Fiche de révision : Fundamentals of Corporate Finance and Valuation

📋 Course Outline

1. Corporate Finance Fundamentals
2. Balance Sheet Structure
3. Financial Ratios
4. Investment Analysis
5. Cost of Capital
6. Time Value of Money
7. Capital Budgeting
8. Debt and Equity Financing
9. Valuation Models
10. ESG and Corporate Governance

📖 1. Corporate Finance Fundamentals

🔑 Key Concepts & Definitions

Corporate finance (from Vernimmen et al., 2025): The field of finance that focuses on how companies raise, allocate, and manage financial resources to achieve their strategic objectives, primarily ensuring sufficient funding for expansion and obligations while maximizing shareholder value.

Role of corporate finance (from Vernimmen et al., 2025): It involves two key missions: (1) securing adequate funds for growth and meeting financial obligations, and (2) efficiently using investor resources to generate returns at least equal to investors’ required rates, thus creating value over the long term.

Coordination of financial and economic data (from Vernimmen et al., 2025): The process of integrating financial information (cash flows, capital structure, valuation) with economic data (investment projects, operational performance) to support sound financial management and strategic decision-making.

Time value of money (from Vernimmen et al., 2025): The principle that a sum of money today is worth more than the same sum in the future due to its potential earning capacity, fundamental for valuation, investment analysis, and financial planning.

Risk-return relationship (from Vernimmen et al., 2025): The concept that higher potential returns are associated with higher risks; it guides investment and financing decisions by balancing expected gains against associated uncertainties.

Cash flow calculation (from Vernimmen et al., 2025): The process of determining the actual inflows and outflows of cash within a firm, essential for assessing liquidity, financing needs, and value creation, often derived from income statements and balance sheet data.

📝 Essential Points

• Corporate finance’s primary missions are to ensure the company has enough funds for expansion and obligations, and to optimize the use of investor resources to generate adequate returns, thereby creating long-term value (Vernimmen et al., 2025).
• Effective financial management requires the coordination of financial data (cash flows, capital structure, valuation metrics) with economic data (investment projects, operational performance) to support strategic decisions (Vernimmen et al., 2025).
• The time value of money underpins valuation techniques and investment decisions, emphasizing that cash flows received today are more valuable than those received in the future due to earning potential (Vernimmen et al., 2025).
• The risk-return relationship influences how firms select projects and financing sources, balancing potential gains against the risks involved (Vernimmen et al., 2025).
• Accurate cash flow calculation is critical for liquidity management, valuation, and assessing the firm’s capacity to generate value, often derived from income and balance sheet data (Vernimmen et al., 2025).

💡 Key Takeaway

Corporate finance is centered on efficiently raising and managing financial resources to support growth and obligations, using key principles like the time value of money and risk-return trade-offs to maximize long-term shareholder value.

📖 2. Balance Sheet Structure

🔑 Key Concepts & Definitions

Assets: Resources owned by a company that are expected to generate future economic benefits. They are classified into current and fixed assets. (Source: Vernimmen, Quiry, Dallocchio, Le Fur, Salvati, 2025-2026)

Liabilities: Obligations the company owes to external parties, representing claims against its assets. They are divided into current liabilities and long-term debt. (Source: Vernimmen et al., 2025-2026)

Equity (Shareholders’ Equity): The residual interest in the assets of the company after deducting liabilities. It includes components such as common stock, preferred stock, additional paid-in capital, and retained earnings. (Source: Vernimmen et al., 2025-2026)

Current Assets: Short-term assets expected to be converted into cash or used within one year, including cash, accounts receivable, and inventories. (Source: Vernimmen et al., 2025-2026)

Fixed Assets: Long-term tangible and intangible assets used in operations, such as property, plant, equipment, goodwill, patents, and trademarks. Tangible fixed assets are physical, while intangible assets lack physical substance. (Source: Vernimmen et al., 2025-2026)

Capital Employed Perspective: An analytical view of the balance sheet focusing on the total funds invested in the company's operating assets, used to assess performance like ROCE. It considers total assets minus current liabilities. (Source: Vernimmen et al., 2025-2026)

📝 Essential Points

• The balance sheet is structured into assets (left side) and liabilities plus equity (right side). Assets are resources, liabilities are claims, and equity represents owners’ residual interest.
• Assets are classified into current (short-term) and fixed (long-term). Current assets include cash, receivables, and inventories, which are expected to be liquidated within a year. Fixed assets encompass tangible assets like buildings and equipment, and intangible assets such as patents and goodwill.
• Liabilities are divided into current liabilities (obligations due within one year, e.g., accounts payable, short-term debt) and long-term debt (e.g., bonds, bank loans payable after more than one year).
• Shareholders’ equity components include common stock, preferred stock, additional paid-in capital, and retained earnings, which reflect the accumulated profits not distributed as dividends.
• The capital employed perspective helps evaluate how a firm finances its assets and measures its economic performance through metrics like ROCE.
• Working capital (current assets minus current liabilities) indicates short-term liquidity, while net debt (total debt minus cash) assesses the company's leverage and financial risk.

