Corporate Finance: Concepts

Finance is a study of trade off between the present and the future value of money. Corporate can raise capital by using various options. There are various financial instruments available in the market. Broadly, most of the companies in the industry raise financial instruments like bonds, Commercial papers and other instruments on the basis of their requirement as it is industry/company specific.

Role of budgeting in organizations

Budgeting is an important tool for planning and controlling expenses, and is a key activity performed by firms, and its departments. Here’s more on the role of budgeting in organizations and how budgeting can improve the financial performance of the company.

Question: Critically analyse the profitability of the organisation that you work for (or any FTSE 100 Company) for the year 2024. Analyse the role that budgeting might play in improving profitability in future years.

Question: Large corporations may follow specific budgeting methods that may not be available in public domain; you are expected to study how large companies (especially large retail malls) like TESCO PLC budget and derive benefits from the budgeting process and ultimately impact the financial performance.

Budgeting information and its possible uses (250 words)

Major budgets and their importance: Sales budget (which drives all other budgets), cash budget (highlights liquidity of company)

Budgeted vs. Actual Performance (Variance analysis and its benefits)

Different types of budgeting methods and their respective benefits (250 words)

Flexible Budgeting, Rolling forecast, Beyond budgeting etc.

Impact of budgeting on companies’ financial performance (300 words)

Case studies, Industry example.

Net Present Value (NPV) and Internal Rate of Return (IRR)

Net Present Value (NPV) is the value of all future cash flows (positive and negative) over the entire life of an investment discounted to the present.

NPV = (Cash Flow / (1 + i) raised to t) – Initial Investment
i = Required return or discount rate
t = Number of time periods

Management / MBA questions on this topic:

Q) Mr. Rathi is about to retire. His employer offers him post-retirement benefits by way of the following two options:
a) A consolidated amount of Rs 15 lacs
b) An annual pension of Rs 3 lacs in the 1st year, Rs 4 lacs in the 2nd year, Rs 5 lacs in the 3rd year and Rs 6 lacs in the 4th year.
Which option should Mr. Rathi go for, assuming a discount rate of 10%?

Q) X Ltd has to replace its machine and the production manager has to decide between Machine A and Machine B. Machine A is having installation cost of 10,000 and annual electric bill 2000. Machine B has installation cost of 15,000 and annual electric bill of 1000. If both have life of 8 years which machine will you recommend if interest rate is 9 %.

Q) ABC Limited is looking at a Project D with following projected cash flows:
Year, Inflows / (outflow), P .V Factor @ 15%, P .V Factor @ 20%
0, (240,000), 1.000, 1.000
1, 25,000, 0.870, 0.833
2, 75,000, 0.756, 0.694
3, 150,000, 0.658, 0.579
4, 150,000, 0.572, 0.482

Calculate and interpret results

a. NPV at 15 % & 20% (5 Marks)
b. IRR (5

Questions and Answers

Question: Introduction to Financial Instruments: (Submission in Excel only)

A. Identify the types of financial instruments issued by your company as well as for two peers in the same industry. The peer company can be any company’s data available in the public domain. Provide a brief note on the characteristics of these financial instruments. (8 m)

B. Identify the interest paid on these instruments and the term for which the instrument is issued. (6 m)

C. From the past records (you can check the last 5 years), recognize if any financial instruments have been repaid and new instruments have been raised like bonds and the effect in the capital structure. (6 m)

Points to note before attempting the exercise:

In case your company is debt free, work on the assumption that if your company was to borrow, what would be the cost of debt. Even if the management of the company follows a no-debt policy, please work out an optimal debt equity position.

Question:

A. “The basic rationale for the objective of shareholder’s wealth maximization is that it reflects the most efficient use of society’s economic resources and thus leads to a maximization of society’s economic wealth”(Ezra Solomon).Comment critically.
B. Exactly 10 years from now sri chand will start receiving a pension of Rs 3,000 a year .The payment will continue for sixteen years .How much is the pension worth now,if srichand’s interest rate is 10 per cent.

Question:

a) A company is using a machine the original cost of which was Rs 3,70,000 . the machine is 2 years old and has a remaining useful life of 10 years . It is expected that scrapping the old amchine in 10 years from now will fetch Rs 10,000 but if it is sold now to another firm in the industry it would receive Rs 1,00,000 : the straight line method of depreciation is in effect.

The management is contemplating replacing it with a newer and more efficient machine which costs Rs 420000 and has an estimated salvage value of Rs 20000 after its useful life of 10 years. The new machine will have a greater capacity and annual returns are expected to go up by Rs 40,000 per year. The operatinf efficiency of the new machine will also produce an expected savings of Rs 50,000 a year. The company’s tax rate 55%. A 25% investment allowance will apply if the new machine is purchased. Additionally , if the new machine is purchased, inventories will increase by Rs 50,000 receivables by Rs 25000 and payables by Rs 20000 during the life of the project. Determine the economic desirability of the purchase of the machine, assuming the cost of capital to be 12 %.

b) What is meant by the term “leverage”? What are its types? With what type of risk is each leverage generally associated ? why is the increasing leverage ratio indicative of increasing risk? State the situation when there is neither a financial risk nor business risk.

