Corporate Finance
Corporate finance is concerned with the decisions taken by different corporations. Corporate finance studies and analyses the tools that are mandatory in arriving at important corporate decisions. The primary objective of corporate finance is maximization of corporate value and minimizing of corporate risks. It is important to take into consideration the short term as well as the long term goals of companies/corporations.
Capital Investment Decisions:
The goal of corporate sector is to maximize return on investment in projects having a positive Net Present Value. Capital investment decisions are:
- Investment Decision
- Dividend Decision
Working Capital Management:
This form of corporate finance is used for the management of current assets of the company. Short term financing is also dealt with in this case such that the cash flows and the returns are acceptable.
Financial Risk Management:
Financial Risk Management is very important for Corporate Finance. The risks that are to be hedged by using different kinds of financial instruments are highlighted here. The financial risks include changes in commodity prices, foreign exchange rates, interest rates, and stock prices. Derivatives such as options, futures, forwards and swaps are used as instruments for financial risk management.
Functions of Corporate Finance
Corporate finance has 2 basic functions: 1] Acquisition of Resources, 2] Allocation of Resources
- Acquisition of Resources
Acquisition of resource indicates fund generation at the lowest possible cost. Resource generation is possible through:
- Equity - This includes proceeds received from retained earnings, stock selling, and investment returns.
- Liability - This includes warranties of products, bank loans, and payable account.
- Allocation of Resources
Allocation of resources is nothing but investment of funds for profit maximization. Investment can be categorized into 2 groups:
- Fixed Assets - Buildings, Land, Machinery etc.
- Current Assets - cash, receivable accounts, inventory, etc.
Functions of Corporate Finance are:
- Raising of Capital or Financing
- Budgeting of Capital
- Corporate Governance
- Financial management
- Risk Management
Decision making in corporate finance
- Long term decisions:
This includes capital investment decisions like viability assessment of projects, financing it through equity and/or debt, pay dividend or reinvest the profit.
Long term corporate finance decisions that are normally related to fixed assets and capital structure are known as Capital Investment Decisions. Senior management always targets to maximize the value of the firm by investing in projects having positive Net Present Value. If such opportunities are not arising then reinvestment of profits should be stalled and excess cash should be returned to shareholders in form of dividends. Thus, Capital Investment Decisions constitute 3 decisions:
- Decision on Investment
- Decision on Financing
- Decision on Dividend
- Short term decisions:
These are also called working capital management decisions which try to strike a balance between current assets such as cash, inventories, etc. and current liabilities i.e. a company's debts/obligations impending for less than a year.
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