CORPORATE FINANCE SHORT VERSIONShort term debt are loans and other obligations that must be repaid within 1 year Long term debt is debt that does not have not to be repaid within 1 year Capital budgeting or capital expenditure is process of making and managing expenditures on long lived assets Net working capital is defined as current assets minus current liabilities NWC = current assets current liabilitiesCreditors are persons or institutions that buy debt from the firm Stakeholders are the holders of equity shares.Value of the firm: V = B+ S (B - the value of the debt, S - the value of the equity)The Financial ManagerFinance activity is associated with a top officer of the firm, such as a vice president and chief financial officer. (CFO)The treasurer is responsible for handling cash flows, making capital expenditures decisions and making financial plans. The controller handles the accounting function, includes taxes, cost and financial accounting and information systems.The most important job of a financial manager is to create value from the firms capital budgeting, financing and liquidity activities.The Corporate Firm - The firm is a way of organizing the economic activity of many individuals, and there are many reasons why so much economic activity is carried out by firms and not by individuals. The most of large firms are corporations rather than any of the other legal forms that firms can assume. A basic problem of the firm is how to raise cash.The Sole Proprietorship - This is a business owned by one person. More information! Two basic types of securities to investors: debt and equity securities. The financial markets are composed of the money markets and the capital markets. The financial markets can be classified as the primary and the secondary markets.Time Value of Money

The time value of money(TVM) serves as the foundation for all other notions in finance. It impacts corporate finance, consumer finance and government finance. Time value of money results from the concept of interest.Time Value of Money (TVM) is an important concept in corporate finance. It can be used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities. TVM is based on the concept that a KM that you have today is worth more than the promise or expectation that you will receive a KM in the future. Money that you hold today is worth more because you can invest it and earn interest. A key concept of TVM is that a single sum of money or a series of equal, evenlyspaced payments or receipts promised in the future can be converted to an equivalent value today.Compounding the process of finding the future value (FV) of a cash flow or a series of cash flows. The compounded amount, or future value, is equal to the beginning amount plus the interest earned.Discounting the process of finding the present value (PV) of a future cash flow or a series of cash flows;One of the most important tools in time value analysis is the time line. Time line is used to help visualize what is happening in a particular problem and then to help set up the problem for solution.You can calculate the fifth value if you are given any four of: Interest Rate (i) the cost stated as a percent of the amount borrowed per period of time, usually one year.Number of time periods (n) Periods are evenlyspaced intervals of time. Payments a series of equal, evenlyspaced cash flows.Future Value (FV) the value at some future time of a present amount of money, or a series of payments, evaluated at a given interest rate.Present Value (PV) the current value of a future amount of money, or a series of payments, evaluated at a given interest rate

Simple VS Compound Interest Simple interest is calculated only on the beginning (original) principal. Accumulated interest from previous periods is not used in calculations for the following periods.Compound interest is calculated each period on the original principal and all interest accumulated during past periods. The interest earned in each periodis added to the principal of the previous period to become the principal for the next period.

An annuity is a series of equal payments or receipts that occur at evenly spaced intervals. The most common payment frequencies are annually (once a year), semi-annually (twice a year), quarterly (four times a year) and monthly (once a month). There are two basic types of annuities: When the payments appear at the end of each time period, the annuity is said to be an ordinary annuity. When the payments appear at the beginning of each time period, the annuity is said to be an annuity due.These annuities are characterized by recurring, identical, cash payment amounts (payments, receipts, deposits, withdrawals, rents) at the end or beginning of each equal period.

In order to calculate the present value or future value of an annuity, payments (PMT) must: be the same amount each period occur at evenly spaced intervals occur exactly at the beginning or end of each period be all inflows or all outflows (payments or receipts) represent the payment during one compounding (or discounting) period

The Future Value of an Ordinary Annuity (FVoa) is the value that a stream of expected or promised future payments will grow to after a given number of periods at a specific compounded interest. The Future Value of an Ordinary Annuity could be solved by calculating the future value of each individual payment in the series using the future value formula and then summing the results.

The Future Value of an Annuity Due (FVad) is identical to an ordinary annuity except that each payment occurs at the beginning of a period rather than at the end. Since each payment occurs one period earlier, we can calculate the present value of an ordinary annuity and then multiply the result by (1 + i).

Since table 3 is built for ordinary annuities, we need to make one simple adjustment to theformula to allow for the extra compounding period.

FVad = FVoa (1+i)The Present Value of an Ordinary Annuity (PVoa) is the value of a stream of expected or promised future payments that have been discounted to a single equivalent value today. The Present Value of an Ordinary Annuity could be solved by calculating the present value of each payment in the series using the present value formula and then summing the results.

The Present Value of an Annuity Due is identical to an ordinary annuity except that each payment occurs at the beginning of a period rather than at the end.

