Introduction To: Corporate Finance

Introduction to Corporate Finance
Corporate Finance InstituteⓇ

Learning objectives
Click to edit Master title style
By the end of this course, you will be able to:
Discuss the main capital Explain the process of Compare debt financing with
investment activities and mergers and acquisitions, equity financing and explain
valuation techniques and key considerations for the optimal capital structure
the deal
Outline the capital raising Explore various career paths

process in corporate finance
CorporateFinance
InstituteⓇ
Introduction

Corporate finance overview
The ultimate purpose of corporate finance is to maximize the value of a business through
planning and implementing management resources while balancing risk and profitability.
Capital Investments Capital Financing Dividends & Return

of Capital
• Decide what projects / • Determine how to fund
businesses to invest in capital investments • Decide how and when
• Earn the highest possible • Optimize the firm’s to return capital to
risk-adjusted return capital structure investors

Players in corporate finance – primary market
Public
Bonds or shares
accounting
$
firms
“Sell side”
$
Contacts Contacts “Buy side”
Fund
Manager
$
Corporations Investment Institutions

Banks Investors
Capital

Players in corporate finance – secondary market
Wants to sell Wants to buy

Stock
Fund Manager exchange
Fund Manager
/
OTC
Investment bank Investment bank

Sales, trading Sales, trading
and research and research

Types of participants
Retail Institutional Public Private

Investors Corporations
• High net worth • Mutual funds • Traded on stock • Owned and

individuals • Pension funds exchanges traded by a few
private investors
• Private equity firms
• Venture capital firms
• Seed / angel investors

Types of transactions
Initial public Follow-on Private

offering (IPO) offering placement
Mergers & Leverage Divestiture

acquisitions buyout (LBO)
(M&A)

Capital Investments

What is a capital investment?
Any investment for which the economic benefit is greater than one year.
Opening a new Entering a new Acquiring another Research and

factory market business development of new
products

Capital investment
Capital investments will increase the assets of a company.
Debt
Assets
Equity

Techniques for valuing an investment
Whether such investments are worthwhile depends on the approach that the company uses
to evaluate them. A company may value the projects based on:
Net Present Value (NPV): The value of all future

cash flows (positive and negative) over the entire life
of an investment discounted to the present.
Internal Rate of Return (IRR): The expected

compound annual rate of return that will be
earned on a project or investment.

Net Present Value (NPV)
Future Cash Flows $100 $100 $100 $100 $100 $100 $100 $100 …
2019 2020 2021 2022 2023 2024 2025 2026 …

Future Cash Flows $100 $100 $100 $100 $100 $100 $100 $100 …
2019 2020 2021 2022 2023 2024 2025 2026 …
Forecast Period

Future Cash Flows $100 $100 $100 $100 $100 $1,200
2019 2020 2021 2022 2023 2024 - onwards

(terminal value)
Forecast Period

Future Value $100 $100 $100 $100 $100 $1,200

1 x 1 x 1 x 1 x 1 x 1
x
1.10 1.102 1.103 1.104 1.105 1.105
745 Net Present

Present Value 91 + 83 + 75 + 68 + 62 + = Value (NPV)
1
= FV x (1+ i)n = $1,124
2019 2020 2021 2022 2023 2024 - onwards
Discount Rate
(terminal value)
Forecast Period
(Cost of Capital)
i = 10%

Terminal value
Terminal Value: Value of free cash flow beyond the forecast period
Growing perpetuity formula
Free cash flow x (1 + growth)

Terminal value
= Cost of capital - growth
Exit multiple formula
Financial Metric (i.e. Earnings,

Terminal value
= EBITDA, Revenue) x Multiple

Terminal value
Terminal value $100 x (1 + 1.54%)

Perpetual growth = 10.00% - 1.54% = $1,200
Terminal value
Exit multiple = 12 x $100

= $1,200

Unlocking the drivers of value
• Business strategy
• Revenue
• Cost structure • Organic growth?
• Asset utilization • What’s sustainable?
Free cash flow x (1 + growth)

Terminal value
= Cost of capital - growth
• Risk • Organic growth?

• Current capital • What’s sustainable?
structure
• Macro factors

Enterprise value vs. equity value
Enterprise value is the value of the entire business.

