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The word Corporate Finance can be defined In terms that may vary considerably across the world. Corporate Finance Is one of the three areas of the discipline of finance and can be defined broadly as a fled of finance dealing with acquisition and allocation of a corporation’s funds or resources, with the goal of maximizing shareholder wealth I. E. Stock value. This division of a company is basically concerned with the financial operation of the company from company’s point of view. Every decision made in a business has financial implications, and any decision that involves the use of money is a corporate financial decision.
It may Include financial decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value while managing the firm’s financial risks. Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. The essence of business Is to raise money from Investors to fund projects that will return more money to the investors.
All businesses have to invest their resources wisely, find the right kind and mix of financing to fund these investments, and return cash to the owners if there are not enough good investments. In most businesses, corporate finance focuses on raising money and funds for various projects or ventures. Funds are acquired from both internal and external sources at the lowest possible cost and may be obtained through two basic ways equity and debt. Equity Investors get ownership In the company but do not have a guaranteed return Issuing stock Is the most obvious way o raise funds using equity.
Retained earnings (when the company uses its own earning to finance projects) are also an equity investment. With retained earnings, the company takes money that could have been returned to shareholders and uses it to fund capital projects. Effectively, it is using the shareholders money to fund these projects, Increasing the value of their equity holdings. Debt financing Is borrowing; investors get a promise of fixed future payments, but do not have any ownership. Borrowing can be done through a financial Intermediary, such as a bank, or directly by issuing bonds.
For investment banks and similar corporations, corporate finance focuses on the analysis of corporate acquisitions and other decisions. For stable operations to be led, corporate finance must balance the needs of employees, customers, and suppliers against the interests of the shareholders. Thus, the terms corporate finance may be associated with dealings In which capital Is raised In order to create, develop, grow or acquire businesses. Resource allocation Is the investment of funds; these investments fall into the categories of current assets (such as cash and inventory) and fixed assets (such as real estate and machinery).
The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, short term the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers). All of corporate finance is built on three principles that are; the investment principle, the financing principle, and the dividend principle.
The investment principle determines where businesses invest their resources, the financing principle governs the mix of funding used to fund these investments, and the dividend principle answers the question of how much earnings should be reinvested back into the business and how much returned to the owners of the business. Firms have scarce resources that must be allocated among competing needs. The first and foremost function of corporate finance is to provide a framework for firms to make this decision wisely.
Accordingly, investment decisions include not only those that create revenues and profits but also those that eave money. Furthermore, it also deals with decisions about how much and what inventory to maintain and whether and how much credit to grant to customers that are traditionally categorized as working capital decisions, are ultimately investment decisions as well. At the other end of the spectrum, broad strategic decisions regarding which markets to enter and the acquisitions of other companies can also are considered investment decisions.
Corporate finance attempts to measure the return on a projected investment decision and compare it to a minimum acceptable difficulty rate to decide whether the project is acceptable. The hurdle rate has to be set higher for riskier projects and has to reflect the financing mix used, I. E. , the owner’s funds (equity) or borrowed money (debt). In the discussion of risk and return, process begins with defining risk and developing a procedure for measuring risk. Having established the hurdle rate, attention is turned to measuring the returns on an investment.
In analyzing projects, three alternative ways of measuring returns are evaluated; conventional accounting earnings, cash flows, and time-weighted cash flow. In extensions of this analysis, some of the potential side sots that might not be captured in any of these measures, including costs that may be created for existing investments by taking a new investment, and side benefits, such as options to enter new markets and to expand product lines that may be embedded in new investments, and synergies, especially when the new investment is the acquisition of another firm are considered.
Every business, no matter how large and complex, is ultimately funded with a mix of borrowed money (debt) and owner’s funds (equity). With a publicly trade firm, debt may take the form of bonds and equity is usually common stock. In a private business, debt is more likely to be bank loans and an owner’s savings represent equity. Though the existing mix of debt and equity can be considered and its implications for the minimum acceptable hurdle rate as part of the investment principle, the question of whether the existing mix is the right one is thrown in the financing principle section.
There might be regulatory and other real-world constraints on the financing mix that a business can use, but there is ample room for flexibility within these constraints. Financing methods includes, looking at the range of choices that exist for both private businesses and publicly rated firms between debt and equity. Then the question arises that whether the existing mix of financing used by a business is optimal, given the objective function of maximizing firm value. Although the trade-off between the benefits and costs of quantitative approaches to arriving at the optimal mix.
In the first approach, the specific conditions under which the optimal financing mix is the one that minimizes the minimum acceptable hurdle rate are considered. In the second approach, there are effects on firm value of changing the financing mix. When the optimal financing ix is different from the existing one, the best ways of getting from where firm is (the current mix) to where firm would like to be (the optimal) are mapped out, keeping in mind the investment opportunities that the firm has and the need for timely responses, either because the firm is a takeover target or under threat of bankruptcy.
Having outlined the optimal financing mix, we turn our attention to the type of financing a business should use, such as whether it should be long-term or short- term, whether the payments on the financing should be fixed or variable, and if variable, what it should be a function of. Using a basic proposition that a firm will minimize its risk from financing and maximize its capacity to use borrowed funds if it can match up the cash flows on the debt to the cash flows on the assets being financed, the perfect financing instrument for a firm is designed.
Then additional considerations relating to taxes and external monitors (equity research analysts and ratings agencies) are added and arrive at strong conclusions about the design of the financing. Most businesses would undoubtedly like to have unlimited investment opportunities that yield returns exceeding their hurdle rates, but all businesses grow and mature. As a consequence, every business that thrives reaches a stage in its life when the cash flows generated by existing investments is greater than the funds needed to take on good investments. At that point, this business has to figure out ways to return the excess cash to owners.
In private businesses, this may Just involve the owner withdrawing a portion of his or her funds from the business. In a publicly traded corporation, this will involve either paying dividends or buying back stock. The dividend policy, the basic trade-off are introduced that determines whether cash should be left in a business or taken out of it. For stockholders in publicly traded firms, this decision is fundamentally one of whether they trust the managers of the firms with their cash, and much of this trust is based on how well these managers have invested funds in the past.
Finally, the options available to a firm to return assets to its owners;dividends, stock buybacks and spin-offs are considered and investigation to pick between these options is started. Corporate finance utilizes tools from almost all areas of finance. Some of the tools developed by and for corporations have broad application to entities other than corporations but in other cases their application is very limited outside of the corporate finance arena.
Because corporations deal in quantities of money much greater than individuals, the analysis has developed into a discipline of its own. It can be differentiated from personal finance and public finance. Corporate Finance is processes and decisions that are matter of important attention in related with any firm. The primary goal of corporate finance is to maximize corporate value while managing the firm’s financial risks. A firm should be fully geared to meet the changing economic challenges present in order to lead it toward success.
While being in the run, any successful firm is ever striving to build meaningful relationships with their customers and become partners in their growth and progress by acting as financial advisors and consultants as well be made so that the people involved can rely on the firm’s decisions. Corporate finance flourishes when the firm made decision that not only aim toward long term success but also fulfill the present needs a firm is facing. Corporate finance, for this purpose, focuses on time-line given with resources in hand and a special focus on profits and winning decisions in favor of firm.