Finance at Fields

Finance at Fields

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The hurdle rate is the minimum acceptable return on an investment — i. 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.

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A common error in choosing a discount rate for a project is to apply a WACC that applies to the entire firm. Such an approach may not be appropriate where the risk of a particular project differs markedly from that of the firm's existing portfolio of assets. In conjunction with NPV, there are several other measures used as secondary selection criteria in corporate finance. See list of valuation topics. 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.

See further under Real options valuation. The difference between the two valuations is the "value of flexibility" inherent in the project. Given the uncertainty inherent in project forecasting and valuation, [37] [39] analysts will wish to assess the sensitivity of project NPV to the various inputs i. In a typical sensitivity analysis the analyst will vary one key factor while holding all other inputs constant, ceteris paribus.

The sensitivity of NPV to a change in that factor is then observed, and is calculated as a "slope": For example, the analyst will determine NPV at various growth rates in annual revenue as specified usually at set increments, e. Often, several variables may be of interest, and their various combinations produce a "value- surface ", [40] or even a "value- space ", where NPV is then a function of several variables. See also Stress testing. Using a related technique, analysts also run scenario based forecasts of NPV.

Here, a scenario comprises a particular outcome for economy-wide, "global" factors demand for the product , exchange rates , commodity prices , etc As an example, the analyst may specify various revenue growth scenarios e. 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.

An application of this methodology is to determine an " unbiased " NPV, where management determines a subjective probability for each scenario — the NPV for the project is then the probability-weighted average of the various scenarios; see First Chicago Method. See also rNPV , where cash flows, as opposed to scenarios, are probability-weighted. A further advancement which "overcomes the limitations of sensitivity and scenario analyses by examining the effects of all possible combinations of variables and their realizations" [41] is to construct stochastic [42] or probabilistic financial models — as opposed to the traditional static and deterministic models as above.

This method was introduced to finance by David B. Hertz in , although it has only recently become common: Here, the cash flow components that are heavily impacted by uncertainty are simulated, mathematically reflecting their "random characteristics". In contrast to the scenario approach above, the simulation produces several thousand random but possible outcomes, or trials, "covering all conceivable real world contingencies in proportion to their likelihood;" [43] see Monte Carlo Simulation versus "What If" Scenarios. The output is then a histogram of project NPV, and the average NPV of the potential investment — as well as its volatility and other sensitivities — is then observed.

This histogram provides information not visible from the static DCF: Continuing the above example: These distributions would then be "sampled" repeatedly — incorporating this correlation — so as to generate several thousand random but possible scenarios, with corresponding valuations, which are then used to generate the NPV histogram. The resultant statistics average NPV and standard deviation of NPV will be a more accurate mirror of the project's "randomness" than the variance observed under the scenario based approach. These are often used as estimates of the underlying " spot price " and volatility for the real option valuation as above; see Real options valuation Valuation inputs.

A more robust Monte Carlo model would include the possible occurrence of risk events e.

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Dividend policy is concerned with financial policies regarding the payment of a cash dividend in the present or paying an increased dividend at a later stage. Whether to issue dividends, [44] and what amount, is determined mainly on the basis of the company's unappropriated profit excess cash and influenced by the company's long-term earning power.

When cash surplus exists and is not needed by the firm, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program. If there are no NPV positive opportunities, i. This is the general case, however there are exceptions.

For example, shareholders of a " growth stock ", expect that the company will, almost by definition, retain most of the excess cash surplus so as to fund future projects internally to help increase the value of the firm. Management must also choose the form of the dividend distribution, as stated, generally as cash dividends or via a share buyback. Various factors may be taken into consideration: Alternatively, some companies will pay "dividends" from stock rather than in cash; see Corporate action.

Financial theory suggests that the dividend policy should be set based upon the type of company and what management determines is the best use of those dividend resources for the firm to its shareholders. As a general rule, shareholders of growth companies would prefer managers to retain earnings and pay no dividends use excess cash to reinvest into the company's operations , whereas shareholders of value or secondary stocks would prefer the management of these companies to payout surplus earnings in the form of cash dividends when a positive return cannot be earned through the reinvestment of undistributed earnings.

