Corporate Finance

Hi everyone,So I have an essay to submit in a week and am struggling a bit with this section of the question:Critically discuss the key functions of corporate finance?

My understanding of this is:

1. Management function: that includes corporate governance, CFO's role, board of directors, shareholders etc and what impact these actors have.

2. Investing function: Capital budgeting and CAPEX i.e. what are the best projects to invest in.

3. Financing function: debt and equity mix, interplay with financial markets, corporate transactions and capital formation.

Slightly struggling a bit to be honest as lots of authors say very different things. I need a bit of an anchor so any help would be greatly appreciated.

Many thanks. R

You seem to have a good idea of what to discuss in your essay. You could talk about agency theory for your first point. Second point you can discuss the variety of methods used in capital budgeting and their advantages and disadvantages. Third point - don't forget the dividend decision. But here you basically criticize the multiple debt-equity theories.

Hi Aliman,

Many thanks for your response - you have essentially anchored me, so thank you.

One question:

When you talked about criticising the multiple debt/equity theories - what theories are you talking about. Would it be possible to give me a quick explanation?

It would be greatly appreciated.

R

Debt/equity theories are basically the theories of capital structure:

1. Net operating income approach - assumes leverage of the firm has no effect on the total value of the firm. The weighted average cost of capital (WACC) stays constant and so the value of the firm is unaffected. Google a diagram here and explain it more would be good.

2. Modigliani and Miller (MM) approach - also theories that capital structure has no relevance on the value of a firm based on the idea that the company can do nothing the shareholders cannot do for themselves. Therefore the value comes from the cash flows into the company. Also find a diagram and explain it here.

3. Traditional approach - suggests there is an optimal debt-equity ratio where WACC is minimized. Therefore this point is where the value of the firm is maximized. Again find a diagram and explain it.

Lots of the key arguments I have missed out on purpose so you can research it yourself - I don't want to do the essay for you.

You could also talk about the tax implications of debt financing with the present value of the tax shield. Furthermore, you could argue about the firm minimizing the present value of all taxes paid, including corporation tax and all personal taxes paid by bondholders and stockholders - more of an extra section if you have space.

Another really important section is costs of financial distress. Will let you research this yourself as again don't want to write the essay for you.

Hopefully I have helped somewhat, without doing too much of the essay for you.