Corporate finance Theory Notes

Q.1 What do you Understand by corporate finance?

Corporate finance deals with the capital structure of a corporation, including its funding and the
actions that management takes to increase the value of the company. Corporate finance also
includes the tools and analysis utilized to prioritize and distribute financial resources.

Investments and Capital Budgeting

Investing and capital budgeting includes planning where to place the company’s long-term
capital assets in order to generate the highest risk-adjusted returns. This mainly consists of
deciding whether or not to pursue an investment opportunity, and is accomplished through
extensive financial analysis.

Capital Financing

This core activity includes decisions on how to optimally finance the capital investments
(discussed above) through the business’ equity, debt, or a mix of both. Long-term funding for
major capital expenditures or investments may be obtained from selling company stocks or
issuing debt securities in the market through investment banks.

Dividends and Return of Capital

This activity requires corporate managers to decide whether to retain a business’s excess
earnings for future investments and operational requirements or to distribute the earnings to
shareholders in the form of dividends or share buybacks.

Retained earnings that are not distributed back to shareholders may be used to fund a business’
expansion. This can often be the best source of funds, as it does not incur additional debts nor
dilute the value of equity by issuing more shares.

Q.2 Explain the silent feature of corporate finance?

• Financial activity − This kind of duties are done by financial manager and consists
activities like planning, raising, investing and monitoring the finance of the company.
• Raising the finance − It is raised through shares, debentures, bank loans etc. New
companies will face difficulties to raise finance, whereas established companies can
do it easily because of their reputation.
• Investing the finance − It will help in purchasing the fixed asset to fulfil the company
objectives.
• Objective oriented − The main objectives are to earn maximum profits, to pay regular
dividends to shareholders and to create a future growth by maintaining proper
reserves.
• Types of finance − Proper finances should be maintained either by long term or short
term to meet companies’ long term and short-term needs.
• Relationship with other departments − Inter relation should be strong between all
departments.
• Dynamic in future − Corporate finance is dynamic in nature. It will change from time
to time. So, it is important for finance manager, according to market, to invest their
money to get regular profits.
 • Requires proper planning and control − Planning and control plays an important role
in corporate finance. Corrective measures should be taken, if amount is not invested
properly.
• Managing finance − Managing finance is not easy, it is an art because, it requires
proper skill and best judgement by a systematic approach.
• Legal requirements − Company has to follow rules set by SEBI right from controlling
of capital etc. sole trade firms need not to follow these rules.
• Business management − Business management is an important part in corporate
finance. It is required to carry out business smoothly by expansion, diversification,
modernisation etc. and also required to pay their taxes, dividends and interests.
Q.3 Factoring influencing the capital structure?
Factors affecting the Capital Structure

Several factors affect a company’s capital structure, and it also determines the composition of debt
and equity portions within this structure. Some of these factors are as follows:

• Business Size – The size and scale of a business affect its ability to raise finance. Small-
sized companies face difficulty in raising long-term borrowings. Creditors are hesitant to give
them loans because of the scale of their business operations. Even if they do get these loans,
they have to accept high-interest rates and stringent repayment conditions. It limits their
ability to grow their business.
• Earnings – Firms with relatively stable revenues can afford a more significant amount of debt
in their capital structure. Since debt repayment is periodical with fixed interest rates,
businesses with higher income prospects can bear these fixed financial charges. On the other
hand, companies that face higher fluctuations in their sales, like consumer goods, rely more
on equity shares to finance their operations.
• Competition: If a company operates in a business environment with more competition, it
should have more equity shares in its capital structure. Their earnings are prone to more
fluctuation compared to businesses facing lesser competition.
• Stage of the life cycle: A business in the early stage of its life cycle is more susceptible to
failure. In that case, they should use a more significant proportion of ordinary share capital to
finance their operations. Debt comes with a fixed interest rate, and it is more suitable for
companies with stable growth prospects.
• Creditworthiness: Any company that has a reputation for paying back its loans on time will be
able to raise funds on less stringent terms and at lower interest rates. It allows them to pay
back their loans on time. The opposite is true for firms that don’t have a good credit standing
in the market.
• Risk Aptitude of the Management: The attitude of a company’s management also affects the
proportion of debt and equity in the capital structure. Some managers prefer to follow a low-
risk strategy and opt for equity shares to raise finances. Other managers are confident of the
company’s ability to repay big loans, and they prefer to undertake a higher proportion of long-
term debt instruments.
• Control: A management that wants outside interference in its operations may not raise funds
through equity shares. Equity shareholders have the right to appoint directors, and they also
dilute the stake of owners in the company. Some companies may prefer debt instruments to
raise funds. If the creditors get their instalments on loans and interest on time, they will not
be able to interfere in the workings of the business. But if the company defaults on their
credit, the creditors can remove the present management and take control of the business.
• State of Capital Market: The tendencies of investors and creditors determine whether a
company uses more debt or equity to finance their operations. Sometimes a company wants
to issue ordinary shares, but no one is willing to invest due to the high-risk nature of their
business. In that case, the management has to raise funds from other sources like debt
markets.
 • Taxation Policy: The government’s monetary policies in terms of taxation on debt and equity
instruments are also crucial. If a government levies more tax on gains from investing in the
share market, investors may move out of equities. Similarly, if the interest rate on bonds and
• other long-term instruments is affected due to the government’s policy, it will also influence
companies’ decisions.
• Cost of Capital: The cost of raising funds depends on the expected rate of return for the
suppliers. This rate depends on the risk borne by investors. Ordinary shareholders face the
maximum risk as they don’t get a fixed rate of dividend. They get paid after preference
shareholders receive their dividends. The company has to pay interest on debentures under
all circumstances. It attracts more investors to opt for debentures and bonds.

Q.4 Corporate risk management process

• Identify the risk: Risks can be internal or external, so include any events that could cause
problems or benefits for the company.
• Analyse the risk: Thoroughly analyse the potential effects each risk will have on consumer
behaviour, the company or any endeavours underway.
• Evaluate the risk: Rank risks according to the likelihood of each outcome to see how severely
a set risk could impact the company or its strategy.
• Treat the risk: Look at ways to reduce the probability of a negative risk and increase the
probability of positive risks, preparing preventative and contingency plans as needed.
• Monitor the risk: Track variables and proposed possible threats, and calmly treat any
problems that arise as your tracking system identifies changes .

Q.5 what are the functions of finance manager?

Estimating the Amount of Capital Required:

This is the foremost function of the financial manager. Business firms require capital for:

(i) purchase of fixed assets,

(ii) meeting working capital requirements.

(iii) modernisation and expansion of business.

The financial manager makes estimates of funds required for both short-term and long-term.

2. Determining Capital Structure:

Once the requirement of capital funds has been determined, a decision regarding the kind and
proportion of various sources of funds has to be taken. For this, financial manager has to determine
the proper mix of equity and debt and short-term and long-term debt ratio. This is done to achieve
minimum cost of capital and maximise shareholders wealth.

3. Choice of Sources of Funds:

Before the actual procurement of funds, the finance manager has to decide the sources from which
the funds are to be raised. The management can raise finance from various sources like equity
shareholders, preference shareholders, debenture- holders, banks and other financial institutions,
public deposits, etc.

Q.6 How many types of mergers and acquisition is there

4. Procurement of Funds

The financial manager takes steps to procure the funds required for the business. It might require
negotiation with creditors and financial institutions, issue of prospectus, etc. The procurement of
funds is dependent not only upon cost of raising funds but also on other factors like general market
conditions, choice of investors, government policy, etc.

5. Utilisation of Funds:

The funds procured by the financial manager are to be prudently invested in various assets so as to
maximise the return on investment: While taking investment decisions, management should be
guided by three important principles, viz., safety, profitability, and liquidity.

6. Disposal of Profits or Surplus:

The financial manager has to decide how much to retain for ploughing back and how much to
distribute as dividend to shareholders out of the profits of the company. The factors which influence
these decisions include the trend of earnings of the company, the trend of the market price of its
shares, the requirements of funds for self- financing the future programmes and so on.

7. Management of Cash:

Management of cash and other current assets is an important task of financial manager. It involves
forecasting the cash inflows and outflows to ensure that there is neither shortage nor surplus of cash
with the firm. Sufficient funds must be available for purchase of materials, payment of wages and
meeting day-to-day expenses.