The PV calculation is useful in a variety of situations including: valuing a series of retirement payments; calculating the lump sum value of lottery winnings; establishing the purchase price of property sold for instalment payments; determining the value of periodic payments under an insurance contract or a structured settlement; pricing a coupon bearing bondRisk and ReturnPrinciples for Risk analysis:1. All financial assets are expected to produce cash flows, and the risk of an asset is judged in terms of the risk of its cash flows.2. The risk of an asset can be considered in two ways: (1) on a stand-alone basis, where the assets cash flows are analyzed by themselves, or (2) in a portfolio context, where the cash flows from a number of assets are combined and then the consolidated cash flows are analyzed.3. In a portfolio context, an assets risk can be divided into two components: (a) diversifiable risk, which can be diversified away and thus is of little concern to diversified investors, and (b) market risk, which reflects the risk of a general stock market decline and which cannot be eliminated by diversification, does concern investors. Only market risk is relevant -diversifiable risk is irrelevant to rational investors because it can be eliminated.4. An asset with a high degree of relevant (market) risk must provide a relatively high expected rate of return to attract investors. Investors in general are averse to risk, so they will not buy risky assets unless those assets have high expected returns.5. Our focus is on financial assets such as stocks and bonds, but the concepts discussed here also apply to physical assets such as computers, trucks, or even whole plants.

Investment Return Investment returns measure the financial results of an investment. Return refers to the gain or loss on an investment. It is generally stated as a percent of the original investment, and annualized. Returns may be expected or historical. Returns can be expressed in: Absolute terms Percentage termsThe concept of return provides investors with a convenient way of expressing the financial performance of an investment.One way of expressing an investment return is in absolute terms. The absolute return is simply the total KM received from the investment less the amount invested:Absolute return =Amount received-Amount invested

Although expressing returns in absolute amount is easy, two problems arise:a) To make a meaningful judgment about the return, you need to know the scale (size) of the investment; a KM10 return on a KM10 investment is a good return (assuming the investment is held for one year), but a KM10 return on a KM1,000 investment would be a poor return.b) You also need to know the timing of the return; a KM10 return on a KM10 investment is a very good return if it occurs after one year, but the same absolute return after 20 years would not be very good.The solution to the scale and timing problems is to express investment results as rates of return, or percentage returns.

Risk Risk refers to the chance that some unfavorable event will occur. It is defined as uncertainty of outcomes. In a financial sense, we are uncertain of the outcome of any investment.An assets risk can be analyzed in two ways:a) on a stand-alone basis, where the asset is considered in isolation, andb) on a portfolio basis, where the asset is held as one of a number of assets in a portfolio.Thus, an assets stand-alone risk is the risk an investor would face if held only this one asset. Obviously, most assets are held in portfolios, but it is necessary to understand stand-alone risk in order to understand risk in a portfolio context.Probability Distributions An events probability is defined as the chance that the event will occur. If all possible events, or outcomes, are listed, and if a probability is assigned to each event, the listing is called a probability distribution. Probabilities can also be assigned to the possible outcomes (or returns) from an investment.If you buy a bond, you expect to receive interest on the bond plus a return of your original investment, and those payments will provide you with a rate of return on your investment. The higher the probability of default, the riskier the bond, and the higher the risk, the higher the required rate of return. The possible outcomes from this investment are:a) that the issuer will make the required payments orb) that the issuer will default on the payments.If you invest in a stock instead of buying a bond, you will again expect to earn a return on your money. A stocks return will come from dividends plus capital gains.Expected Rate of ReturnIf we multiply each possible outcome by its probability of occurrence and then sum these products, we have a weighted average of outcomes. The weights are the probabilities, and the weighted average is the expected rate of return.The expected return on an investment is the mean value of its probability distribution of returns. The expected rate of return calculation can be expressed as an equation:

Here Ri is the ith possible outcome, Pi is the probability of the ith outcome, and n is the number of possible outcomes. Thus, is a weighted average of the possible outcomes (the Ri values).The tighter, or more peaked, the probability distribution, the more likely it is that the actual outcome will be close to the expected value, and, consequently, the less likely it is that the actual return will end up far below the expected return. Thus, the tighter the probability distribution, the lower the risk assigned to a stock.Measuring Stand-Alone Risk: The Standard DeviationA common definition is stated in terms of probability distributions: The tighter the probability distribution of expected future returns, the smaller the risk of a given investment. Formally, uncertainty is measured by variability.Risk in statistics and financial economics is measured by standard deviation, which measures the variability of the return. Thus, the standard deviation is essentially a weighted average of the deviations from the expected value, and it provides an idea of how far above or below the expected value the actual value is likely to be.The smaller the standard deviation, the tighter the probability distribution, and, accordingly, the lower the riskiness of the stock. Standard deviation is an absolute measure of stand-alone risk.

Using Historical Data to Measure RiskIf only sample returns data over some past period are available (historical data), the mean and standard deviation of returns can be estimated using these formulas:

Measuring Stand-Alone Risk: The Coefficient of VariationIf a choice has to be made between two investments that have the same expected returns but different standard deviations, most people would choose the one with the lower standard deviation and, therefore, the lower risk.Similarly, given a choice between two investments with the same risk (standard deviation) but different expected returns, investors would generally prefer the investment with the higher expected return.How do we choose between two investments if one has the higher expected return but the other the lower standard deviation? To help answer this question, we often use another measure of risk, the coefficient of variation (CV), which is the standard deviation divided by the expected return:The coefficient of variation shows the risk per unit of return, and it provides a more meaningful basis for comparison when the expected returns on two alternatives are not the same. Coefficient of variation is an alternative measure of stand-alone risk.

Investor attitude toward risk can be: Risk aversion assumes investors dislike risk and require higher rates of return to encourage them to hold riskier securities.Risk premium the difference between the return on a risky asset and less risky asset, which serves as compensation for investors to hold riskier securities.8