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What Is Corporate Finance? - Definition & Fundamentals

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  • 0:02 Definition of…
  • 1:20 Capital Budgeting
  • 1:57 Capital Sources
  • 2:42 Example of Corporate Finance
  • 6:10 Lesson Summary
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Lesson Transcript
Instructor: Christian George
This lesson will introduce the topic of corporate finance and its effects on a corporation and its shareholders. It will discuss capital funding sources and provide an example of a corporation needing to use capital funding for improvements.

Definition of Corporate Finance

Big business equals big money. At least that's how they've always said it. Of course, when you are an integral part of the business' decision-making process concerning finances, there never seems to be enough money. If you work for a small business, especially a start-up, it seems like no one wants to give you money and no one starting the business has any either. Some days it feels like a no-win situation. We need money to grow and provide our product or service in order to earn revenue - we need money to make money.

Never fear. This problem has been dealt with by business owners and corporate executives ever since humans first had the idea to go into business. One of the benefits of today's modern business owner or corporate executive is that there are more sophisticated sources from which to draw capital and more defined and mature capital streams from which to seek financing.

Corporate finance is the area of finance that deals with providing money for businesses and the sources that provide them. These sources provide capital to corporations to pay for structural improvements, expansion, and other value-added projects and enterprises. Capital is a good that can be used now. For this lesson, it will primarily refer to money. The purpose of corporate finance is to maximize shareholder value. There are many methods that a corporation can utilize to maximize shareholder value.

Capital Budgeting

One method is capital budgeting, which involves long-term planning for use of capital on corporate financial projects that affect the overall capital structure of the corporation. Managers and executives must select criteria for the funding of projects that will provide the best possibility of maximizing value for shareholders. When executives determine that there is no additional room for value growth, they are expected to pay out through dividend policies or stock repurchase programs using the surplus of capital. This adds perceived value to the corporation because of its ability to pay out extra cash to investors.

Capital Sources

A corporation has two primary capital sources for investment purposes. These include:

  • Self-generation of capital (primarily through revenue streams)
  • External capital funding sources (primarily through debt and equity capital)

As managers and executives consider their options, they must determine the optimum mix of capital funding in order to maximize value for the corporation. For example, self-generation of capital takes time and resources and the end product (free cash on hand) can be minimal. This would decrease shareholder value over time. If they consider debt capital, the debt becomes a liability on the balance sheet and affects cash flow. Equity capital is less risky than debt capital, but it dilutes the value of share ownership.

Example of Corporate Finance

XYZ Inc. is a manufacturing company that makes telephone wire for telecommunication purposes. They operate three plants in different locations. Each plant makes a different type of telephone wire. Plant #1 makes an older type of wire called Cat 3 used primarily in developing countries and in low-end production. Plant #2 makes a new type of wire called Cat 5, which is the primary type of telephone wire used worldwide. Plant #3 makes special orders of various types of telephone wire, including sub-sea wire.

Each of the three plants is older and in need of capital improvements. Each plant needs extensive physical remodeling to update the facility, increase safety measures, and comply with modern building and fire codes. In addition, each plant needs to update machinery to make the manufacturing process more efficient and ultimately produce more product. Corporation executives meet with each of the plant managers and commission a proposal of needed improvements for each plant.

After receiving the proposals from each of the three plants, executives work with the finance team to determine projected costs of the improvements to each of the plants.

Let's outline the expected capital outlays needed for each plant:

Remodeling and Upgrading for Plant #1
Physical remodeling $125,000
Machinery upgrades $600,000
Total capital required $725,000

Remodeling and Upgrades for Plant #2
Physical remodeling $400,000
Machinery upgrades $1,250,000
Total capital required $1,650,000

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