A share buyback program may be accepted when the value of the stock is greater than the returns to be realized from the reinvestment of undistributed profits. In all instances, the appropriate dividend policy is usually directed by that which maximizes long-term shareholder value. Managing the corporation's working capital position to sustain ongoing business operations is referred to as working capital management.

In general this is as follows: As above, the goal of Corporate Finance is the maximization of firm value. In the context of long term, capital budgeting, firm value is enhanced through appropriately selecting and funding NPV positive investments. These investments, in turn, have implications in terms of cash flow and cost of capital. The goal of Working Capital i.

In so doing, firm value is enhanced when, and if, the return on capital exceeds the cost of capital; See Economic value added EVA. Managing short term finance and long term finance is one task of a modern CFO. Working capital is the amount of funds which are necessary to 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.

As a result, capital resource allocations relating to working capital are always current, i.

In addition to time horizon , working capital management differs from capital budgeting in terms of discounting and profitability considerations; they are also "reversible" to some extent. 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.

The short term goals of working capital are therefore not approached on the same basis as long term profitability, and working capital management applies different criteria in allocating resources: Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital.

Use of the term "corporate finance" varies considerably across the world. In the United States it is used, as above, to describe activities, analytical methods and techniques that deal with many aspects of a company's finances and capital. In the United Kingdom and Commonwealth countries, the terms "corporate finance" and "corporate financier" tend to be associated with investment banking — i.

Risk management [42] [51] is the process of measuring risk and then developing and implementing strategies to manage " hedge " that risk. Financial risk management , typically, is focused on the impact on corporate value due to adverse changes in commodity prices , interest rates , foreign exchange rates and stock prices market risk.

It will also play an important role in short term cash- and treasury management ; see above. It is common for large corporations to have risk management teams; often these overlap with the internal audit function. While it is impractical for small firms to have a formal risk management function, many still apply risk management informally. See also Enterprise risk management. The discipline typically focuses on risks that can be hedged using traded financial instruments , typically derivatives ; see Cash flow hedge , Foreign exchange hedge , Financial engineering.

Because company specific, " over the counter " OTC contracts tend to be costly to create and monitor, derivatives that trade on well-established financial markets or exchanges are often preferred. These standard derivative instruments include options , futures contracts , forward contracts , and swaps ; the "second generation" exotic derivatives usually trade OTC. Note that hedging-related transactions will attract their own accounting treatment: This area is related to corporate finance in two ways. Firstly, firm exposure to business and market risk is a direct result of previous capital financial investments.

Secondly, both disciplines share the goal of enhancing, or preserving, firm value. There is a fundamental debate [52] relating to "Risk Management" and shareholder value. Per the Modigliani and Miller framework , hedging is irrelevant since diversified shareholders are assumed to not care about firm-specific risks, whereas, on the other hand hedging is seen to create value in that it reduces the probability of financial distress. A further question, is the shareholder's desire to optimize risk versus taking exposure to pure risk a risk event that only has a negative side, such as loss of life or limb.

The debate links the value of risk management in a market to the cost of bankruptcy in that market. From Wikipedia, the free encyclopedia. Corporate finance Working capital Cash conversion cycle Return on capital Economic value added Just-in-time Economic order quantity Discounts and allowances Factoring Sections Managerial finance Financial accounting Management accounting Mergers and acquisitions Balance sheet analysis Business plan Corporate action Societal components Financial law Financial market Financial market participants Corporate finance Personal finance Peer-to-peer lending Public finance Banks and banking Financial regulation Clawback v t e.

Bankruptcy and Financial distress. Business valuation , stock valuation , and fundamental analysis. Real options analysis and decision tree. Sensitivity analysis , Scenario planning , and Monte Carlo methods in finance. Introduction to Financial Technology. The Declaration of Dependence: Dividends in the Twenty-First Century.

A History of the Global Stock Market: From Ancient Rome to Silicon Valley. As Mark Smith notes, "the first joint-stock companies had actually been created in England in the sixteenth century. These early joint-stock firms, however, possessed only temporary charters from the government, in some cases for one voyage only. One example was the Muscovy Company , chartered in England in for trade with Russia; another, chartered the same year, was a company with the intriguing title Guinea Adventurers. The Dutch East India Company was the first joint-stock company to have a permanent charter.

