Fundamentals of Corporate Finance

The fundamentals of corporate finance carry a lot of importance in the corporate decision making issues.

Corporate finance addresses the financial decisions that the companies take and the methods and analytical devices applied for taking those decisions. Corporate finance is a key segment of finance.

The principal objective of corporate finance is the maximization of corporate value and at the same time, decreasing or diminishing the financial risk factors of the company. Rationally, corporate finance is not similar to managerial finance that analyzes the financial decisions of every company instead of corporations solely. However, the principal ideas in the field of corporate finance are capable of being applied for resolving adverse financial circumstances of every type of company.

The fundamentals of corporate finance deal with two aspects of corporate finance and they are the following:

• Short term decisions and methods
• Long term decisions and methods

Capital investment decisions are regarded as long term decisions that deal with which project to invest in, whether it is feasible to fund the investment with debt or equity, as well as the time when dividend should be paid to the shareholders. Contrarily, the short-term decisions may be consolidated under Working Capital Management. This domain addresses the short-term equilibrium between current liabilities and current assets. Here the stress is on management of stocks and inventories, cash, as well as borrowing and loaning on the short-term basis, for example the terms and conditions on which loan is provided to the clients.

In addition, the expressions 'corporate financier" and 'corporate finance' are related to investment banking. The common function of an investment banker is to assess investment plans for a banking institution for taking decisions on investment.

The capital investment decisions are corporate finance decisions and are associated with capital structure and fixed assets in the long term. The decisions are taken on the basis of various interconnected standards. Corporate management tries to produce the highest possible value of the firm through investment in ventures that generate positive NPV or net present value at the time when valuation is done utilizing a proper rate of discount. All the projects should be funded in a proper manner. Capital investment decisions consist of a financing decision, an investment decision, as well as a dividend decision.

The capital investment decisions can be categorized into the following types:

Investment Decision

The procedure of allocation of resources carried out by the management is termed as capital budgeting.

Project valuation

The methods utilized include the following:


• Discounted Cash Flow Method (DCF)
• NPV or Net Present Value Method
• Weighted Average Cost of Capital (WACC)
• Capital Asset Pricing Model (CAPM)
• Arbitrage Pricing Theory (APT)
• Internal Rate of Return (IRR)
• Modified IRR
• ROI or Return on Investment
• Equivalent annuity

Valuation of flexibility

The most basic devices are the following:

• Real Options Analysis
• Decision Tree Analysis or DTA

Financing Decision

The following tools and models are utilized regarding financing decisions:

• Capital Asset Pricing Model (CAPM)
• Weighted Average Cost of Capital (WACC)
• Balance Sheet Analysis
• Modigliani-Miller theorem
• Fisher separation theorem
• Pecking Order Theory
• Trade-Off Theory

Dividend Decision

Basically, dividend is distributed in two forms and they are the following:

• Share buyback
• Cash dividends

Working Capital Management

The process of working capital management can be categorized into the following types:

• Debtors management
• Cash management
• Inventory management
• Short term financing

The decision regarding working capital is dependent on the following criteria:

• Cash conversion cycle
• Return on capital (ROC)

The essentials of corporate finance also focus on various types of corporate risks and they include the following:

• Default risk
• Financial risk
• Interest rate risk
• Credit risk
• Market risk
• Liquidity risk
• Volatility risk
• Operational risk
• Settlement risk