PAPER NO. 10 CORPORATE FINANCE
UNIT DESCRIPTION
This paper is intended to equip the candidate with the knowledge, skills and techniques that will enable him/her to make effective corporate financial decisions.
8.0 LEARNING OUTCOMES
A candidate who passes this paper should be able to:
• Analyse the cost of capital of various sources of debt and equity in a firm
• Formulate appropriate capital structure decisions and select the optimal capital structure of a firm
• Appraise and formulate capital budgeting decisions under environment of certainty, uncertainty and risk
• Manage working capital for a firm
• Analyse mergers and acquisitions and corporate restructuring in firms
• Advise on dividend policy decisions
CONTENT
1. Overview of Corporate Finance
1.1 Nature and scope of corporate finance
1.2 Overview of financial decision-making process
1.3 Functions of a finance manager
1.4 The goals of a firm
1.5 Agency theory concepts, conflicts and resolutions
1.6 Measuring managerial performance, compensation and incentives.
2. Capital Structure
2.1 Sources of capital
2.2 Factors to consider when selecting source of funds
2.3 Capital structure of a firm and factors influencing capital structure
2.4 Evaluation of financing proposals and determination of operating profit/EPS at the point of indifference, range of combined operating profit within which to recommend the financing option, lease vs. buy decisions
2.5 Capital structure theories: traditional theories; net income (NI) approach; net operating income (NOI) approach; Franco Modigliani and Merton Miller (MM) propositions-MM without taxes, MM with corporate taxes, MM with corporate and personal taxes, and MM with taxes and financial distress costs; trade-off theory and pecking order theory.
2.6 Target capital structure; reasons why a company’s actual capital structure may fluctuate around its target
2.7 Measures of leverage: Overview of leverage; importance of business risk, sales risk, operating risk, and financial risk in leverage; classification of a risk; degree of operating leverage, the degree of financial leverage, and the degree of total leverage; breakeven quantity of sales and determination of the company’s net income at various sales levels; computation of the operating breakeven quantity of sales, evolution of financing options and determination of operating profit (EBIT)/EPS at the point of indifference, range of combined operating profit (EBIT) within each financing
3. Cost of Capital
3.1 The concept and significance of cost of capital
3.2 Components of cost of capital
3.3 Weighted average cost of capital (WACC)
3.4 Marginal cost of capital (MCC)
3.5 Use of marginal cost of capital and the investment opportunity schedule in determination of the optimal capital budget
3.6 Cost of debt capital using the yield-to-maturity approach and the debt-rating approach
3.7 Computation of the cost of non-callable and nonconvertible preferred shares
3.8 Computation of the cost of equity capital using the capital asset pricing model, the dividend discount model, and the bond-yield-plus risk-premium approach
3.9 Computation of the beta and cost of capital for a project
3.10 Uses of country risk premiums in estimating the cost of equity
4. Capital Investment Decisions
4.1 Capital Investment Decisions under Certainty
4.1.1 Nature of capital investment decisions under certainty
4.1.2 Classification of capital budgeting decisions
4.1.3 Ideal features of a capital budgeting technique
4.1.4 Categories of capital projects
4.1.5 Basic principles of capital budgeting; evaluation and selection of capital projects: mutually exclusive projects and project sequencing
4.1.6 Capital budgeting techniques under certainty
4.1.7 Estimating project cash flows.
4.2 Capital Investment Decisions under Uncertainty
4.2.1 Nature and measurement of risk and uncertainty
4.2.2 Investment decision under capital rationing: multi period; investment decision under inflation, investment decision under uncertainty/risk
4.2.3 Techniques of handling risk: sensitivity analysis; scenario analysis; simulation analysis; decision theory models; certainty equivalent; risk adjusted discount rates; utility curves
4.2.4 Special cases in investment decisions: projects with unequal lives; replacement analysis; abandonment decisions
4.2.5 Real options in investment decisions: types of real options; evaluation of capital projects using real options
4.2.6 Common capital budgeting pitfalls
4.2.7 Computation of accounting income and economic income in the context of capital budgeting
4.2.8 Evaluation of a capital project using economic profit, residual income, and claims valuation models for capital budgeting.
5. Management of Working Capital
5.1 Factors influencing working capital requirements of a firm
5.2 Distinction between working capital and management of working capital
5.3 Working capital concepts; gross and net working capital; seasonal and permanent working capital
5.4 Primary and secondary sources of liquidity; factors that influencing a company’s liquidity position
5.5 Company’s liquidity measures in comparison to those of peer companies
5.6 Evaluation of working capital effectiveness of a company based on its operating and cash conversion cycles; comparison of the company’s effectiveness with that of peer companies
5.7 Effect of different types of cash flows on a company’s net daily cash position
5.8 Computation of comparable yields on various securities; evaluation of a company’s short-term working capital investment and financing policy guidelines
5.9 Company’s management of accounts receivable, inventory, cash and accounts payable over time and compared to peer companies
