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CORPORATE FINANCE-METHODS OF FINANCING ENTERPRISES

CORPORATE FINANCE-METHODS OF FINANCING ENTERPRISES. Lecture outline. The notion and goal of corporate finance Sources of financing companies Sources of capital in companies. Corporate finance-definition.

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CORPORATE FINANCE-METHODS OF FINANCING ENTERPRISES

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  1. CORPORATE FINANCE-METHODS OF FINANCING ENTERPRISES Finance 110631-1165

  2. Lecture outline • The notion and goal of corporate finance • Sources of financing companies • Sources of capital in companies Finance 110631-1165

  3. Corporate finance-definition • An area of finance focused on monetary flows in enterprises, on the ways of financing the companies’ activity and methods of financial analysis Finance 110631-1165

  4. Financial decisions • Short term eg. settling current liabilities • Long term egg. fundraising, investments Finance 110631-1165

  5. The goal of corporate finance • The goal depends on the legal form and activity profile of the company • Maximizing the company’s profit • Ensuring the company’s liquidity • Maximizing the company’s value Finance 110631-1165

  6. Liquidity vs. solvency • Liquidity- the ability to settle current payments within the specified contract deadlines (short term) • Solvency- the ability to meet long term financial liabilities Finance 110631-1165

  7. The company’s value • Several ways of company valuation eg.asset based, income based, market based • The problem- which method reflects best the company’s value? • The most popular- discounted cashflow Finance 110631-1165

  8. Financing the company’s activity • The company’s activity requires several types of resources • Monetary resources • Current assets • Fixed assets Finance 110631-1165

  9. Financing the company’s activity • In the process of corporate financing there is constant transformation of monetary resources into assets and vice versa • E.g. the purchase of production infrastructure or the sell of manufactured goods Finance 110631-1165

  10. Sources of financing Internal sources e.g. the company’s profits, sell of assets External sources- fundraising e.g. issuing bonds, issuing equity securities, bank loans Finance 110631-1165

  11. Sources of capital (1) • Sources of capital ≠ sources of financing • Not every source of financing is a source of capital! • Monetary resources become capital only if they are invested! Finance 110631-1165

  12. Sources of capital (2) Own capital also called equity- contributed by the owner or entrepreneur Borrowed capital- contributed by an external institution or person Finance 110631-1165

  13. Own capital (equity) • Own capital does not have to be returned in contrast to borrowed capital • Therefore it is a safe source of financing • It constitutes a guarantee for the creditors • It enables the supervision of the shareholders/owners over the management Finance 110631-1165

  14. Own capital-examples • Income derived from equity securities (shares) issuance –this is an external source of own capital • Income derived from the companies profit division –this is an internal source of own capital Finance 110631-1165 Finance 110631-1165

  15. Short term and long term loans Income derived from the issuance of long term and short term debt securities eg. bonds Borrowed capital- examples Finance 110631-1165

  16. Capital provision process • Investors provide capital to the company and receive a rate of return (interest payments) • The company invests the capital during its activity and receives a rate of profitability • Providing capital enables the company to invest and not to achieve a monetary surplus therefore this process is different from just providing finance! Finance 110631-1165

  17. The financial decisions of the company • Decisions concerning the sources of financing and the sources of capital • Decisions concerning investments • Decisions concerning revenue division (payment of dividends) Finance 110631-1165

  18. The financing strategy (1) • External or internal financing • The choice of capital sources • The choice of instruments to raise capital Finance 110631-1165

  19. The financing strategy (2) • The financing strategy depends on the specific financing need • E.g. Fixed assets should be financed by long term capital Finance 110631-1165

  20. The choice of capital source • Own or borrowed • Long term or short term • Domestic or international sources • Provided by financial markets or financial institutions • Balance sheet or off-balance sheet capital Finance 110631-1165

  21. Capital structure The choice of capital sources influences the capital structure vital importance For some types of companies there are regulatory requirements concerning capital structure Finance 110631-1165

  22. Own or borrowed capital? • The most important decision is whether the company requires own or borrowed capital • This choice influences the division of future profits • The profit can constitute a future internal source of own capital • If the company has to pay dividends- it will need external sources of capital Finance 110631-1165

  23. Long term or short term capital? • The share of long and short term capital depends on the structure of the assets of the company • Current assets • Fixed assets Finance 110631-1165

  24. Assets • Fixed assets • Current assets Liabilities • Equity • Borrowed capital (interest payments) • Other liabilities (no interest payments) Finance 110631-1165

  25. Long term or short term capital? • The capital requirement period should be synchronized with the period of the requirement of the assets which are financed by this capital • Fixed capital≥Fixed assets • Short term liabilities≤ current assets • This should ensure liquidity Finance 110631-1165

  26. Why do companies raise capital abroad? • More investors compared to the domestic market • Higher market liquidity • Lower capital cost (lower interest payments, favorable regulations) • Diversification of capital sources • Company’s image Finance 110631-1165

  27. What risk do firms face when raising capital abroad? • Exchange rate risk the need of insurance • Currency mismatch- assets and liabilities held in different currencies • High start up costs on foreign financial markets Finance 110631-1165

  28. Broader access to capital Higher liquidity of issued securities Objective valuation of the company Increasing credibility of the company High entry costs Disclosure requirements Hostile takeover possibility Is it profitable to raise capital on financial markets ? Finance 110631-1165

  29. Balance-sheet or off balance sheet capital? • Off-balance sheet capital- a tool of risk management • Off-balance sheet capital is a reserve for unforeseen circumstances e.g. in the case of indemnity payments Finance 110631-1165

  30. Off- balance sheet capital-examples • Conditional financing- funds are provided if specified conditions are met e.g. a natural disaster takes place • Contingent capital • Catastrophe bonds Finance 110631-1165

  31. The meaning of capital provision • Capital provision determines the scope of economic activity • Potential measure-domestic credit to private sector • Financial resources provided to the private sector: loans, purchases of nonequity securities, trade credits Finance 110631-1165

  32. Source:World Bank

  33. Literature R.W.Melicher, E.A.Norton, Introduction to Finance. Markets, Investments and Financial Management, John Wiley&Sons,2007 Finance 110631-1165

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