8. Financial Control

Evaluation of financial performance is also an important function of financial manager. The overall
measure of evaluation is Return on Investment (ROI). The other techniques of financial control and
evaluation include budgetary control, cost control, internal audit, break-even analysis and ratio
analysis. The financial manager must lay emphasis on financial planning as well.

Q.6 How many types of mergers and acquisition is there with

example?
Horizontal merger

A horizontal merger occurs when two companies operating in the same market (and selling similar products
or services) come together to dominate market share. This type is attractive for merging companies aiming to
build economies of scale and decrease market competition. However, there are potential downsides. A
horizontal merger comes with increased regulatory scrutiny and stringency, and can lead to a loss of value if
the post-merger integration is not fully realized. Regulatory due diligence should be executed with extra
special care.

Vertical merger

Vertical mergers involve two companies in the same industry who operate in different stages of production.
This could involve a retailer who merges with a wholesaler, or a wholesaler merging with a manufacturer, for
example. This type of merger is ideal for streamlining operations, boosting efficiencies, and cutting costs
across the supply chain, but it can also reduce flexibility and result in new complexities for the business to
manage.

Congeneric merger (also ‘Concentric merger’)

In a congeneric merger, the acquirer and target company have different products or services, but operate
within the same market and sell to the same customers. They could be indirect competitors, although their
products often complement each other. As these companies already share similar distribution channels,
production or technology, this type of merger can allow the new business entity to expand its product lines
and increase market share. As a downside, the fact that these two companies already operate within the same
industry could limit further diversification.

Market-extension and product-extension mergers

A market extension merger describes two companies in the same industry who join forces with the aim of
expanding market reach. Commonly, this type of transaction occurs across multiple geographic regions. A
product extension merger occurs when a specific product is added to the product line of the acquirer from
the acquired company.

Conglomerate merger

Unlike the other types of mergers, a conglomerate merger occurs between two companies whose
business activities and industries may be completely unrelated. In pure conglomerate mergers, the
two firms may continue to operate separately within their own markets, whereas in a mixed one,
they may look to expand product or market reach. While this type of merger can help the new
entity increase market share and diversify its business, it can be especially challenging to integrate
dissimilar companies, raising the risk of culture clashes and lost efficiency due to disrupted
business operations.
Let us try to understand the types of mergers and acquisitions with examples.

Horizontal merger – An example of a horizontal merger is the merger of Facebook and Instagram
that took place in 2012. Both of them belong to the same industry and similar types of business.

Vertical merger – An example of a vertical merger is the merger of Paypal and eBay in 2002 in which
eBay got the different types of synergies in mergers and acquisitions in the form of an online payment
facility and Paypal got a platform to expand further.

Concentric Merger – An example of a concentric merger is the merger of Heinz and Kraft, which took
place in 2015, and is considered to be the largest merger of this kind in history.

Conglomerate Merger – An example of a conglomerate merger is the merger of Berkshire Hathaway

and Precision Castparts merger in 2015.

In all the above cases each entity got different types of synergies in mergers and acquisitions.

Q.7 Difference between Insolvency and Bankruptcy?

Difference Between Insolvency and Bankruptcy

You may often hear the terms “insolvency” and “bankruptcy” being used interchangeably, but

they have different meanings. Insolvency is a financial state where a person cannot meet debt

payments on time. Bankruptcy is a legal process that happens when the individual declares he or

she can no longer pay back his or her debts to creditor.

Insolvency

Though both terms deal with excessive debts, insolvency is a state that can lead to

declaring bankruptcy. In very simple terms, an individual becomes insolvent when he or

she is unable to pay back lenders on time.

Although filing for bankruptcy is a possible resolution for insolvency, this type of

situation does not automatically lead to bankruptcy. Depending on your circumstances,

you may be able to address your insolvency by other means, such as making a consumer

proposal or taking out a debt consolidation loan.

• What is Bankruptcy?

Bankruptcy is a legal process that provides protection and relief for individuals who are

unable to pay off their debts. When you file for bankruptcy, a Licensed Insolvency

Trustee will be assigned to liquidate your assets, contact your creditors, and investigate

your affairs. You will also have to comply with bankruptcy duties including attending

credit counselling sessions.

Once you have completed all necessary tasks, you will be released from your bankruptcy

and become solvent again. The process typically takes 9 to 21 months.