Equity value is the value shareholders would receive if the company is sold.
Market value
of net debt
=Equity Value + Debt – Cash Enterprise

=NPV of the business value Market value
of equity =Share Price x Outstanding Shares
(market =NPV of the business – Debt + Cash
capitalization)

Internal Rate of Return (IRR)
Internal Rate of Return

IRR = 22%
22% IRR is economically equivalent to earning a 22% compound annual growth rate.

Mergers and Acquisitions (M&A)
Mergers and acquisitions is the process of companies buying, selling, or

combining businesses.
Benefits: Potential drawbacks:
• Cost savings • Overpaying

• Revenue enhancements • Large expenses associated
• Increase market share with the investment
• Enhance financial resources • Negative reaction to the

merger or acquisition

10 step acquisition process
10
9 Integration
8 Financing
7 Purchase &
6 Sales Contract
Due
5 Diligence
Negotiation
4 Data & Detailed
3 Approaching Valuation
2 Targets
Searching
1 Acquisition
for Target
Criteria
Acquisition
Strategy

Strategic versus financial buyers
Strategic buyers
VS Financial buyers
• Operating businesses • Private equity (financial sponsor)

• Horizontal or vertical expansions • Professional investor (non-operator)
• Involves identifying and delivering • Leverage for maximum equity
operating synergies returns

Rival bidders
The vast majority of acquisitions are

competitive or potentially competitive.
• Companies normally have to offer more than rival bidders

• To pay more than rival bidders, the buyer may:
• Be able to “do more” with the acquisition
• Accept a lower expected return
• Have a different view or forecast for the future

Acquisition valuation process
Strategic Buyer Scenario:
• Sales growth
1. Value the target • EBIT margin
as stand-alone
• Operating tax
• Working capital requirements
Enterprise value
• Capital expenditures
• Sales (volume & price) • Working capital

2. Value synergies • EBIT margin • Vendor relationships
• Product mix • Capital expenditures
• Overhead reductions • Efficiencies
Hard (cost savings) and soft
(revenue enhancements) • Operating tax
• Tax efficiency
• Tax losses

Best practice acquisition analysis
1 2 3 4 5 6
Soft Transaction
synergies costs
Hard Net Value created
synergies synergies
Stand-alone Consideration
enterprise Stand- (price paid)
value alone value

Issues to consider when structuring a deal
Market Environment
Contract Structuring Antitrust

law Environment rules
Strategic Competing
plan bidders
Accounting Deal Available

rules financing
Hostile vs Public vs
friendly private
Capital
structure
Corporate
Tax
Law
Market
conditions


of Capital
businesses to invest in capital investments
• Decide how and when
• Earn the highest • Optimize the firm’s to return capital to
possible risk-adjusted capital structure investors
return

Capital Financing

What is capital financing?
Any type of funding that is used to finance the purchase of an asset/project (an investment).
Equity Debt

Capital financing
Capital financing will increase the liabilities and/or equity of a company.
Debt
Capital Capital
investment financing
(spending Assets (where the
money to money
purchase comes from)
assets) Equity

Capital financing
Capital Debt Capital

money to money
purchase comes from)
assets)
Equity

Capital financing
Debt
Capital Capital
money to money
purchase Equity comes from)
assets)

The business life cycle
LAUNCH GROWTH SHAKE MATURITY

-OUT
$ Life cycle
extension
Sales
Cash flow
Profit
Time

The corporate funding life-cycle
LAUNCH GROWTH SHAKE MATURITY

-OUT
Debt funding
Business risk
Stage of the firm life cycle

Capital structure
Capital Structure: the amount of debt and/or equity employed by a firm to fund its operations
and finance its assets. In order to optimize the structure, a firm will decide if it needs more debt
or equity and can issue whichever it requires.
Low Leverage High Leverage

Optimal capital structure
The equity versus debt decision relies on a large number of factors:
The current economic climate
The business’ existing capital structure
The business’ life cycle stage
Having too much debt may increase the risk of default in repayment.
Depending too heavily on equity may dilute earnings and value for original investors.

Optimal capital structure
Companies are usually looking for the optimal combination of debt and equity to
minimize the cost of capital.
Weighted Average Cost of Capital (WACC)
Debt/Total Capital (Leverage)

Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC) is the proportion of debt and equity a firm has,
multiplied by their respective costs.
Cost of Equity: Cost of Debt:

The rate of return a The rate of return that a
shareholder requires for lender requires given the
investing equity into a business risk of the business
The optimal capital structure of a firm is often defined as the proportion of debt and equity that result in
the lowest weighted average cost of capital (WACC) for the firm.

