Corporate Finance

Introduction:

Corporate finance is an area of finance dealing with financial decisions; make tools and analysis used to make decisions, the main concept in the study of corporate finance are applicable to the financial problems of all kinds of firms.

Explanation:

The discipline can be divided in to long term and short term decisions and techniques:-

Capital management deals with the decision in long term choices about which projects receive investments, whether to finance that investment with equity or debt, will see in detail.

Working capital management deals with the decision in short term balance of current assets and current liabilities, the focus here is on managing cash, inventories and short term borrowing and lending, will see in detail

1. Capital investment decision:

As mentioned above it’s a long term decisions relating to the fixed assets and capital structure. Decisions are based on several inter-related criteria.


1.1 The investment decision

This comes under the capital investment decision, management must allocate limited resources between competing opportunities in a process know as capital budgeting. Making this capital allocation decision requires estimating the value of each opportunity or project: a function size, timing and predictability of future cash flows.

1.1.1 Project valuation

In general , each project’s value will be estimated using discount cash flow valuation , and the opportunity with the highest value, as measured by the resultant net present value will be selected.


1.1.2 Valuing flexibility

In many cases like R&D projects, a project may open or close paths of the action to the company, but this reality will not typically be captured in a net present value. The most common tools are Decision Tree Analysis(DTA) and Real Options Analysis(ROA).

The DTA values flexibility by incorporating possible events and consequent management decisions. In the decision tree, each management decision is response to an event generates branch or path which could the company follow.

The ROA is usually used when the value of a project is contingent on the value of some other asset

2. working capital management

Decision relating to working capital and short term financing are referred to as working capital management. The goal is therefore to ensure that firms is able to operate, it has sufficient cash flow to service long term debt.

2.1 Decision criteria

Working capital is the amount of capital which is really available to an organization. That is, working capital is the difference between resources in cash or readily convertible into cash and cash requirements.

2.2 Management of working capital

Management will use a combination of policies and techniques for the management of working capital, some are as follows

Cash management- Identify the cash balance which allows for the business to meet day to day expenses

Inventory management- Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials

Debtors management- Identify the appropriate credit policy, credit terms will attract customers, such that any impact on cash flows and the conversion cycle will affect increased revenue and hence return on capital