained
earnings, equity, term loans, debt, letter of
credit, debentures, working capital loans, and venture
funding, etc.
 The major applications of funds are the purchase of new
FIXED ASSETS, repayment of LOANS and payments of
TAXES and DIVIDENDS. Investment in SECURITIES,
FIXED RATE INVESTMENTS, PURCHASE OF
GOVERNMENT BONDS, BMR, INVESTMENTS IN
STOCKS, ACQUIZITION OF NEW BUSINESS, ETC

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Conclusion
 The objective of a firm should not be to make a
profit or even maximize profit, increase market
share or sales, but to maximize shareholders’
wealth
 But this should not be achieved at the expense of
other investor groups
 Financial markets are efficient to some extent, they
can see whether a firm is adding value or not; this
will be reflected in the share price of the firm

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