WACC formula
Net debt % net debt x Cost of debt = Contribution
Assets
Market
value % equity x Cost of equity = Contribution
of equity
Cost of capital
Example
$32bn 14%* x 3.5% = 0.5%
$225bn
$193bn 86%* x 9.0% = 7.7%
8.2%
*Rounded for ease of calculation.

Capital stack
How to optimally finance the capital investments through the

business’ equity, debt, or a mix of both?
Senior debt
Subordinated debt
Equity

Types of equity
Senior debt
Subordinated debt
S/holder loans S/holder loans Higher liquidation position; no dividend but pays interest
Equity
Pref. shares Pref. shares Higher liquidation and higher dividend priority (vs Common)
Common shares Common shares Last liquidation position and last dividend position

Common shares
Terms Issues
Typically the majority of a • Last level of priority (highest
firm’s equity capital: risk) for investors
• Proportional share of
residual value of the business
• Proportional payment of
common dividends
• Voting rights (or not)

Preferred shares
Terms Issues
The ‘norm’ is for private equity Preferred shares are
to subscribe for preferred becoming less attractive as:
shares which are: • More costly than Common
• Liquidity preference shares
• Have a fixed dividend • Even if company has cash,
• Anti-dilution rights payment may not be made if
lack of distributable reserves.

Shareholder loans
Shareholder loans are a means for private equity houses to invest sufficient equity into a
buyout situation, whilst still allowing management a significant equity stake.
Max debt
$30m
Enterprise
value
$50m Shareholder
loan - PIK
Equity $16m
$20m Private equity $2m
Management $2m

Sources of equity
Private Markets Public Markets
Founders Institutional
Venture Capital Retail
Private Equity

Private equity and venture capital firms
Private equity firms manage funds or pools of capital that invest in companies
that represent an opportunity for a high rate of return.
Private equity funds invest for limited time periods. Exit strategies include IPOs,
selling to another private equity firm, etc.
Private equity funds are typically split into two categories:
Venture capital funds typically invest in Buyout or LBO funds typically invest in more mature businesses,
1 early stage or expanding businesses that have
limited access to other forms of financing.
2 usually taking a controlling interest and leveraging the equity
investment with a substantial amount of external debt. Buyout funds
tend to be significantly larger than venture capital funds.
• Sequoia Capital
• Blackstone
• Y Combinator
• KKR
• Andreessen Horowitz
• Carlyle Group

Typical exit routes for private equity
Total Exit Partial Exit
Private Corporate
Sale to Strategic Sale to Sponsor
Placement Restructuring
Flotation/IPO

Why use debt
Corporation: (1) to lower the cost of Investor: to increase their equity return
capital, and (2) avoid equity dilution
Weighted Average
Cost of Capital (WACC)
Senior debt
Senior debt Three to five years
Equity
Equity IRR = 28%
Debt/Total Capital
(Leverage)

Assessing debt capacity
General measures Balance sheet measures Cash flow measures
• Level of EBITDA • Debt to equity • Total debt / EBITDA

• Volatility and hence • Debt to capital • Senior debt / EBITDA
stability of EBITDA • Debt to assets • Net debt / EBITDA
• Capital expenditures • Etc. • Cash interest cover
• Cyclicality
• EBITDA-Capex / interest
• Risk
• Competition

Senior debt overview
Revolver Revolver: Revolving line of credit facility from a bank
Term loan A
Senior debt Term loans: have a fixed schedule where they repay
Term loan B or are amortized, and have a final principal
repayment. Can be stacked.
Term loan C
Subordinated Senior Debt Capacity:

debt
• Provide 2x to 3x EBITDA
• Require 2x interest coverage
Equity • Typically provided by: commercial banks, credit

companies, insurance companies

Types of subordinated debt
Increasing Increasing
subordination return
Senior debt
High yield bonds Increasing

Mezz warrantless dilution
Subordinated
debt is used to fill Subordinated
Mezz warranted
the funding gap. debt
PIK notes
Vendor notes
Equity

How much subordinated debt?
Subordinated debt holders will only supply so much debt.
Total debt / EBITDA ~ 5 to 6 times
xEBITDA / Cash interest ~ 2 times
Equity funding ~ 30% to 35%.
The appropriate financial structure has to be constructed

within these constraints.

