finance

Investment and Financing Overview

The Investment and Financing course at Eötvös Loránd University covers crucial aspects of capital management including corporate financing decisions, theories, and practical implications. The financing process impacts the overall value of the company and how stakeholders perceive it.

Corporate Financing Decisions

  • Theory: Understanding how and how much to finance affects a company's value and cost of capital.

  • Corporate Analysis: Key to enhancing value through financial and business planning, considering both short and long-term objectives.

  • Financial Markets: Examines funding sources and products, including bank loans, their implications, and associated risks like illiquidity and insolvency.

  • Project Financing: Focuses on definitions, structure, and risk assessment through real case studies.

Key Considerations in Financing

  • Stakeholder Dynamics: Potential conflicts between owners, management, and creditors arise due to:

    • Interest conflicts

    • Agency problems

    • Information asymmetry

    • Moral hazard

Capital Structure Policies

Under Perfect Market Conditions

  • Investigates whether altering the liability side of capital structure adds value; the baseline scenario involves 100% equity.

  • Questions if financing scenarios beyond 100% equity can increase shareholder assets.

Modigliani-Miller Propositions

  • According to MM Proposition I, in perfect markets, the capital structure does not influence company value, meaning financing is neutral with respect to value if assets remain the same.

  • Key assumptions include:

    • No taxes or transaction costs

    • No restrictions and indefinite security division

    • Many rational investors, all equally informed

Imperfect Markets

  • Real-world observations show markets are not perfectly efficient, but the theory provides a foundation for practical analyses and conclusions.

Cost of Capital

Leveraged Financing

  • The concept of financing leverage is discussed, highlighting the relationship between equity and debt as a portfolio. This leads to the calculation of Weighted Average Cost of Capital (WACC), which averages the cost of capital from all sources.

    • WACC Formula: WACC = E/A · rE + D/A · rD

    • The optimal capital structure aims to lower WACC to enhance firm value.

MM Theorem II

  • As debt increases, the expected rate of return on equity grows, establishing a direct correlation between indebtedness and returns.

  • Financial implications of increasing debt include:

    • Risk-free periods initially, followed by increased risk leading to rising costs of equity as leverage rises.

Practical Applications

CF Analysis and Business Planning

  • The course emphasizes importance of cash flow (CF) analysis and its role in corporate finance, focusing on:

    • Forecasting based on understanding business models and market dynamics.

    • Sensitivity Analysis: Adjusting single factors to observe potential impacts.

    • Scenario Analysis: Evaluating multiple variables together under certain scenarios, ensuring a robust understanding of relationships between factors.

Corporate Financing Sources

  • Various sources and forms of corporate financing are evaluated including internal earnings, external liabilities, hybrid capital, and equity.

Conclusion: Trade-off and Pecking Order Theories

  • Trade-off Theory: Evaluates the balance between tax benefits of debt and potential costs of financial distress.

  • Pecking Order Theory: Addresses the hierarchy in financing options due to information asymmetry and how firms prefer internal funding over issuing new equity.

In the context of real-world financing, students are tasked with understanding how these theoretical frameworks relate to practical scenarios, examining the specific financial landscapes like Hungary’s venture capital scene and banking sector as indicative examples.