Introduction to Corporate Finance: A Practical Guide for Postgraduate and Research Students

Abstract

The current position of the business can be verified through ratios analysis. According to this analysis managers, creditors, and investors can receive valuable information about the effectiveness and efficiency of the operations. Managers by using especially profitability, operating, and asset utilization ratios can maintain a fairly accurate perception of the financial health of their business. Different types of ratios can help them as they are indicator of well goals are being achieved. When actual results can not meet the standard set, then, ratios indicate where the problem may be. There are different types of ratios. Liquidity ratios are current and quick asset ratios. Profitability and operating ratios are return on asset, gross profit margin and net profit margin. Gearing ratios are divided into debt to equity ratio and number of times interest earned. There are different shareholder investment ratios such as return on shareholders, earnings per share, price earnings ratio, dividend yield and dividend covers. Under asset utilization ratios, we have the net asset turnover, debtor collection period, stockholding period and creditor payment period. Investment appraisal is a process which assists mangers to take decisions and evaluate the future success of a project in terms of profitability, suitability, and compatibility with company objectives. The value of money changes with time. Money received today has a different value from money received in the future. the investors before making any investment must take into consideration that different types of securities will have different kinds of risks. The several sources of risk can be classified as: interest rate risk, market risk, inflation risk, business risk, exchange rate risk, financial risk, country risk, and liquidity risk. No investment will be made unless the expected rate of return is high enough to compensate the investor for taking extra risks. In general, it is believed that the higher the perceived risk associated with an investment opportunity, the higher should be its expected return to persuade an investor to accept the investment opportunity. Investors are risk averse, namely that they want to reduce their risk through a diversified balanced portfolio. This leads us to modern portfolio theory, which was developed by Markowitz (1959). Arbitrage pricing theory, APT, is a more general approach to asset pricing because it allows for the possibility that many factors can be used to explain security returns. The assets of a company are financed by either debt or equity. After calculating the cost of capital for equity and debt, then, we combine them in a form of weighted average to calculate the final weighted average cost of capital. The reason of measuring the weighted average cost of capital is to find how much interest the company or the government has to pay for every Euro it borrows. Factors that affect the cost of capital are the capital structure of the company, the dividend policy, the investment policy, the level of interest rates and the tax rates. Managing the working capital of the business is very important step that will prevent the shareholders from bankruptcy. It is very important to control short and long – term cash in relation to short and long – term liabilities. The relationship between fixed and variable costs is very important to determine the amount of leverage that the company will use. Leverage is determined by the profit changes due to changes in sales. The proportion of costs in the capital structure of a company determines the level of leverage that the company will use. The valuation of a derivative product is determined by changes of the main asset. They are risky products and due to the leverage effect they provide high positive or negative returns. Business valuation is an important measure in case that the shareholders seek short- term liquidity to finance their debt. The most common measures are dividend yield, price earnings ratio and net asset value.