Credit ratings and high yield debt
Moody’s S&P Fitch DBRS
Aaa AAA AAA AAA

Aa1 AA+ AA+ AA (high)
Aa2 AA AA AA
Investment grade Aa3 AA- AA- AA (low)
A1 A+ A+ A (high)
• Low risk A2 A A A
• Low return A3 A- A- A (low)
• Low fees Baa1 BBB+ BBB+ BBB (high)
Baa2 BBB BBB BBB
Baa3 BBB- BBB- BBB (low)
Ba1 BB+ BB+ BB (high)

Ba2 BB BB BB
Ba3 BB- BB- BB (low)
High yield B1 B+ B+ B (high)
• High risk B2 B B B
B3 B- B- B (low)
• High return
Caa1 CCC+ CCC+ CCC (high)
• High fees Caa2 CCC CCC CCC
Caa3 CCC- CCC- CCC (low)
- D D D

Mezzanine debt characteristics
Mezzanine debt:
• Non-traded
• Subordinated to senior debt
• Repaid as a bullet (not amortized)
• Combination of cash and accrued interest
built into return
• Can have equity warrants attached

• Debt with warrants, convertible loan stock,
convertible preferred shares

Mezzanine returns
Warrants
3% to 10%
of post
exit value
Total
Mezzanine
Accrued Return
Contractual
interest
return
(IRR 14%
to 20%)
Cash pay
interest

Mezzanine returns
Senior Debt
Warrants IRR <10%
3% to 10%
of post
exit value
Total
Mezzanine Subordinated
Accrued Return Debt
Contractual
interest Mezzanine
return
(IRR 14%
to 20%)
investors
IRR 14-20%
Cash pay
interest
Equity
IRR 20-30%

Debt repayment profiles
Mezzanine finance – high yield debt
Equal Balloon Bullet Bullet

amortizing repayment repayment repayment
time

Capital Raising Process

Underwriting
The process where a bank raises capital for a

corporation, or institution from investors in the
form of equity or debt securities.
Underwriting involves conducting research,
financial modeling, valuation, and marketing
and a deal.

Types of underwriting
Types of underwriting commitment:
Firm Commitment Best Efforts

The underwriter agrees to buy Underwriter commits to selling
the entire issue and assume full as much of the issue as possible
financial responsibility for any at the agreed-on offering price,
unsold shares. but can return any unsold shares
to the issuer without financial
responsibility.

Underwriting advisory services
Planning Issue Structure Timing and Demand
• Identify investor themes • Domestic or international • Hot or cold issue market

• Investment rationale • Institutional investor focus • Supported by positive news-flow
• Financial modeling & valuation • Retail investor focus • Investor appetite
• Is IPO the best option? • Offer for sale • Precedents and benchmark
• Size of float and lock-up issues • Intermediaries offer offerings
• Preliminary view on investor • Introduction • Pricing

demand

Underwriting - the book building process
Institutional Price is
Book of
Indicative price investor set to
demand Allocation
range commitment ensure
built
at firm price clearing

Underwriting - the road show
The roadshow is an opportunity for management to convince investors of the

strength of the business cases.
Areas that are critical include:
Management structure, A thorough analysis of

governance and quality the industry/sector
Strategy, both tactical

Key risks
and long-term
Funding requirements and purpose:

Cash in versus cash out

Pricing the issue
Key issues in pricing
Price stability
Buoyant after market
Depth of investor base

Pricing the issue
After market price

performance Maximizing price

Under-pricing
There are two costs associated with a flotation:

• Direct cost / Fees
• Indirect cost / Under-pricing
There is a temptation for the advising bank to

underprice the issue — why?
• Reduces the risk of equity overhang
• Ensures after market is buoyant

• BUT this fails to make the best possible returns for
the current owners and could lead to profit-taking
and hence volatility

The IPO pricing process
IPO
discount
Full
value
IPO
pricing

IPO
discount Indicative maximum
10 to 15%
pricing range
Indicative minimum
Full
value IPO
pricing

IPO
10 to 15%
pricing range
Indicative minimum
Full
value
IPO
pricing

IPO
10 to 15%
pricing range
Indicative minimum
Full
value
IPO
pricing
You will be pricing the deal based on:
• Relative valuation
• Intrinsic valuation

Dividends and Return of Capital


of Capital
businesses to invest in capital investments • Decide how and when to
• Earn the highest possible return capital to investors
• Optimize the firm’s capital
risk-adjusted return structure

