corporate finance final

8/3/2019 Corporate Finance Final

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Corporate Finance

SYBFM


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Corporate

Corporate is a business or entity which has separate legalpersonality, with limited liability or unlimited liability for itsmembers or shareholders, who buy and sell theirshares/stocks depending on the performance of the board

of directors. corporations differ from sole proprietorships

Finance function is the function which determines andbrings the future financial resources need for the companyfrom different sources like banks and financial institutions

finance deals with matters related to money and themarkets.

It is nothing but management of money.


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Introduction to Corporate FinanceIntroduction to Corporate Finance

Corporate Finance addresses the following three

questions:

1. What long-term investments should thefirm engage in?

2. How can the firm raise money for the

required investments?

3. How much short-term cash flow does a

company need to pay its bills?


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Shareholders Equity

Current Liabilities

Long-Term Debt

Liabilities to company

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Total Value of Assets:


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Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

Current Liabilities

Long-Term Debt

What long-

terminvestmentsshould thefirm engagein?

The Capital Budgeting Decision(Investment Decision)


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How can the firm

raise the money

for the required

investments?

The Capital Structure Decision

(Financing Decision)

Current Assets

Fixed Assets

1 Tangible

2 Intangible

Shareholders

Equity

Current Liabilities

Long-Term Debt


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How much short-

term cash flowdoes a companyneed to pay itsbills?

The Net Working Capital Investment Decision

(Financial Decision)

NetWorking

Capital

Shareholders

Equity

Current Liabilities

Long-Term Debt

Current Assets

Fixed Assets

1 Tangible

2 Intangible


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Financial Markets

Primary Market

When a corporation issues securities, cash flows

from investors to the firm.

Usually an underwriter is involved

Secondary Markets

Involve the sale of used securities from one

investor to another.

Securities may be exchange traded or trade over-

the-counter in a dealer market.


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Financial Markets

Company

Investors

Secondary Market

money

securities

SellBuy

Stocks and

Bonds

Money

Primary Market


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Role of Financial institution in working

capital finance Working capital finance

Bridge finance

Project finance

Project Report

Feasibility study

Priority sector lending

Concessional rate of interest

Credit rating

Supplementary sources Advisory role

Helps in implementing govt. policies.


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Bridge finance

It is short term source of finance.

Rate of interest is very high.

A method of financing, used by companies before their IPO, toobtain necessary cash for the maintenance of operations.

Financing that an investment bank or venture capital firm extendsuntil long-term financing can be arranged.

A bridge loan is a short-term, high-interest loan that provides aquick source of cash for commercial or individual needs. It is calleda bridge loan because it serves as a bridge between one period offunding and another, more permanent source of funding.

Example: suppose a company has been approved for a 10 crore loanfrom a bank. However, this money will not be available for sixmonths, and they are running short on cash. The company couldapply for a six-month bridge loan of 10 lakhs to cover theirexpenses until the money from the 10 crore comes through.


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Project finance

Financing of long term infrastructure and/or industrial projects using debtand equity

Debt is typically repaid using cash flow generated from the operations ofthe project.

Limited recourse to project sponsorsDebt is typically secured by projects assets, including revenue producing

contractsFirst priority on project cash flows is given to the Lender

Consent of the Lender is required to disburse any surplus cash flows to projectsponsors

Higher risk projects may require the surety/guarantees of the projectsponsors

project financing is a loan structure that relies primarily on the project'scash flow for repayment, with the project's assets, rights, and interestsheld as secondary security or collateral.


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Type of finance on the basis of time of

payment.

Short term finance is less than 36 months

Medium term finance is 36-72 months

Long term finance greater than 72 months


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Credit analysis/Rating

Credit rating evaluate the capacity of borrower torepay the debt(Principal + Interest) in timeaccording to agreement.

Five cs of credit rating Character(Citizen)

Capacity(cash flow)

Capital(wealth) Collateral(security)

Conditions(downside).


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Term Loan

Basic Features

Maturity

Agreement

Security

Charge


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security

Primary security:

Term loan are secured by assets acquired

using term loan fund. Secondary security:

Term loan secured by the company current

assets and future assets. It is also known ascollateral security.

Verification of security:


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Charge

Charge means transfer the right or interest in theassets of person in favour of lender for thepurpose of security the repayment of loan.

First charge and second charge: Fixed and floating charge:

Lien:

Mortgage:

Hypothecation: Pledge:

Pari passu clause:


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Covenants

Covenants are the basic condition that the lender should follow.

Assets related

Minimum assets base

Current ratioNot to sell assets without lenders approval

Refrain from creating additional charge on assets

Liability related

Restrained from incurring additional debt.Repay existing loan

Reduce debt equity by incurring additional equity shares

Limits the freedom of promoters to dispose of their shareholding.