5.10 Evaluation of the choices of short-term funding available to a company
5.11 Profitability- liquidity trade-off.
6. Mergers and Acquisitions
6.1.1 Classification of merger and acquisition (M&A) activities based on forms of integration and relatedness of business activities
6.1.2 Common motivation and demotivation behind mergers and acquisitions; mergers and acquisition in global context
6.1.3 Bootstrapping of earnings per share (EPS); computation of a company’s post- merger EPS
6.1.4 The relationship between merger motivations and types of mergers based on industry life cycles
6.1.5 Contrast merger transaction characteristics by form of acquisition, method of payment and attitude of target management
6.1.6 Pre-offer defence mechanisms and post-offer takeover defence mechanisms
6.1.7 Computation of Herfindahl-Hirschman Index, and the likelihood of an antitrust challenge for a given business combination
6.1.8 Discounted cash flow analysis, comparable company analyses, and comparable transaction analyses for valuing a target company, including the advantages and disadvantages of each
6.1.9 Computation of free cash flows for a target company, and estimation of the company’s intrinsic value based on discounted cash flow analysis
6.1.10 Estimation of the value of a target company using comparable company and comparable transaction analyses
6.1.11 Evaluation of a takeover bid; computation of the estimated post-acquisition value of an acquirer and the gains accrued to the target shareholders versus the acquirer shareholders
6.1.12 Effect of price and payment method to the distribution of risks and benefits in M&A transactions
6.1.13 Characteristics of M&A transactions that create value
6.1.14 Reasons for failed mergers
6.1.15 Emerging trends in mergers and acquisitions.
7. Analysis of Corporate Growth and Restructuring
7.1.1 Measurements of growth: methods of determining growth rates, sustainable versus non sustainable growth analysis of potential growth, franchise value and the growth process
7.1.2 Return on assets (ROA) and return on capital (ROC)
7.1.3 Common reasons for restructuring
7.1.4 Relative company return analysis
7.1.5 Valuation and analysis of corporate restructuring; leveraged buyouts (LBO); divestitures; strategic alliances; liquidation; recapitalisation
7.1.6 Financial distress, predicting organisational failure, solutions to financial distress
7.1.7 Financial restructuring; restructuring via capital reorganisation, the impact of financial restructuring on share price and WACC; forms of financial restructuring
7.1.8 Portfolio restructuring; divestment, demergers, spinoffs, liquidation, equity carve- outs, MBO and management buy in
7.1.9 Organisational restructuring and emerging trends in corporate restructuring.
8. Dividend Policy
8.1.1 Forms of dividends: Regular cash dividends, extra dividends, liquidating dividends, stock dividends, stock splits, and reverse stock splits: their expected effect on shareholders’ wealth and a company’s financial ratios
8.2 Dividend payment chronology: Declaration date, holder-of-record date, ex- dividend date, and payment dates
8.3 Theories of dividend policy
8.4 Types of information (signals) that dividends convey
8.5 Clientele effects and agency issues: their effect on a company’s payout policy
8.6 Factors that affect dividend policy of a firm
8.7 Dividend payout policies; stable dividend, constant dividend, payout ratio, and residual dividend
8.8 Choice between paying cash dividends and repurchasing shares
8.9 Calculation and interpretation of dividend coverage ratios under net income and free cash flow
8.10 Emerging trends of dividend policy in corporate firms.
9. Islamic Finance
9.1 Justification for Islamic Finance; history of Islamic finance; capitalism; halal; haram; riba; gharar; usury
9.2 Principles underlying Islamic finance: principle of not paying or charging interest, principle of not investing in forbidden items example alcohol, pork, gambling or pornography; ethical investing; moral purchases
9.3 The concept of interest (riba) and how returns are made by Islamic financial securities
9.4 Sources of finance in Islamic financing: muhabaha, sukuk, musharaka, mudaraba
9.5 Types of Islamic financial products: – sharia-compliant products: Islamic investment funds; Takaful the Islamic version of Insurance Islamic Mortgage, Murabahah; Leasing- Ijara; safekeeping- Wadiah; Sukuk- Islamic bonds and securitisation; Sovereign sukuk; Islamic investment funds; Joint venture – Musharaka, Islamic banking, Islamic contracts, Islamic treasury products and hedging products, Islamic equity funds; Islamic derivatives
9.6 International standardisation/regulations of Islamic Finance: Case for standardisation using religious and prudential guidance, National regulators, Islamic Financial Services Board.
10. Green/Environmental Finance
10.1 The nature and scope of green or environmental finance
10.2 Green financing strategies and challenges
10.3 Carbon finance, emissions trading, green trading and renewable energy
10.4 Green finance trading of financial instruments
10.5 Valuation of green financial instruments namely; green bonds, green stocks, green derivatives, grants and guarantees
10.6 Theoretical and methodological approaches in developing green financial framework
10.7 Modern risks emerging from ecological, social, and geopolitical environment in green finance context
10.8 Green finance trends and regulation locally and globally
11 Corporate Risk Management
11.1 The nature and scope of corporate risk management in firms
11.2 Value of risk management and comparative advantages of risk taking
11.3 Value at risk and numerical and parametric methods of VaR in a firm
11.4 Description of CVaR and CVaR in Basel Regulation
11.5 Regulation of Bank risk and use of VaR
11.6 Risk management, corporate governance and financial crisis
11.7 Corporate risk management trends in firms
Sample reading and reference material
1. Brealey, R. A., Myers, S. C., & Allen, F. (2019). Principles of Corporate Finance (13th edition). Boston: McGraw-Hill Education.
2. Brigham, E. F., & Daves, P. R. (2021). Intermediate Financial Management (14th edition). Australia: Cengage Learning.
3. Dionne, G. (2019). Corporate Risk Management: Theories and Applications. New Jersey: Wiley.
4. Ross, S., Westerfield, R., & Jordan, B. (2021). Fundamentals of Corporate Finance (13th edition). New York: McGraw-Hill.
5. Thompson, S. (2021). Green and Sustainable Finance: Principles and Practice. London: KoganPage.
6. Kasneb e-learning resources (link on the Kasneb website)
7. Kasneb approved study packs