Question:

A company is considering the possibility of raising Rs 100 million, by issuing debt, preference capital, and equity and retaining earnings. The book values and the market values of the issues are as follows:

Ordinary Shares: 40, 60. Preference Shares: 20, 24. Debt: 40, 36

The following costs are expected to be associated with the above mentioned issues of capital. (Assume a 30 per cent tax rate.)
i The debt is in the form of Rs 1,000 face value debenture with a 16 per cent rate of interest.
ii The 11 per cent Rs 100 face value preference shares currently sell at Rs 120 per share.
iii The firm’s ordinary share is currently selling for Rs 150. It is expected that the firm will pay a dividend of Rs 12 per share at the end of the next year, which is expected to grow at a rate of 7 per cent.

Compute the weighted average cost of capital using (i) book value weights (ii) market value weights.

Question:

a) Explain fully the concept of modified IRR? Under what circumstances is it useful? Compare NPV and IRR methods of project evaluation.

b) Management of Talash Ltd. Has the option to buy either Machine A or Machine B. Machine A has cost of 75,000. Its expected life is 6 years with no salvage value at the end. It would generate net cash flows of Rs. 20,000per year. Machine B on the other hand would cost Rs. 50,000. Its expected life is 6 year with no salvage value at the end. It would generate net cash flows of Rs.15,000 per year. Assuming that the cost of capital of both the machine is 10 percent, you are required to calculate:
a. Net present value for each Machine.
b. Internal rate of each Machine.
c. Which machine should be recommended and why?
d. What is the Profitability Index and the Pay Back of the machine.

Academic Questions, examples on DCF Analysis.

Question:

Hier Mobile Ltd. has acquired the licence to manufacture mobile phones from the Sagem catalogue. The new phones will have some modern features that did not exist when the original phones were made but it will NOT have Smartphone capability. The phone has been designed to attract the first generation mobile phone users and is expected to be 90% cheaper than an iPhone. The company expects to generate £3,000,000 of free cash flow, that is expected grow at 30% a year for 3 years and 1.5% thereafter. The company’s cost of capital is 12%.

• a) What is the value of Hier Mobile Ltd.?
• b) Outline the risks for potential investors in Hier Mobile Ltd.

In these practice questions you were given the growth rates 30% a year for 3 years and 1.5% thereafter. In your assignment YOU have to forecast the growth rates for the first five years… You also have to CALCULATE the discount rate and divide the value by the number of outstanding shares of your chosen company. YOU then compare this with the ACTUAL share price to decide whether the share is worth more (BUY) or less (SELL).

Another Example

• Year: 2020, 2021, 2022, 2023, 2024, 2025
• Levered FCF $ millions: -2.4b, -455m, 2.3b, 4.4b, 6.3b
• Present Value: -2,200, -387, 1,700, 3,100, 4,200, 5,100
• Growth Rate: 20 times, 4 times, 7 times, Estimate +47%, Estimate +33.9%, Estimate +24.5%

Consider the above information, the present value of the 10-year cash flow gives a total of $37.3b with a terminal value of $272 billion compared to the present value of $119.9 billion.

But as mentioned, several intrinsic factors come into play with investments.

Depreciation is the reduction in the cost of an asset used for business purpose over a period of time due to factors such as usage, passage of time, wear and tear, technological out-dating or obsolescence, depletion, inadequacy, rot, decay.

Methods of calculating depreciation: Straight line depreciation (Straight line depreciation, Salvage value), Declining balance method, Activity depreciation, Sum-of-years digit method, Units-of-production depreciation method, Group depreciation methods, Composite depreciation methods.

Question on preparing a Balance Sheet

From the following entries, prepare a balance sheet for KKT corp. Ltd. in terms of current assets, fixed assets, intangible assets, current liabilities, long term liabilities and stockholder’s equity.

Entries -> Amount (Rs.)

Goodwill -> 3,000
Patents -> 2,000
Land -> 30,000
Buildings -> 10,000
Equipment -> 5,000
Notes payable -> 8,000
Bonds payable -> 2,000
Common Stock -> 15,000
Retained Earnings -> 7,000
Cash in Hand -> 7,500
Cash in bank -> 7,500
Accounts payable -> 20,000
Taxes payable -> 3,000

Here’s the balance sheet for KKT corp. Ltd.

Question on TDS & Cash Payment.

