CORPORATE FINANCE

Finance: Management of money. Managing money is known as finance.

Finance is the procurement and proper utilization of fund.
In this definition of finance there are some key terms that must be address:
Procurement: Is the collection, accumulations and raising of fund from
various sources that a financial manager can achieve the goal and objective.
Utilization: Utilization in finance is also important which refers to the uses
of fund, investment of fund for holding assets to generate returns during
some holding period in future.
Fund: Fund is money when it is ready for investment purpose.
Finance is the art and science of managing money that a financial manager
performs to achieve the objective of the firm. Financial manager is the
person or authority that manages fund for the business.
Financial management: What a financial manager done his/her capacity is
known as financial management. Financial management is the activities of a
financial manager.
With empowerment of managing money financial management acts as
achieving the goals and objectives of the fund.
Financial
Management
Wealth
Maximization
Financial Decisions

Financing
Decisions

Returns

Investment
Decision

Dividend
Decision

Liquidity
Decision

Risk
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Trade Of
Financial assets refers to the paper, documents or certificates that represent
claims upon the fixed assets of the business. This is actually the long term
liabilities of the business.
Worth/Wealth: Worth is the diference between the total assets and total
debt.
How to maximize the wealth:
Wealth can be maximize through financial decisions. Financial decision can
be categorized as:

Financing Decisions (FD)

Investment Decisions (ID)
Dividend Decisions (DD)
Liquidity Decisions (LD)

Financing Decisions: Part of financial decision. It involves with collection,

procurement and raising of fund. Financing decision is followed by
Investment decision.
Investment Decisions: refers to the utilization, allocation of fund,
deployment and use of fund for maximize the return. Along cant maximize
the value of the assets rather it can maximize the profit of the year.
Dividend Decisions: Dividend is the part of profit that the company
distributes to the common stock holders or the owners of business. Common
stock holders or stock holders provides the paid-up capital to the business to
become the owners.
Dividend is the income or return to the common stock holders or stock
holders which is distributed by the financial manager.
Dividend are two types:

Cash Dividend: Cash dividend (partial liquidation) is the amount of

cash that stock holders receives from the profit of the organization.
Stock Dividend: Stock dividend is refers to the additional shares
distributed to the common stock holders as a result the stock holders
receives the additional shares without meeting the payment.

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Liquidity Decisions: Liquidity refers to the capacity of the assets to be

converted to the cash or near cash without any loss. Liquidity means the
cash asset or the assets that can be converted into cash immediately.
Liquidity decision is an important decision of the financial manager because
the working capital decision/activity depends upon the liquidity. Liquidity is
used to meet the current liabilities within the current assets. Total current
assets is the Gross Working Capital and diference between current assets
and current liabilities is Net Working Capital.
Financial
Management
Wealth
Maximization
Financial Decisions

Financing
Decisions

Investment
Decision

Returns

Dividend
Decision

Liquidity
Decision

Risk

Trade Of

Return is the access amount taken as the diference between net cash inflow
and net cash outflow (CIF COF). It is the outcome of investment.
And return is calculated by the financial manager through preparing financial
statement or income statement.
Risk is the uncertainty of the returns. There is a proverb, Higher return
higher risk. But there is a functional.
Risk only measures, but uncertainty cant be measured. Risk is totally a
measure of statistics.
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Standard Deviation: diference between actual return and chance

Votelity of certain events.

Forms of various business organizations:

Sole Proprietorship: Owner of the business is a single person or a family.
The profit and loss of the business remain within the owner of the business.
Partnership: Where more than 1 person will be the owner of the business
and each partner will provide capital and contribute to run the business.
Profit and loss will be distributed according to the partnership deed
formulated as per partnership act 1932.
Joint Stock Company: If the paid up capital or owners contribution of sole
proprietorship & partnership business exceed a certain limits then the
company is supposed to convert the capital into share which is called share
capital. It means sole proprietorship and partnership business in course of
time will become a limited company. Finally government can acquire or hold
the total assets of the company to convert it into a state owned enterprise.
There are two types of company.

