Corporate Finance – KASNEB Syllabus

PAPER NO. 8  CORPORATE FINANCE

GENERAL OBJECTIVE

This paper is intended to equip the candidate with the knowledge, skills and techniques that will enable him/her to make corporate finance decisions.

LEARNING OUTCOMES

On successful completion of this paper, the candidate should be able to:

  • Make capital budgeting decisions under environment of certainty, uncertainty and risk
  • Make appropriate capital structure decisions of a firm
  • Select the optimal capital structure of a firm
  • Manage the working capital of a firm
  • Undertake corporate restructuring
  • Evaluate mergers and acquisitions
  • Make decisions in the context of Islamic Finance

CONTENT

Overview of corporate finance

  • Nature and scope of corporate finance
  • Financial decision making process
  • Finance functions
  • Goals of the firm
  • Agency theory concept, conflicts and resolutions
  • Measuring managerial performance, compensation and incentives

Cost of capital

  • The concept and significance of cost of capital
  • Components of cost of capital
  • Weighted average cost of capital (WACC) of a company
  • Marginal cost of capital( MCC) of a company
  • Use of marginal cost of capital and the investment opportunity schedule in determination of the optimal capital
  • Cost of debt capital using the yield-to-maturity approach and the debt-rating approach
  • Computation of the cost of non-callable and nonconvertible preferred stock
  • Computation of the cost of equity capital using the capital asset pricing model approach, the dividend discount model approach, and the bond-yield-plus risk-premium approach
  • Computation of the beta and cost of capital for a project
  • Uses of country risk premiums in estimating the cost of equity

Capital structure

  • Sources of capital
  • Factors to consider when selecting source of funds
  • Capital structure of a firm
  • Factors influencing capital structure
  • 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
  • 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
  • Target capital structure; reasons why a company’s actual capital structure may fluctuate around its target
  • 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

Capital investment decisions

Capital investment decisions under certainty

  • Nature of capital investment decisions under certainty
  • Classification of capital budgeting decisions
  • Ideal features of a capital budgeting technique
  • Categories of capital projects
  • Basic principles of capital budgeting; evaluation and selection of capital projects: mutually exclusive projects, project sequencing, and capital rationing.
  • Capital budgeting techniques under certainty
  • Estimating project cash flows

Capital investment decisions under uncertainty

  • Nature and measurement of risk and uncertainty
  • Investment decision under capital rationing :multi period; investment decision under inflation ,investment decision under uncertainty/risk
  • Techniques of handling risk: sensitivity analysis; scenario analysis; simulation analysis; decision theory models; certainty equivalent; risk adjusted discount rates; utility curves
  • Special cases in investment decision: projects with unequal lives; replacement analysis; abandonment decision
  • Real options in investment decisions: types of real options ;evaluation of a capital project using real options
  • Common capital budgeting pitfalls
  • Computation of accounting income and economic income in the context of capital budgeting
  • Evaluation of a capital project using economic profit, residual income, and claims valuation models for capital

Management of working capital

  • Factors influencing working capital requirements of a firm
  • Distinction between working capital and management of working capital
  • Working capital concepts; gross and net working capital; seasonal and permanent working capital
  • Primary and secondary sources of liquidity; factors that influencing a company’s liquidity position
  • Company’s liquidity measures in comparison to those of peer companies
  • 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
  • Effect of different types of cash flows on a company’s net daily cash position
  • Computation of comparable yields on various securities; evaluation of a company’s short- term working capital investment and financing policy guidelines
  • Company’s management of accounts receivable, inventory, cash and accounts payable over time and compared to peer companies
  • Evaluation of the choices of short-term funding available to a company
  • Profitability- liquidity tradeoff

Mergers and acquisitions

  • Classification of merger and acquisition (M&A) activities based on forms of integration and relatedness of business activities
  • Common motivations and demotivations behind mergers and acquisitions; mergers and acquisition in global context
  • Bootstrapping of earnings per share (EPS); computation of a company’s post-merger EPS
  • The relation between merger motivations and types of mergers, based on industry life cycles
  • Contrast merger transaction characteristics by form of acquisition, method of paymentand attitude of target management
  • Pre-offer defence mechanisms and post-offer takeover defence mechanisms
  • Computation of Herfindahl-Hirschman Index, and the likelihood of an antitrust challenge for a given business combination
  • Discounted cash flow analysis, comparable company analyses, and comparable transaction analyses for valuing a target company, including the advantages and disadvantages of each
  • Computation of free cash flows for a target company, and estimation of the company’s intrinsic value based on discounted cash flow analysis
  • Estimation of the value of a target company using comparable company and comparable transaction analyses
  • 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
  • Effect of price and payment method to the distribution of risks and benefits in M&A transactions
  • Characteristics of M&A transactions that create value
  • Reasons for failed mergers

Analysis of corporate growth and restructuring

  • Measurements of growth: methods of determining growth rates, sustainable versus non sustainable growth analysis of potential growth, franchise value and the growth process
  • Return on assets (ROA) and return on capital (ROC)
  • Common reasons for restructuring
  • Relative company return analysis
  • Valuation and analysis of corporate restructuring; leveraged buyouts (LBO); divestitures; strategic alliances; liquidation; recapitalisation
  • Financial distress, predicting organisational failure, solutions to financial distress
  • Financial restructuring; restructuring via capital reorganisation, the impact of financial restructuring on shareprice and WACC; forms of financial restructuring
  • Portfolio restructuring; divestment, demergers, spinoffs, liquidation, equity carveouts, MBO and management buy in
  • Organisational restructuring

Islamic finance

  • Justification for Islamic Finance; history of Islamic finance; capitalism; halal; haram; riba; gharar; usury
  • Principles underlying Islamic finance: principle of not paying or charging interest, principle of not investing in forbidden items e.g alcohol, pork, gambling or pornography; ethical investing; moral purchases
  • The concept of interest (riba) and how returns are made by Islamic financial securities
  • Sources of finance in Islamic financing: muhabaha, sukuk, musharaka, mudaraba
  • 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
  • International standardisation/regulations of Islamic Finance: Case for standardisation using religious and prudential guidance, National regulators, Islamic Financial Services Board

Emerging issues and trends



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