Corporate Finance Basics
Topics
1) 2) 3) 4) 5) 6) Capital Budgeting Cost of Capital Measures of Leverage Dividends and Share Repurchases Working Capital Management Financial Statement Analysis

Capital Budgeting
Introduction
The Capital Budgeting Process is the process of identifying and evaluating capital projects, i.e., projects where the cash flow to the firm will be received over a period longer than a year. Capital budgeting usually involves the calculation of each project’s future accounting profit by period, the cash flow by period, the present value of the cash flows after considering the time value of money, the number of years it takes for a project’s cash flow to pay back the initial cash investment, an assessment of risk, and other factors. 5 Key Principles of Capital Budgeting 1) Decisions are based on cash flows, not accounting income (Incremental cash flows are to be considered, not sunk costs) 2) Cash flows are based on opportunity costs 3) The timing of cash flows is important 4) Cash flows are analyzed on an after-tax basis 5) Financing costs are reflected in the project’s required rate of return

Net Present Value (NPV)
The NPV is the sum of present values of all expected incremental cash flows if a project is undertaken. The discount rate used is the firm’s cost of capital. For a normal project with an initial cash outflow, flowed by a series of cash inflows (after tax), the NPV is given by:-

For independent projects, the NPV decision rule is to accept projects with positive NPVs and to reject projects with negative NPVs. Simple Example Year 0 1 2 3 4 Project A (INR) -2000 1000 800 600 200 Project B (INR) -2000 200 600 800 1200 The Table shows the expected net after-tax cash flows of two projects, A and B. Discount Rate (Required rate of Return) = 10%

NPV of A = -2000 + 1000/(1.1)^1 + 800/(1.1)^2 + 600/(1.1)^3 + 200/(1.1)^4 = INR