Public Limited Company

Private Limited Company

Limited means the liability of the business would be limited by the no. of
shares of the owner. According to the law a company is supposed to provide
a financial and information about total assets and total liabilities of the
company even though a limited company must prepare income statement
and balance sheet of each year focusing the profit and loss. Total assets and
total liabilities must submit this document to the secretary.
Current Assets: known as working capital that includes the specific items
of a company like cash in hand, cash with bank (bank balance), accounts
receivables, bills receivable (bill of exchange / draft), marketable securities
(like shares, bonds, debentures, to earn profit), accruals (means the dues of
the past year receive this year), prepaid expense / expenditure (advance
taka), inventories (raw materials, work in process, semi-finished goods and
finished goods).
Current Liabilities: bank over drafts, initial amount of money over the
deposit (against current account), and the party withdraws from the bank are
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known as current liabilities, short term loans / advances that bank gives to its
client cash credit (its the account that only calculates the loans), accounts
payable, bills payable, accruals, secure / unsecured loans and advances.
Long-term Liabilities: in the form of loans or advances.
Current assets and current liabilities are addressed as working capital by
corporate finance.

Current Assets: Gross Working Capital

Current Assets Current Liabilities: Net Working Capital

Financing decision through capital structure. Total capital of the business

would be equal to the fixed asset. Outcome of the capital is converted to
cash.
Investment decision through capital budgeting that long term liabilities used
to acquisition of the fixed assets. The value of the fixed asset must be
appreciated in the balance sheet.
Balance Sheet Model Analysis:

Diference between current asset and current liability must be equal to the
diference between capital and fixed assets.

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Corporate Finance basically discuss 3 aspects:

i.
ii.
iii.

Working Capital Management

Financing Decisions
Investment Decisions through Capital Budgeting

The related issues are:

Time value of money

Cost of Capital
Risk and return
Analysis of Financial Statement
Capital Budgeting
Theories, Policies and Practice of Dividend
Deviation of Common Stock
Deviation of Fixed incomes security
Merger and acquisition
Derivatives

Financial Market Structure:

Financial
Market

Money
Market
instrument

Equities
eg: Share,
Stock

Direct
investment

Indirect
Investment

capital
market
Instrument

Derivatives

Debt instruments
eg: Bonds,Debentures,
Mortgage backed
assets

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Financial Assets refers to the equities that represents claims, upon the
fixed asset like land, building, and equipment etc. of business enterprise like
Joint Stock Company. These assets are held by individual investors and
institutional investors through direct / indirect.
1. Direct investment: Direct investment indicates the purchasing and
holding of the securities by the investors itself where the profit and loss will
be invested to the investors. It means investment decision is taken by the
investor (like purchasing share, stock, depositing money to the commercial
bank, giving or disbursing loan to the borrowers and purchasing other
financial assets)
2. Indirect Investment: Indirect investment refers to the management of
fund by the organization managed company and trustee. If the fund is
managed by the managed company without the opinion and choice of the
investors is known as the indirect investment. For example mutual fund
(certain amounts of money invested in the portfolio by a group of
individuals).
Direct Investment is further subdivided into three parts asI.

Money Market instrument: Money market instrument are short

term investment invested in securities with maximum duration of one
year. On the other hand, assets having the maturity of less than one
year are the money market instruments. Money market instrument
causes high degree of liquidity but lower profitability. [Here,
profitability is a relative term that indicates the percentage of profit
like- Return on Assets (ROA), Return on Equity (ROE), Return on
Investment (ROI), Earning per share (EPS)]
The popular money market instrument that are commonly traded,
bought and sold which are Treasury Bills, Treasury Notes, Commercial
Papers, Bankers Acceptance, Certificate of Deposits(CDs), Negotiable
Certificate of Deposits, Bills or Drafts means Bill of Exchange. Euro
dollar is the certificate of deposits (CDs) which is only appropriate for
American people. Above
instrument are popular money market
instrument which are high degree of liquidity and the maturity
duration is less than 1 year (It can be one month, 7 days, 6 months
etc.).

II.

Capital Market Instrument: deals with long term financial assets.

