Corporate Finance Part 1

Regular blog readers may have noticed the two-month gap since my last blog post; I have recently returned from a self-imposed moratorium on MBA studies, to spend some time with my second newborn son. This is one of the advantages of the distance-learning MBA, as you can adjust your schedule within each six-month semester to suit personal circumstances. However, it was only feasible for me this semester as I’m studying a single module and starting my project; I wouldn’t recommend taking two months off with the usual three modules to complete! Anyway, I’ve recently picked up the textbook again, and am swiftly working through my final MBA module, Corporate Finance.

This module fits in the same discipline as one of my previous electives, Management Accounting. However, whereas the latter mainly focussed on operational financial topics such as costing, budgeting and performance measurement, Corporate Finance instead looks at the financial decisions taken prior to this, with a focus on three specific questions:

Corporate Finance textbook
The Corporate Finance textbook
  1. Capital budgeting decisions – How should different investment opportunities be analysed, evaluated and compared?
  2. Financing decisions – Should investment be financed through equity in the corporation, or through the sale of debt?
  3. Payout policy decisions – How should the corporation balance shareholder returns with investing for future growth?

Another difference between the two modules is that Corporate Finance only looks at corporations, which is an organisation where ownership is separate from control (ie. owned by shareholders, controlled by management). However, I think some of the concepts that are discussed will also be valuable to privately-owned organisations.

The module is split into three different sections, the first being a ‘Foundations’ section, which includes two lessons to provide an introduction to the overall subject. These were mainly refresher lessons, reminding us of the time value of money, the different types of companies, and potential areas of conflict between shareholders, managers and creditors of a corporation. There was also a review of the financial statements and financial ratios – although these were covered in depth in Accounting and Financial Management, it was helpful to review these given the latter module was studied two years ago. In addition, the concept of financial planning was introduced in the second lesson, which in the context of this module means looking at a stated corporate strategy (eg. grow revenues by 20%), and then building future financial statements based on a set of rules for the future (eg. Percentage-of-sales model).

The second section of the module is called ‘The firm and the financial markets’, and although still providing background and context to the above three questions, this is where we are introduced to some new concepts. It starts with a lesson that explores the different sources of capital, including short-term sources of debt such as bills and commercial paper, along with long-term sources such as bonds. This was followed by an explanation of raising capital through equity in the form of an IPO and SEO; I found this discussion really interesting, as I have read about a number of IPOs in the news during the course of my MBA, but never properly appreciated the processes involved in the initial pricing of shares.

Lesson four, which I am currently studying now, is a natural progression from the IPO discussion, as it looks at how equity is valued when being traded on the secondary markets after an IPO. The Dividend-Discount and Discounted Cash Flow models are explained, following which the lesson looks at whether it is better to retain earnings instead of paying dividends, and the role of the P/E ratio. The section then closes with lesson five, which looks at risk, return, and the capital asset pricing model (CAPM).

The final section of this module is ‘Corporate financial management‘, and has one lesson for each of the three questions above, plus a second lesson on Advanced Capital Budgeting and a final lesson on Mergers and Acquisitions. In addition to looking forward to exploring the core questions for this module, I’m also really keen to study the final lesson, as Mergers and Acquisitions was on my shortlist of elective modules, and hence it will be good to spend some time looking at this from a financial perspective.

So that’s a quick summary of the first half of Corporate Finance. Although it has been reasonably interesting, most of the topics in lessons 1-4 have been contextual to the main issues; I expect the second half of the module will be much more in-depth and start to provide some real insight into how and why different financial decisions are made. I’ll post a further update when I’m finished, to give an overview of what was covered.

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