Dividends and return of capital
Corporate managers need to decide to:
Distribute the earnings to shareholders in the

form of dividends or share buybacks, OR
Retain the excess earnings for future

investments and operational requirements

Internal Rate of Return (IRR)
Internal Rate of Return

IRR = 22% (based on cash flows)

WACC
Net debt % net debt x Cost of debt = Contribution
Assets
Market
value % equity x Cost of equity = Contribution
of equity
Weighted Average Cost of Capital

WACC = 28%

Decision
Internal Rate of Return Cost of Capital

= 22% = 28%
Return Capital
(Dividend or Buyback)

Retained earnings and excess cash
Balance Sheet

Retained earnings / excess cash decision flowchart
Retained earnings /
Cash balance
Rate of return on capital Rate of return on capital

investment < WACC investment > WACC
Repurchase Pay cash Reinvest in

shares dividends other projects

Dividend vs Share Buyback
Dividend Buyback (Repurchase)

• Can be one-time or ongoing • Reduces the number of
• Contribute to the “yield” on a shares outstanding
stock if ongoing regular • Increases EPS
dividends
• No impact on shares
outstanding or EPS


of Capital
businesses to invest in capital investments • Decide how and when
to return capital to
• Earn the highest possible • Optimize the firm’s
investors
risk-adjusted return capital structure

Corporate Finance Careers

Career map

Roles in corporate finance
Banks (‘Sell side’) Public Accounting Institutions (‘Buy side’) Corporates

• Client facing / sales • Mix of client or inward • More internally focused • Internally focused
component focus • Hire from banks • Hire from banks, accounting
• Capital Markets hire from • Hire from schools or from • Hire grad school students firms, institutions and schools
schools other accounting firms • Hire across all entry points
• Long hours
• Retail hires at various • Long / medium hours • Hours vary
• Competitive
points • Competitive
• Quick career progression • Competitiveness varies by
• Long hours • Clear career path company
• Competitive • Career progression varies
• Quick career progression

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Introduction to Corporate Finance

Corporate Finance InstituteⓇ

By the end of this course, you will be able to:

Outline the capital raising Explore various career paths

Corporate Finance InstituteⓇ

Capital Investments Capital Financing Dividends & Return

Corporate Finance InstituteⓇ

Corporations Investment Institutions

Corporate Finance InstituteⓇ

Wants to sell Wants to buy

Investment bank Investment bank

Corporate Finance InstituteⓇ

Retail Institutional Public Private

• High net worth • Mutual funds • Traded on stock • Owned and

Corporate Finance InstituteⓇ

Initial public Follow-on Private

Mergers & Leverage Divestiture

Corporate Finance InstituteⓇ

Corporate Finance InstituteⓇ

Opening a new Entering a new Acquiring another Research and

Corporate Finance InstituteⓇ

Capital investments will increase the assets of a company.

Corporate Finance InstituteⓇ

Net Present Value (NPV): The value of all future

Internal Rate of Return (IRR): The expected

Corporate Finance InstituteⓇ

Corporate Finance InstituteⓇ

2019 2020 2021 2022 2023 2024 2025 2026 …

Corporate Finance InstituteⓇ

Future Cash Flows $100 $100 $100 $100 $100 $1,200

2019 2020 2021 2022 2023 2024 - onwards

Corporate Finance InstituteⓇ

Future Value $100 $100 $100 $100 $100 $1,200

745 Net Present

Corporate Finance InstituteⓇ

Growing perpetuity formula

Free cash flow x (1 + growth)

Exit multiple formula

Financial Metric (i.e. Earnings,

Corporate Finance InstituteⓇ

Terminal value $100 x (1 + 1.54%)

Exit multiple = 12 x $100

Corporate Finance InstituteⓇ

Free cash flow x (1 + growth)

• Risk • Organic growth?

Corporate Finance InstituteⓇ

Enterprise value is the value of the entire business.

=Equity Value + Debt – Cash Enterprise

Corporate Finance InstituteⓇ

Internal Rate of Return

Corporate Finance InstituteⓇ

Mergers and acquisitions is the process of companies buying, selling, or

Benefits: Potential drawbacks:

• Cost savings • Overpaying

• Enhance financial resources • Negative reaction to the

Corporate Finance InstituteⓇ

Corporate Finance InstituteⓇ

• Operating businesses • Private equity (financial sponsor)

Corporate Finance InstituteⓇ