Corporate Finance

Corporate finance is an area of finance that deals with the sources of funding and the capital structure of companies. Furthermore, it examines the activities that managers undertake to increase the value of a firm to its shareholders. Corporate finance also looks at the tools and analysis used to manage and allocate capital.

The objective of this module is to give you an understanding of the key components of the capital structure of a business. The chapter will start by assessing various theories of capital structure including: M&M irrelevance theory of capital structure, the trade-off theory and the pecking order theory. According to the irrelevance theory of Modigliani and Miller (1963), in prefect markets, the capital structure of a company is not relevant in determining a company’s value.  The trade-off theory argues that the decision to use various sources of capital is a trade-off between the benefits and costs of different sources of capital, especially those of debt, as the cost of debt is lower and there are tax deductibility advantages. The pecking order theory proposes that that a company prefers internal capital rather than external finance to finance its business. Furthermore, the module examines the key factors that influence the choice of capital structure. Subsequently, the module explains the key components of the cost of capital (cost of debt and equity and weighted average cost of capital) and their role in valuing a business.

You will also gain an understanding of the different sources of finance available to a business. These include: debt, equity, long-term and short-term sources of finance. In addition to this, you will learn the merits and demerits of using each source of finance.

A dividend is a voluntary sum of money that is paid to the company’s shareholders out of its profits. Dividend payments can be seen a sign of a firm’s strength, as it can indicate that the management has a positive outlook about the company’s future earnings and prospects. The module explains various theories of dividend such as: dividend irrelevance hypothesis, bird-in-the-hand hypothesis, signaling theory, agency theory, tax effect hypothesis and clientele effect, pecking order hypothesis and catering theory. Two dividend policies are also discussed, namely: constant dividend payout and constant dividend growth. The role of dividends in valuing a business is also examined.

As mentioned previously, corporate finance involves examining the activities that managers undertake to increase the value of a firm to its shareholders. One-way management seeks to increase the value of a company is through mergers and acquisitions. A merger involves two existing companies joining together to make one new company. On the other hand, an acquisition occurs when a company takes control over another company, specifically when the buying company obtains more than 50% ownership in the target company. This module examines the motivations (such as increasing market share and acquiring technological resources and capabilities), advantages and challenges associated with mergers and acquisitions.


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