ABC Ltd.’s profit before tax as per P&L account was Rs. 240 crores. The following information was available regarding ABC Ltd on scrutiny:

1. During the year, it had paid royalty of Rs. 40 crores to a German company, but TDS was not deposited with the
2. IT department till the time of filing income tax returns.
   For a bill of Rs. 30000, ABC Ltd made cash payment of Rs. 30000 to the vendor on 29th January 2018.

Critically analyze whether the above expenditures will be allowed or disallowed as deductions, with reasons, discussing the applicable sections. What will be the impact of such allowance / disallowance on the computation of Profits and Gains from Business or Profession of ABC Ltd for the AY 2018 – 19?

Sources for small businesses and startups to raise funds

Corporate Venture Capital

Money that is invested in Startups is called venture capital, and the investors are called venture capitalists. In return for their capital, the venture capitalists receive an equity stake in the company,

Corporate venturing (or corporate venture capital) is the practice where firms directly invest corporate funds into external startup companies (usually in small, innovative startup companies) with the intention of acquiring a competitive advantage and to access new markets and technologies.

Question: The titles corporate venturing and venture capital are often confused. Using theory, discuss their differences and explain when each is suitable.

Horizontal Analysis vs. Vertical Analysis

Horizontal analysis is the review of a company’s financial statements (performed horizontally ) over multiple periods. Also known as static analysis, Vertical Analysis is the study of relationship between various items of Balance Sheet or statement of Profit & Loss of a single year or period. Vertical analysis is performed vertically inside of a column. It represents amounts as percentages of a base figure.

Question: Economic and Financial Management of the Strategic Decisions of International Marketing.

The work will consist of making an economic-financial analysis from the annual accounts of a real company, applying the content of the subject seen in the class (Descriptive analysis of the business; Horizontal and Vertical Analysis; Ratio analysis).

The scheme of work could be:

• Business presentation;
• Study of the Balance Sheet and Income Statement (Horizontal and Vertical Analysis of the most important components);
• Working Capital calculation;
• Ratios calculation (Liquidity; Solvency; Profitability; Activity);
• Analysis and Valuation of the business
• Final conclusions and Implications

Factors that affect ‘working capital’ management.

Working capital is refers to the capital that a business uses for its day-to-day trading operations. It’s calculated as current assets minus current liabilities.

Here we take a look at the various factors that has an impact on the working capital. Depending on these factors (that applies to the business), a company may require less or more working capital for conducting its business smoothly.

Nature of the Business / Industry
Seasonal Factors
Length of the Production Cycle
Scale of Operations / Growth Prospects
Credit Policy
Level of Competition
Operating Efficiency
Availability of Raw Material
Inflation

Management / MBA question on this topic:

Miss Ninna is planning to open a boutique at link road. Her financial advisor says that its essential to take care and manage well the working capital, as it ensures smooth running of the operating cycle of business. However, there are various factors which affects the working capital management. If you being the financial advisor of Miss Ninna, discuss those factors in detail.

SWIFT interbank payments system explained.

SWIFT is the acronym for The Society for Worldwide Interbank Financial Telecommunication. Founded in 1973, Belgium-based SWIFT is the world’s international payments network.

Swift does not handle actual transfer of funds itself, but instead uses a messaging system (operates more like a middleman) to facilitate rapid cross border payments in a secure and inexpensive manner.

The SWIFT messaging system was developed in the 1970s to replace relying upon Telex machines.

The firm is a co-operative of banks that uses messaging service to facilitate cross border payments. The firm is managed by the G-10 central banks (Belgium, Canada, France, Germany, Italy, Japan, The Netherlands, United Kingdom, United States, Switzerland, and Sweden), the European Central Bank, and the National Bank of Belgium.

In 2012, a SWIFT Oversight Forum was further established, in which central banks from several major economies also joined the G-10 central banks.

Today, thousands of financial institutions in over 200 countries use the SWIFT international payments system.

A per SWIFT’s official website, over 40 million messages are sent every day using the SWIFT system, amount to transactions worth trillions of dollars.

Today, SWIFT is to the financial world like what Internet is to the common population.

Website: Swift.com

What is SWIFT? How Russian banks got cut out of the financial system due to the Ukraine war

Operating leverage, financial leverage, combined leverage

The degree of combined leverage (DCL) summarizes the effect of both operating and financial leverage has on the Earning per share (EPS). The ratio provides an idea of the total risk of the business, because it includes both operational risk as well as financial risk.

Management (MBA) questions on this topic:

The data related to two companies A and B, are as under-

Company A
Sales 500000
Variable cost 20% of sales
Fixed Cost 1.2 lacs
Interest 0.5 lacs

company B
Sales 1000000
Variable cost 25% of sales
Fixed Cost 2 lacs
Interest 0.75 lacs

Q) Determine the operating and financial leverage (5 Marks)
Q) Determine the combined leverage for them. Also, comment on the relative risk position of the companies