Accounting by the First Public Company: The Pursuit of Supremacy. The World's First Stock Exchange: Translated from the Dutch by Lynne Richards. The Little Crash in '62 , in Business Adventures: Economics , Financial Markets: It usually encompasses a long-term strategic perspective regarding investment decisions that affect public entities.

Central banks, such as the Federal Reserve System banks in the United States and Bank of England in the United Kingdom , are strong players in public finance, acting as lenders of last resort as well as strong influences on monetary and credit conditions in the economy. Capital , in the financial sense, is the money that gives the business the power to buy goods to be used in the production of other goods or the offering of a service.

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Capital has two types of sources, equity and debt. The deployment of capital is decided by the budget. This may include the objective of business, targets set, and results in financial terms, e. A budget may be long term or short term. Budgets will include proposed fixed asset requirements and how these expenditures will be financed. Capital budgets are often adjusted annually done every year and should be part of a longer-term Capital Improvements Plan.

A cash budget is also required. The working capital requirements of a business are monitored at all times to ensure that there are sufficient funds available to meet short-term expenses. The cash budget is basically a detailed plan that shows all expected sources and uses of cash when it comes to spending it appropriately. The cash budget has the following six main sections:. Financial economics is the branch of economics studying the interrelation of financial variables , such as prices , interest rates and shares, as opposed to goods and services.

Financial economics concentrates on influences of real economic variables on financial ones, in contrast to pure finance. It centres on managing risk in the context of the financial markets , and the resultant economic and financial models. It essentially explores how rational investors would apply risk and return to the problem of an investment policy. Here, the twin assumptions of rationality and market efficiency lead to modern portfolio theory the CAPM , and to the Black—Scholes theory for option valuation ; it further studies phenomena and models where these assumptions do not hold, or are extended.

Financial econometrics is the branch of financial economics that uses econometric techniques to parameterize the relationships suggested. Although they are closely related, the disciplines of economics and finance are distinct. Financial mathematics is a field of applied mathematics , concerned with financial markets. The subject has a close relationship with the discipline of financial economics , which is concerned with much of the underlying theory that is involved in financial mathematics.

Generally, mathematical finance will derive, and extend, the mathematical or numerical models suggested by financial economics. In terms of practice, mathematical finance also overlaps heavily with the field of computational finance also known as financial engineering. Arguably, these are largely synonymous, although the latter focuses on application, while the former focuses on modelling and derivation see: The field is largely focused on the modelling of derivatives , although other important subfields include insurance mathematics and quantitative portfolio problems.

See Outline of finance: Mathematical tools ; Outline of finance: Experimental finance aims to establish different market settings and environments to observe experimentally and provide a lens through which science can analyze agents' behavior and the resulting characteristics of trading flows, information diffusion and aggregation, price setting mechanisms, and returns processes.

Researchers in experimental finance can study to what extent existing financial economics theory makes valid predictions and therefore prove them, and attempt to discover new principles on which such theory can be extended and be applied to future financial decisions. Research may proceed by conducting trading simulations or by establishing and studying the behavior, and the way that these people act or react, of people in artificial competitive market-like settings.

Behavioral finance studies how the psychology of investors or managers affects financial decisions and markets when making a decision that can impact either negatively or positively on one of their areas. Behavioral finance has grown over the last few decades to become central and very important to finance. A strand of behavioral finance has been dubbed quantitative behavioral finance , which uses mathematical and statistical methodology to understand behavioral biases in conjunction with valuation.

Studies by Jeff Madura, Ray Sturm and others have demonstrated significant behavioral effects in stocks and exchange traded funds. Among other topics, quantitative behavioral finance studies behavioral effects together with the non-classical assumption of the finiteness of assets. There are several related professional qualifications , that can lead to the field:. As the debate to whether finance is an art or a science is still open, [8] there have been recent efforts to organize a list of unsolved problems in finance. From Wikipedia, the free encyclopedia. For the board game, see Finance game.

For the Caucasian newspaper, see The Financial. This article has multiple issues. Please help improve it or discuss these issues on the talk page. Learn how and when to remove these template messages. This article possibly contains original research. Please improve it by verifying the claims made and adding inline citations. Statements consisting only of original research should be removed.

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Corporate finance

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