Securities or financial assets having the maturity of greater than one
year particularly for longer time are known as capital market
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instrument. These instrument are capital asset because company

collect money through selling these securities as capital which are
shown in the liability side of the balance sheet.
These money as collected through financing decision is used to
acquire the long-term assets, which are real or fixed assets of the
business.
The capital assets are divided into equities and debt instruments. Both
of them are shown in the liability side of the balance sheet.
a. Equity: Equity represents many items as capital. It refers
to a certain amount of money that includes the share and
stocks with other capital. The components of equities are

Paid-up Capital
Surplus
Retained
Earnings
(Undistributed profit)
Reserves
Minority Interest
Convertible debentures
Equity commitment Notes
The composition of money that constitutes the equity is very important term
in understanding corporate finance. A brief on the above components are
given as below

Paid-up capital: Certain amount of company collects through selling

shares or stocks.
Surplus: Amount of money the company collects in addition to the
paid-up capital.
Retained Earnings: Amount of profit that the company retained rather
distributing to the common stock holder is called retained earnings. It
is the part of profit that the company retains for the expansion of the
business, which would be the source of internal equity financing.
Reserve: Reserve is the cumulative of the retained earnings. The
company preserves during the past years. It is the accumulation of
the profit that the owners of the business can get, it is the sources of
internal equity financing. Retained earnings are the profit of the
current years while the reserves are the profit of the past years of the
company. Sometimes it is called the equity reserves because the

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fund is used on may be used to procure the equity capital of the

business.
Minority Interest: Minority Interest is the amount of money that the
company invests into the marketable securities or on the other
company. It is one kind of investment in the financial market for
holding securities of other company. Whatever the amount of
investment, these are the part of equity.
Convertible Debentures: Credit Instrument Company issues this type
of security for raising external capital. It is the money company
borrows under repurchase agreement. i.e. it must be repay on the
maturity. When a company converts the amount of money collected
from selling debentures is as known as convertible debentures.
Debenture holders will be given certain amount of share of the
company as the valued equivalent of the money. In this course of
action company is not supposed to repay the debt rather it can
increase the paid up capital. The higher the debt equity ratio the
higher will be the return on equity. (This rules is comes from MM
Proposition in 1961)
Equity Commitment note: Equity Commitment note is the certain
amount of money that the company would repay through the
issuance of new shares to collect money that it can use to repay the
debt.

Debt Instruments:
Debt instrument refers to the credit of the business. Financial assets that the
company issues to collect companys debt is known as brand or debentures.
This are also known as fixed income securities because income on this assets
is predetermine, certain and fixed. Though bond and debentures are credit
instruments and are fixed income securities there are some diference
between them.
Following are the aspect of the diference1) Bonds are generally issued by public limited companies. State own
enterprises, government organization, autonomous bodies and other
government organizations. On the other hand debentures are issued by
private limited company, private organization
2) The duration or maturity of the bond is longer period of time. But
debentures are issued for short-run period of time.

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3) The income or interest on bond is higher. Then that of debenture. The

certainty of the return of principal and interest bear on higher in case
of bond then those of debentures.
4) Bond is more secure but investment of debenture is less secure.
5) Bonds are secure debentures and debentures are insecure bond.
Derivative:
Derivative refers to financial assets which are derived underlying assets.
These are derived from financial assets which refers to the right to purchases
or sell, financial assets at a certain price at a certain future specified data.
These are exercise in a future debt.
Underlying Assets means existing assets which are tradable held by the
investor.

July 21, 2016

Time Value of Money:
Money can perform four basic function:
i.
ii.
iii.
iv.

