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Still looking for deals on Corporate finance ? Find our amazing Corporate finance offers at our top source site today where we have compared Corporate finance for you. ask.com About Corporate FinanceCorporate finance is an area of [finance] dealing with the financial decisions [corporation]s make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to enhance [valuation (finance)] while reducing the firm's financial [risks]. Equivalently, the goal is to [maximization] the corporations' [return on capital]. Although it is in principle different from [managerial finance] which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. The discipline can be divided into long-term and short-term decisions and techniques.[Capital investment] decisions are long-term choices about which projects receive investment, whether to finance that investment with [ownership 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 [assets] and [liabilities]; the focus here is on managing cash, [inventory], and short-term borrowing and lending (such as the terms on credit extended to customers). The terms Corporate finance and Corporate financier are also associated with [investment banking]. The typical role of an [investment banker] is to evaluate investment projects for a bank to make investment decisions. Capital investment decisionsThe framework for this section is based on Notes by Aswath Damodaran at New York University's Stern School of Business Capital investment decisions are long-term corporate finance decisions relating to [fixed assets] and [capital structure]. Decisions are based on several inter-related criteria. Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive [net present value] when valued using an appropriate discount rate. These projects must also be financed appropriately. If no such opportunities exist, maximizing shareholder value dictates that management return excess cash to shareholders. Capital investment decisions thus comprise an investment decision, a financing decision, and a dividend decision. ===The investment decision=== Management must allocate limited resources between competing opportunities ("projects") in a process known as [capital budgeting]. Making this capital allocation decision requires estimating the value of each opportunity or project: a function of the size, timing and predictability of future cash flows. Project valuation In general, each project's value will be estimated using a [discounted cash flow] (DCF) valuation, and the opportunity with the highest value, as measured by the resultant [net present value] (NPV) will be selected (see [Fisher separation theorem]). This requires estimating the size and timing of all of the incremental cash flows resulting from the project. These future cash flows are then [discount]ed to determine their [present value] (see [Time value of money]). These present values are then summed, and this sum net of the initial investment outlay is the [Net present value]. The [Net present value] is greatly influenced by the [discount rate]. Thus selecting the proper discount rate—the project "hurdle rate"—is critical to making the right decision. The hurdle rate is the minimum acceptable [Return on investment] on an investment—i.e. the [Capital asset pricing model#Asset-specific required return]. The hurdle rate should reflect the riskiness of the investment, typically measured by [volatility] of cash flows, and must take into account the financing mix. Managers use models such as the [capital asset pricing model] or the [arbitrage pricing theory] to estimate a discount rate appropriate for a particular project, and use the [weighted average cost of capital] (WACC) to reflect the financing mix selected. (A common error in choosing a discount rate for a project is to apply a WACC that applies to the entire firm. Such an approach may not be appropriate where the risk of a particular project differs markedly from that of the firm's existing portfolio of assets.) In conjunction with [Net present value], there are several other measures used as (secondary) [Decision making#Decision making in business] in corporate finance. These are visible from the DCF and include payback, [internal rate of return], [Modified Internal Rate of Return], [Equivalent Annual Cost], capital efficiency, and [Return on investment]. See also: [list of finance topics#valuation], [stock valuation], [fundamental analysis] Valuing flexibility In many cases, for example [R&D] projects, a project may open (or close) paths of action to the company, but this reality will not typically be captured in a strict NPV approach. Management will therefore (sometimes) employ tools which place an explicit value on these options. So, whereas in a DCF valuation the [expected value] or average or [scenario planning] cash flows are discounted, here the “flexibile and staged nature” of the investment is [Mathematical model], and hence "all" potential [Moneyness] are considered. The difference between the two valuations is the "option value" inherent in the project. The two most common tools are [decision tree] (DTA) and [Real options analysis]:
===The financing decision=== Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. As above, since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected, the financing mix can impact the valuation. Management must therefore identify the "optimal mix" of financing—the capital structure that results in maximum value. (See [Balance sheet], [Weighted average cost of capital], [Fisher separation theorem]; but, see also the [Modigliani-Miller theorem].) The sources of financing will, generically, comprise some combination of [Bond (finance)] and [Equity investment]. Financing a project through debt results in a [liability] that must be serviced—and hence there are cash flow implications regardless of the project's success. Equity financing is less risky in the sense of cash flow commitments, but results in a dilution of ownership and earnings. The cost of equity is also typically higher than the cost of debt (see [Capital asset pricing model] and [Weighted average cost of capital]), and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk. Management must also attempt to