BAC 823: Corporate Finance Notes-Kenyatta University

1. Introduction
Overview of Corporate Financial management
Types of firms, Goals of the firm
The Agency problem – Management Vs. Owners
2. The Time Value of Money
Concept of time value of money
The derivation of cash flows
Application of the Time Value of money in project appraisal
Project appraisal methods
3. Valuation of Bonds and Shares
4. Risk and Return
Risk of returns
Returns on securities &Asset returns
Systematic and unsystematic risk
5. Capital Budgetting (Long term financing)
– Capital and financial structure
– The concept of leverage/gearing
– Cost of capital and importance
6. Dividend policies and decisions
– When, How and how much to pay as dividends
– Factors influencing firms dividends policy
7. Working Capital Management
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LESSON 1
FINANCIAL MANAGEMENT
In everyday definition Financial Management refers to the management of organizations money. In
professional terms it refers to the tasks in an organization, which lead to the planning for, acquiring
and utilizing funds in order to maximize the efficiency and value of an enterprise.
A financial manager is concerned with 3 basic questions.
1) Capital budgeting
2) Capital structure
3) Working capital management
Capital budgeting is the processing of planning and managing a firm’s long-term investments. It’s
evaluating the size, timing and value of future cash flows.
Capital structure is the specific mix of long-term debt and equity the firm uses to finance its
operations.
Working capital management refers to firm’s short-term assets such as inventory, the money it is
owed and its debts to suppliers. Managing the firm working capital is the day-to-day activity that
ensures the firm has sufficient resources to continue generating without interruptions.
The goal of the firm
In financial management of an enterprise, all things considered, it is assumed that management’s
primary goal is to maximize shareholders wealth. This translates to maximizing the price of the
shares of the shareholders. This price maximization is central to all financial management action and
decisions.
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Shareholders buy stock because they seek to gain financially. The good decisions by the financial
manager increase value of stock and poor decisions decrease it.
The goal of financials management is to maximize the current value per share of existing stock.
Because the goal of financial management is to maximize the value of the stock, we need to learn
how to identify those investments and financing arrangements that favorably impact on the value of
the stock. Indeed you can think of corporate finance as the study of the relationship between business
decisions and the value of the stock in the business.
What should management do or achieve in order to maximize share prices?
First it must maximize profit. But profit to the firm is not necessarily profit to the shareholder and
profit per share can be diluted by insurance of more shares. So a management interested in the well
being of its shareholders should concentrate on earnings per share rather than total corporate
earnings.
Two factors affect the efforts to increase value of a share
1. Timing of the earnings
2. Risk
For example you are offered 200,000/- per year for 5 years, which is 1,000000/-. And you are offered
a lump sum of 1,100,000/= in the fifth year only. Which is the better deal? We shall soon be able to
tell using a tool called the time value of money to the investors.
As regards risk, suppose one project gives 100/= per share but the other can give 150/= or 90/= per
share. Which is better? We shall soon see that risk can be measured and that what one shareholder
will accept another will reject though the risk be the same as investor’s attitude to risk differs.
We shall soon appreciate that the riskiness of a project depends on how the firm is capitalized. Debt
increases the risk ness- but usually also the profitability as the investor uses other people’s money for
capital.
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We shall soon also see