A measure
A standard
A media
Store

Money functions as media, measure, standard to keep the quality and money
can perform as store. Money can perform the activity of storing. The value of
money refers to the power of money at diferent time or quantity of money
at diferent time. The value or quantity of money changes over time. Time
always passes away. Time line refers to the amount of money at diferent
time value of the money is the function of money that can be used to
purchase the commodity. Value of money asserts the present value of money
and future value of money for the financial manager concept of time value of
money is very important. Financial manager consider the time value of
money. Present Value of Money means the quantity of money today against a
specified amount of money in future. On the other hand, Future value of
money is the consideration of compounding and discounting.
Compounding increases the value of money in future. It is multiple of the
present value of money. Compounding is used to get the future value some

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amount of money today. Compounding is the factor that increases money

over time.
On the other hand, discounting is the process of minimizing the quantity of
money in future. That results a reduction in the quantity of money.
Discounting indicates a discounting factor. Discounting Factor ad
Compounding Factor clear the concept of time value of money. These factors
are important for the calculation of money or valuation of money over time.
Compounding Factor will be higher than 1 and Discounting Factor will be
lower than 1.
Compounding is categorized as:

Simple Compounding
Multiple Compounding

Simple Compounding or single compounding refers to the compounding to

interest once a year. On the other hand multiple compounding refers the
interest will be compounded more than once a year.
The relationship of the factors can be showed as 1 which is greater than
1
(1+i)

which is greater than

1
(1+i)n

Relation:
(1 + i)n > (1 + i) > 1 >

1
(1+i)

>

1
n
(1+i)

We assume that n would be once a year which must be greater than 1.

Compounding Factor are always greater than 1 and Discounting Factor will be
less than 1. Suppose the interest rate is 10% and the number of year is 5.
Then
n

So, (1 + i) > (1 + i) > 1 >

1
(1+i)

= (1 + 0.10) > (1 + 0.10) > 1 >

>

1
(1+i)n

1
(1+0.10)

>

1
5
(1+0.10)

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= (1.10) > (1.10) > 1 >

1
(1.10)

>

1
5
(1.10)

= 1.61 > 1.10 > 1 > 0.91 > 0.62

This inequality is very clear. The value and amount is greater than 1 are
known as compounding and the value and amount is less than 1 is known as
discounting.
It clears the idea of time value of money where discounting is less than 1 and
compounding is greater than 1. It relates with the present value and future
value. Present value is used to get the future value and future value is used
to get the present value.

PV factors refers to discounting

FV factors refers to compounding

The relationship between Future Value and Present Value:

FVn = PV (1 + i)n
Future Value at n period is equal to the Present Value at today multiplied by
the (1 + i) of n times.
PV =

FVn
n
(1+i)

= FVn x

1
n
(1+i)

Problem 1:
How much will you receive after 5 years if you deposit Tk. 1 lac to a bank
paying 12% annual interest?
Solution:
FVn

= PV (1 + i)n
= 100000 (1 + 0.12)5
= 100000 (1.76234)
= Tk. 176234 Ans.

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Problem 2: Suppose you want to get Tk. 1 lac after 10 years. How much
would you deposit today in a certificate that pays 15% annual interest?
Problem 3: How much will you receive after 5 years deposit from Tk. 100 at
10% interest rate. If interest rate is compounded yearly, half yearly,
quarterly, and bi-monthly.
Solution:
i
FVn = PV ( 1+ m )n.m
Here,

Yearly, m = 1
Half-yearly, m = 2
Quarterly, m = 4
Bi-monthly, m = 6
Daily, m = 360 (at accounting concept)

Important Discussion:
Distinguish between present value factor and future value factor
Distinguish between compounding and discounting
Distinguish between simple compounding and multiple
compounding

How to calculate the Interest Rate by using the concept or formula?

Suppose someone promise you to give Tk. 1000 after 3 years if you give
him/her Tk. 700 today. What interest rate does someone ofer to you?
Solution:
PV =

FVn
n
(1+i)

So, (1 + i)n =

FVn
PV

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Or, (1 + i)3 =

Tk . 1000
Tk . 700

Or, (1 + i)3 = 1.4285

1+i=

1.4285

Or, 1 + i = (1.4285)1/3
Or, 1 + i = 1.1262
Or, i = 1.1262 1

i = 12.62%

How to calculate the year by using formula?

Suppose you deposit Tk. 10000 in a bank at pays 15% annual interest when
your money will be double?
Solution:
PV =

FVn
(1+i)n

Or, 10000 =

2000
n
(1+0.15)

Or, (1.15)n =

20000
1000

Or, n =

2.00
1.15

=2
0.6931
0.1397

Or, n = 4.96

n is 4.96 years

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