match the financing mix to the [asset] being financed as closely as possible, in terms of both timing and cash flows. One of the main theories of how firms make their financing decisions is the [Pecking Order Theory], which suggests that firms avoid [external financing] while they have [internal financing] available and avoid new equity financing while they can engage in new debt financing at reasonably low [interest rates]. Another major theory is the [Trade-Off Theory] in which firms are assumed to trade-off the [Tax Benefits of debt] with the [Bankruptcy Costs of debt] when making their decisions. One last theory about this decision is the [Market timing hypothesis] which states that firms look for the cheaper type of financing regardless of their current levels of internal resources, debt and equity. The dividend decision In general, management must decide whether to invest in additional projects, reinvest in existing operations, or return free cash as [dividend]s to [shareholder]s. The dividend is calculated mainly on the basis of the company's unappropriated [profit] and its business prospects for the coming year. If there are no NPV positive opportunities, i.e. where [Return on investment] exceed the hurdle rate, then management must return excess cash to [Equity investment] - these [Cash flow] comprise cash remaining after all business expenses have been met. (This is the general case, however there are exceptions. For example, investors in a "[Growth stock]", expect that the company will, almost by definition, retain earnings so as to fund growth internally. In other cases, even though an opportunity is currently NPV negative, management may consider “investment flexibility” / potential payoffs and decide to retain cash flows; see above and [Real option]s.) Management must also decide on the form of the distribution, generally as cash [dividend]s or via a [Treasury stock]. There are various considerations: where shareholders pay [Dividend tax], companies may elect to retain earnings, or to perform a stock buyback, in both cases increasing the value of shares outstanding; some companies will pay "dividends" from [Treasury stock] rather than in cash. (See [Corporate action].) Today it is generally accepted that dividend policy is value neutral (see [Modigliani-Miller theorem]). ==Working capital management==Decisions relating to [working capital] and short term financing are referred to as working capital management. These involve managing the relationship between a firm's [Asset#Current assets] and its [Current liability]. The goal of Working capital management is to ensure that the firm is able to continue its [Operations management] and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses. Decision criteria By definition, Working capital management entails short term decisions - generally, relating to the next one year period - which are "reversible". These decisions are therefore not taken on the same basis as Capital Investment Decisions (NPV or related, as above) rather they will be based on cash flows and / or profitability.
Management of working capital Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. These policies aim at managing the [Asset#Current assets] (generally [cash] and [cash and cash equivalents], [Inventory] and [debtor]s) and the short term financing, such that cash flows and returns are acceptable.
Financial risk management [Risk management] is the process of measuring [risk] and then developing and implementing strategies to manage that risk. [Financial risk management] focuses on risks that can be managed ("[Hedge (finance)]") using traded [financial instruments] (typically changes in [commodity], [interest rate]s, [exchange rate]s and [stock]). Financial risk management will also play an important role in [cash] management. This area is related to corporate finance in two ways. Firstly, firm exposure to business risk is a direct result of previous Investment and Financing decisions. Secondly, both disciplines share the goal of creating, or enhancing, firm [Value (economics)]. All large corporations have risk management teams, and small firms practice informal, if not formal, risk management. [Derivative (finance)] are the instruments most commonly used in Financial risk management. Because unique derivative [contract]s tend to be costly to create and monitor, the most cost-effective financial risk management methods usually involve derivatives that trade on well-established [financial markets]. These standard derivative instruments include [option (finance)]s, [futures contract]s, [forward contract]s, and [swap (finance)]. See: [Financial engineering]; [Financial risk]; [Default (finance)]; [Credit risk]; [Interest rate risk]; [Liquidity risk]; [Market risk]; [Operational risk]; [Volatility risk]; [Settlement risk]. Relationship with other areas in finance Investment banking Use of the term “corporate finance” varies considerably across the world. In the [United States] it is used, as above, to describe activities, decisions and techniques that deal with many aspects of a company’s finances and capital. In the [United Kingdom] and [Commonwealth of Nations] countries, the terms “corporate finance” and “corporate financier” tend to be associated with [investment banking] - i.e. with transactions in which capital is raised for the corporation.Beaney, Shean, "Defining corporate finance in the UK", The Institute of Chartered Accountants, April 2005 Personal and public finance Corporate finance utilizes tools from almost all areas of finance. Some of the tools developed by and for corporations have broad application to entities other than corporations, for example, to partnerships, sole proprietorships, not-for-profit organizations, governments, mutual funds, and personal wealth management. But in other cases their application is very limited outside of the corporate finance arena. Because corporations deal in quantities of money much greater than individuals, the analysis has developed into a discipline of its own. It can be differentiated from [personal finance] and [public finance]. Related Professional Qualifications Qualifications related to the field include:
References See also
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