Corporate finance

Corporate finance for the pre-industrial world began to emerge in the Italian city-states and the low countries of Europe from the 15th century.

Modern corporate finance, alongside investment management, developed in the second half of the 20th century, particularly driven by innovations in theory and practice in the United States and Britain.

If interest expenses cannot be made by the corporation through cash payments, the firm may also use collateral assets as a form of repaying their debt obligations (or through the process of liquidation).

Shareholder value may also be increased when corporations payout excess cash surplus (funds that are not needed for business) in the form of dividends.

Internal financing, often, is constituted of retained earnings, i.e. those remaining after dividends; this provides, per some measures, the cheapest form of funding.

Preferreds are senior (i.e. higher ranking) to common stock, but subordinate to bonds in terms of claim (or rights to their share of the assets of the company).

"Modigliani and Miller", however, is generally viewed as a theoretical result, and in practice, management will here too focus on enhacing firm value and / or reducing the cost of funding.

To be considered acceptable, the investment must be value additive re: (i) improved operating profit and cash flows; as combined with (ii) any new funding commitments and capital implications.

The hurdle rate should reflect the riskiness of the investment, typically measured by volatility of cash flows, and must take into account the project-relevant financing mix.

[40] Managers use models such as the CAPM or the APT to estimate a discount rate appropriate for a particular project, and use the weighted average cost of capital (WACC) to reflect the financing mix selected.

In conjunction with NPV, there are several other measures used as (secondary) selection criteria in corporate finance; see Capital budgeting § Ranked projects.

In a typical sensitivity analysis the analyst will vary one key factor while holding all other inputs constant, ceteris paribus.

Here, a scenario comprises a particular outcome for economy-wide, "global" factors (demand for the product, exchange rates, commodity prices, etc.)

Note that for scenario based analysis, the various combinations of inputs must be internally consistent (see discussion at Financial modeling), whereas for the sensitivity approach these need not be so.

This method was introduced to finance by David B. Hertz in 1964, although it has only recently become common: today analysts are even able to run simulations in spreadsheet based DCF models, typically using a risk-analysis add-in, such as @Risk or Crystal Ball.

[48] Some analysts account for this uncertainty by adjusting the discount rate (e.g. by increasing the cost of capital) or the cash flows (using certainty equivalents, or applying (subjective) "haircuts" to the forecast numbers; see Penalized present value).

So, whereas in a DCF valuation the most likely or average or scenario specific cash flows are discounted, here the "flexible and staged nature" of the investment is modelled, and hence "all" potential payoffs are considered.

The policy will be set based upon the type of company and what management determines is the best use of those dividend resources for the firm and its shareholders.

Practical and theoretical considerations - interacting with the above funding and investment decisioning, and re overall firm value - will inform this thinking.

Shareholders of a "growth stock", for example, expect that the company will retain (most of) the excess cash surplus so as to fund future projects internally to help increase the value of the firm.

Various factors may be taken into consideration: where shareholders must pay tax on dividends, firms may elect to retain earnings or to perform a stock buyback, in both cases increasing the value of shares outstanding.

Relatedly, investors will then prefer a stable or "smooth" dividend payout - as far as is reasonable given earnings prospects and sustainability - which will then positively impact share price; see Lintner model.

Similarly, under the Walter model, dividends are paid only if capital retained will earn a higher return than that available to investors (proxied: ROE > Ke).

In the context of long term, capital budgeting, firm value is enhanced through appropriately selecting and funding NPV positive investments.

Working capital is the amount of funds that are necessary for an organization to continue its ongoing business operations, until the firm is reimbursed through payments for the goods or services it has delivered to its customers.

(Considerations as to risk appetite and return targets remain identical, although some constraints – such as those imposed by loan covenants – may be more relevant here).

A professional here may be referred to as a "corporate finance analyst" and will typically be based in the FP&A area, reporting to the CFO.

(In large firms, Risk Management typically exists as an independent function, with the CRO consulted on capital-investment and other strategic decisions.)

In the context of corporate finance, [69] a more specific concern will be that executives do not "serve their own vested interests" to the detriment of capital providers.

[70] There are several considerations: In general, here, debt may be seen as "an internal means of controlling management", which has to work hard to ensure that repayments are met, [72] balancing these interests, and also limiting the possibility of overpaying on investments.