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Summary All concepts in One Page - Corporate Finance
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- Katholieke Universiteit Leuven (KU Leuven)
All concepts in One Page - Corporate Finance
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List of ConceptsChapter 1: Introduction to Corporate Finance
Real assets: Can be tangible or intangible assets which generate income. Examples of
intangible real assets are brand names or investments while tangible real assets are plant,
machinery and as such.
Financial assets: Cash, stocks, bonds, mutual funds, and bank deposits are all examples of
financial assets.
Capital structure decision: Choice between financing with debt or equity.
Public companies: Shares are publicly traded.
Private companies: Shares of this company are privately held by a small group of
investors. Shares are not publicly traded and the company is closely held.
Limited liability: Shareholders cant be held responsible for corporation’s debts in case of
bankruptcy.
Unlimited liability: Refers to the full legal responsibility that business owners and partners
assume for all business debts. This liability is not capped, and obligations can be paid
through the seizure and sale of owners' personal assets.
Hurdle rate/Cost of capital/opportunity cost of capital:
Hurdle rate: Minimum acceptable rate of return for a project. So corporations increase value
by accepting all investment projects that earn more than the opportunity cost of capital.
Cost of capital: The opportunity cost is the expected return that investors can achieve in
financial markets at the same level of risk.
Cost of a company's funds, or, from an investor's point of view "the required rate of return on
a portfolio company's existing securities". It is used to evaluate new projects of a company.
Cost of capital is what it costs you to put your money to work. Opportunity cost is what
you can get in alternative investments with similar risk and reward profiles. In simpler terms,
opportunity cost refers to the cost of choosing one alternative and forgoing the other.
The cost of capital is the minimum required return on any new investment that allows a firm
to break even. Since we are using the cost of capital as a benchmark or “hurdle” to
compare the return earned by any project, it is sometimes referred to as the hurdle rate.
,Conflicts between shareholders’ and managers’ objectives create agency problems.
Agency cost: Agency costs are incurred when (1) managers do not attempt to maximize
firm value and (2) shareholders incur costs to monitor the managers and constrain their
actions.
Agency problem I: Conflict between management and shareholders. If you give
management stock options they will start thinking like a shareholder and they will try to
create shareholder value.
Agency problem II: Conflict of interest between majority and minority shareholders. A
solution could be an independent board members on the board of directors, who defend the
interest of minority shareholders.
Dispersed ownership: With dispersed ownership, an entity has at least several
owners/shareholders, and the running of the entity is delegated to the management team
and a board of directors.
The owners and the managers of the firm are different. Shareholders cannot control what the
managers do, except indirectly through the board of directors.
Concentrated ownership: The case where the majority of shares are held by few owners.
Corporate governance: A system of rules that dictate how a company's board of directors
manages and oversees the operations of a company; Corporate governance includes
principles of transparency, accountability, and security.
Independent director: An independent director is a member of the board of directors who
(1) do not have a material relationship with the company, (2) is not part of the company's
executive team, and (3) is not involved with the day-to-day operations of the company.
Independent directors act as a guide to the company. Their roles broadly include improving
corporate credibility and governance standards functioning as a watchdog, and playing a
vital role in risk management. Independent directors play an active role in various
committees set up by companies to ensure good governance.
Code Daems: Belgian code for governance for listed companies.
Code Buysse: Belgian code for governance for non-listed companies.
Stock options: Option to buy a stock at a fixed price. Gives incentive to management to
increase the stock price thus creating shareholder value.
There are two types of options: puts, which is a bet that a stock will fall, or calls, which is a
bet that a stock will rise.
, Board of directors: Group of people who jointly supervise the activities of an organization.
Shareholders elect the board of directors to keep watch on management and replace
unsatisfactory managers. If the board is lax, shareholders are free to elect a different board.
Market for corporate control: The market for corporate control is composed of individuals
and firms that buy ownership positions or take over potentially undervalued corporations and
make changes to those corporations, including the replacement of the top managers.
Proxy fight: When a group of investors believes that the board and its management should
be replaced, they can launch a proxy contest at the next annual meeting. In a proxy contest,
the dissident shareholders attempt to obtain enough proxies to elect their own slate to the
board of directors. A proxy fight is therefore a direct contest for control of the corporation.
Many proxy fights are initiated by major shareholders who consider the firm poorly managed.
Chapter 2: How to Calculate Present Values
Present value: Discounted value of a cash flow. The longer you wait to receive your
money, lower it’s present value.
Future value: Future value is the value of an asset at a specific date.
Discount factor: The expression 1/(1+r)^t
NPV: Present value - Required Investment
Perpetuity: Bonds that the government is under no obligation to repay but that offer a fixed
income each year to perpetuity. (PV=C/r)
(steady stream of cash flows forever)
Annuity: An asset that pays a fixed sum each year for a specified number of years.
Perpetuity with constant growth rate: A growing perpetuity is a stream of cash flow that is
expected to be received every year forever but also grow at the same growth rate forever.
Annual Percentage Rate (APR): The annual percentage rate (APR) of a loan is the total
amount of interest you pay each year represented as a percentage of the loan balance.
Chapter 3: Valuing Bonds
Bond: The bond is a debt security, under which the issuer owes the holders a debt and
(depending on the terms of the bond) is obliged to pay them interest (the coupon) and to
repay the principal at a later date, termed the maturity date. Interest is usually payable at
fixed intervals (semiannual, annual, sometimes monthly).
Face Value: Face value is a financial term used to describe the nominal or dollar value of a
security, as stated by its issuer. For stocks, the face value is the original cost of the stock, as
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