Class notes
FNCE 3323: Corporate Finance
- Course
- Corporate Finance (FNCE3323)
- Institution
- Northern Alberta Institute Of Technology (NAIT )
Lecture notes of 22 pages for the course Corporate Finance at NAIT (n/a)
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Forms of OrganizationFNCE 3323 • Sole Proprietorship (One owner)
- largest in actual number but smallest
Notes
in total sales revenue
- Advantages:
- Freedom
- Simplicity
Chapter 1 - Low starting costs
- Tax benefits
- Disadvantages:
Field of Finance - Unlimited Liability
- making decisions that focus on creating - Lack of Continuity
value within the firm and builds upon - Difficult to raise money
the disciples of economics (theories - Reliance on one person
and decision making) and accounting • Partnership
(financial data and data analysis tools) - Business owned by two or more
- these decision oriented discipline are persons
now used by financial managers - Advantages:
Risk- return Framework: - More capital
1. What long term investments or - Greater talent pool
projects the firm should undertake? - Ease of formation
- Capital budgeting decisions - Tax benefits
2. How the firm shoUld pay for these - Disadvantages:
assets? By issuing equity or debt? - Unlimited liability
- capital structure decision - Lack of continuity
3. How much cash or inventory the firm - Ownership transfer is difficult
should carry? How much trade credit - Possibility of conflicts
the firm should provide or use? • Corporation
- working capital mgmt decision - Separate legal entity
Goals of Financial Management - Advantages:
- shareholder wealth maximization - Limited liability
- May conflict with interest of mgmt - Continuity
and social/ ethical goals - Greater likelihood of
- Agency Theory= the potential professional management
conflict between shareholders and - Easier Access to Capital
managers - Disadvantages:
- Can be consistent with a concern - Higher start-up costs
for social responsibility - More regulations
- Goal is should be measured in terms of - Double taxation
market share price, which is a value - Potential shareholder conflicts
that investors collectively are prepared Role of Financial Markets
to pay - they lend money or invest to
- Profit corporations, financial institutions, gov’t
Functions of Financial Management: or individuals
- Corporate Finance - Public= markets for governments to
- Banking borrow funds for public activities
- Securities trading and underwriting - Corporate= those markets for
- Money management corporations to raise funds
- Financial planning
- Risk management (Insurance) Structure and Functions of Financial
- All are carried out with the intention to Markets
proper balance profitability against risk - Money Markets
- Deal in short term securities
, - less than 1 year - The amount of debt used in
- eg. t-bill, commercial paper, GIC the capital structure (debt/
- Capital Markets equity mix)
- Deal in long-term securities
- Greater than 1 year
- Eg. Common stock, preferred
stock, corporate bonds, gov’t
bonds
- Primary Market
- Where a firm issues new bonds or
shares to raise new funds
- Secondary Market Break-even Analysis:
- Where investors buy and sell - technique used to study the effect of
(trade) outstanding bonds or sales volume on costs and profit
shares - Where the Total Revenue= Total
Risk-Return Tradeoff Costs, which the firm does not make
- Increased Profitability= Increased Risk any money nor lose
- Decreased Profitability= Decreased
Risk Fixed costs FC FC
BE = = =
Securities in Financial Market Contributi on margin Price - VC CM
- Common stock (common share) =
Ownership or Equity
Operating Leverage
- Shareholders own the company - measure the amount of fixed operating
- Much more higher return costs used by a firm
- Bond= debt or liability - DOL= (%Δ OI) / (%Δ Sales)
- Bondholders are owed money by
company - Degree of Operating Leverage (DOL)
- Measures the sensitivity of a firm’s
Why debt is important component of a operating income to a change in
firm’s capital structure? sales
- too much debt can erode the firm’s - Risk Analysis of Leverage:
cash flow and increased the firm’s - Leveraged firm has HIGH FC, a
risk HIGH BE and HIGH DOL
- Interest rates or yields help establish - Non-Leveraged Firm has LOW
the allocation of capital FC, LOW BE, and LOW DOL
- Greater risk increases the spread - Leverage is a double-edged sword
between inflation and yield - *** it magnifies losses as well as
profits
Chapter 5 Financial Leverage
- measure of the amount of debt used by
a firm
Leverage
- using fixed costs to magnify the - DFL= (%Δ EPS) / (%Δ EBIT)
potential return to a firm - Degree of Financial Leverage:
- 2 types of fixed costs: - Measures the sensitivity of a firm’s
earnings per share to a change in
- Operating costs OI
- Financial costs - Formula for I/S:
- 2 types of Leverage:
- Operating Leverage - DFL= OI/ EBT
- The degree to which capital - DFL= EBIT/ EBT
assets and associated fixed
costs are utilized
- Financial Leverage
, Indifference Point Controlling Assets- Matching Sales
- the level of EBIT (OI) at which and production
alternative financing plans yield the 1. Level Production
same earnings per share (EPS) - to smooth the production
schedules and uses labor and
equipment efficiently at a lower
cost but leads to fluctuation in CA
- Most commonly used to control
the fluctuation in CA
2. Matching sales and production
- eliminates the large seasonal
Combined or Total Leverage bulges or sharp reduction in CA
- represents maximum use of leverage Cash Flow Cycle
- DCL= (%Δ EPS) / (%Δ Sales) - its the firms to quickly convert assets
- DCL= (DOL)(DFL) into cash (liquidity)
- Higher the level of FC (both Operating - Liquidity is often will be difficult to
and financial costs), the greater the continue in the business
effect on NI of an increase in Sales - Eg. sales, receivables, inventories
Revenue
Chapter 6
Assets Growth
- Sales are linked in with production
costs
- Receipts (cash inflows) are linked with
payments (cash outflows)
- Sales are supported by investment in
CA often requiring permanent current
assets
- Growth increase the current assets
investment
- Internally generated funds are not
sufficient, there would be additional
external financing may be required
Self liquidating assets
- firm’s current assets are sold at the end Cash Conversion Cycle
of a specific time period - managers should pay attention to the
time it takes from the initial outlay of
funds for RM until the firm collects
funds from its clients for the finished
product
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