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Covenants

Cash flow related covenants

Restricting cash dividend

Restricting cash expenditure

Restricting salaries and perks of managerial staff. Etc

Control related

Appointment of nominee directors by financials institutions to

safeguard the interest of financials institution.


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Repayment schedule

Repayment of term loan has two components

Interest

Repayment of principal

Two types of amortisation

1. Equal principal payment also know as baloon payment: Repayment of principal in equal installment and pay interest

on outstanding loan. Such payment is called baloon payment.

2. Equal installment payment: An alternate way for amortising loan is to require to pay equalloan installment including both interest and principal.


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Interest

1. It is tax deductible for borrowing firm.

2. Concessional rate of interest for projects in backward areas.

3. In case of default in repayment additional interest of 2% p.a. for theperiod of default on the amount of principal and interest is to be paid.

4. Interest= MLR+ Risk involved

5. Interest rate is not related to the period or amount of the loan given butto the credit rating of the borrower as decided by bank.

6. Penal interest and additional interest:

7. Penal interest is charged over and above regular interest rate when theborrower fails to comply with one or more stipulated terms andconditions without any approval of appropriate authority.

Eg. Fails to submit stock statement to bank Sell of assets without approval

Fails to maintain the covenants.


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Term loan:

Advantages:

Cost is low than cost of equity or preference capital

It do not result in dilution of control

They are backed by security which the lender always prefer.

DisadvantagesIt do not carry voting rights

It do not represent negotiable instrument

Payment of interest and repayment of principal is obligation.

Failure to meet result into penalty or additional interest.


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Illustration 1

Prepare an amortisation schedule form the

following information, assuming that theprincipal amount is repayable equally along

with interest payable on outstanding loan:

Amount borrowed Rs 6,00,000

Annual interest 11%

Repayment period 6 years.


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Illustration 2

Prepare an amortisation schedule form the

following information, assuming that theamount is an equated annual installment:

Amount borrowed Rs 12,00,000

Annual interest 10% Repayment period 10 years.


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Moratorium and flash report

Moratorium:The period between the release of loan and the first principal

installment payment is known as moratorium.

This is necessary because new machinery after installationalways take time to recover the overheads and expensesbefore generating the profits to pay installments.

Flash report:It is prepared by the bank

It show whether it is feasible to provide the loan to the applicantsIT determine the amount of money that bank will earn by providing

the loan:

After how many years it will paid it back to the bank.


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Project Appraisal

The purpose of Project Appraisal is to ascertain whether theproject will be sound technically, economically, financiallyand managerially and ultimately viable as a commercialproposition.

The appraisal of a project will involve the examination of:

a) Technical Feasibility : To determine the suitability of thetechnology selected and the adequacy of the technicalinvestigation, and design.

Focus on following aspects

Process of manufacturing

Raw materials and consumables.

Plant & equipment's

Building.

Manpower requirement


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Project Appraisal

b) Economic Feasibility : To determine the conduciveness of economicparameters to setting up the project and their impact on the scale of operations.

Eg. Socio economic benefit

Availability of labour in specific area

c) Financial Feasibility : To determine the accuracy of cost estimates,

suitability of the envisaged pattern of financing and general soundness of thecapital structure.

Estimate of working capital requirement

Study of estimated cash flow pattern of project.

Maintaining various ratios eg debt equity, IRR etc

Appropriateness of financial pattern ie IPO, promoters contribution, stockexchange listing


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Project Appraisal

d) Market appraisal: Examine the reasonableness of demand projection bydoing market survey. Other factor that need to consider are:

distribution network,

transportation facilities.

e) Managerial Competency : To ascertain that competent men are behindthe project to ensure its successful implementation and efficientmanagement after commencement of commercial production. Eg:

person handling project should be well experienced.

F)Ecological analysis:

It is done for big project such as power plant, chemical factory

Questions raised are what are the likely damage caused to environmentdue to project

What is cost of restoration measures so that damages can be withinacceptable limit.


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Sensitivity analysis

Analyst know that future is uncertain and

there can be estimation error. Sensitivity

analysis take care of estimation error by using

number of possible outcomes in evaluating a

projects. Eg

If sales decreased by specific percentage

Interest rate increase by certain percentage

Additional borrowing required if any, etc.


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Ratios

Interest coverage ratio: =EBIT/ Interest

expenses

Interest and loan repayment coverage ration:= EBIT/Interest and installment.

Debt service coverage ratio:(Net profit + Depreciation + interest on loan)

Term loan Interest + term loan installment

corporate finance final

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