Introduction to Corporate Finance

Question 1

It is concerned with the efficient and effective management of the finances of a corporation in order to achieve the objectives of that corporation. This involves in the three most important decisions:

Answer 1

• Financing decision: Planning and controlling the provision of resources (where funds are raised from)
• Investment decision: The allocation of resources (where funds are deployed to)
• Dividend decision: the amount and timing of any cash payments made to the firm’s shareholders.

Question 2

Two key concepts in Corporate Finance

Helping managers to value alternative choices:

Answer 2

1. Relationship between risk and return
2. Time value of money

Question 3

Relationship between risk and return

What is risk?
What is return?
And what is the relationship between them?

Answer 3

Return:

• financial rewards gained as a result of making an investment.
• E.g., profit, dividend payments, capital gains, interest payments

Risk:

• possibility that the actual return may be different from the expected return.
• E.g., risky investment (where there is a significant possibility of actual return being different from its expected return)

Relationship between risk and return:

• “high risk high return” (Investors and companies demand a higher expected return if they think that the possibility of actual return increases)

Question 4

Time value of money

What does this refer to?
Why is it particularly important to companies?
What 3 factors are important?

Answer 4

Time value of money refers to the fact that the value of money changes over time.

particularly important to companies because the financing, investment and dividend decisions made by companies result in substantial cash flows OVER a variety of periods of time.

1. Time
2. Inflation
3. Risk