💡 Key Takeaway

The balance sheet provides a snapshot of a company's resources and claims, classified into assets, liabilities, and equity, with the capital employed perspective offering insights into financing and operational efficiency.

📖 3. Financial Ratios

🔑 Key Concepts & Definitions

Return on Capital Employed (ROCE):
Vernimmen et al. (date) define ROCE as a measure of a firm's efficiency in generating profits from its capital employed, calculated as EBIT (Earnings Before Interest and Taxes) multiplied by (1 – corporate tax rate), divided by capital employed. It indicates the economic return on the firm's operating assets and is used to assess value creation.

PER (Price-to-Earnings Ratio):
A ratio that compares a company's stock price to its earnings per share (EPS). It reflects investor expectations about future earnings growth and is used to evaluate whether a stock is over or undervalued.

EPS (Earnings Per Share):
The portion of a company's profit allocated to each outstanding share of common stock, calculated as net income divided by the number of shares outstanding. It is a key indicator of company profitability.

DPS (Dividends Per Share):
The total dividends paid out by a company divided by the number of outstanding shares, representing the dividend income received per share and used to analyze dividend policy and shareholder returns.

📝 Essential Points

• ROCE is central in evaluating whether a company is creating value; it should be compared to the company's WACC (Weighted Average Cost of Capital). A ROCE greater than WACC indicates value creation (see section 4).
• ROCE is calculated as:
  $\text{ROCE} = \frac{\text{EBIT} \times (1 - \text{Tax Rate})}{\text{Capital Employed}}$
  where capital employed typically includes shareholders’ equity plus long-term debt, or alternatively, total assets minus current liabilities.
• PER, EPS, and DPS are ratios used to analyze firm performance and capital structure, providing insights into valuation, profitability, and shareholder returns.
• Financial ratios like PER and EPS help in comparing firms within the same industry, assessing market expectations, and making investment decisions.
• Use of financial ratios is essential for analyzing firm performance, capital structure, and valuation, aiding in strategic and investment decisions.

💡 Key Takeaway

Return on Capital Employed (ROCE) measures a firm's efficiency in generating profits from its operating assets, serving as a critical indicator of value creation when compared to the cost of capital. Financial ratios such as PER, EPS, and DPS are vital tools for evaluating firm performance and capital structure, guiding investment and management decisions.

📖 4. Investment Analysis

🔑 Key Concepts & Definitions

Capital budgeting: The process of evaluating and selecting long-term investment projects that are expected to generate future cash flows, aiming to maximize shareholder value (Vernimmen et al., 2025). It involves analyzing potential investments to determine their profitability and strategic fit.

Investment rules: Criteria used to assess whether an investment project should be accepted or rejected. The most common rule is Net Present Value (NPV), which calculates the difference between the present value of cash inflows and outflows, with positive NPV indicating value creation (Vernimmen et al., 2025). Other rules include the Internal Rate of Return (IRR), Payback Period, and Profitability Index.

Cash flow analysis: The evaluation of the actual inflows and outflows of cash associated with an investment project. It focuses on estimating the incremental cash flows that the project will generate, which are crucial for applying investment rules like NPV (Vernimmen et al., 2025). Accurate cash flow analysis ensures that investment decisions reflect the true economic impact.

📝 Essential Points

• Capital budgeting is central to strategic financial management, guiding the allocation of resources to projects that enhance firm value (Vernimmen et al., 2025).
• The NPV rule is theoretically optimal because it directly measures value creation by discounting future cash flows at the firm’s cost of capital (Vernimmen et al., 2025).
• Cash flow analysis must exclude non-cash expenses (e.g., depreciation) and consider the timing and risk of cash inflows and outflows to accurately evaluate project viability (Vernimmen et al., 2025).
• Other investment criteria, such as IRR and Payback Period, are often used as supplementary or initial screening tools but may have limitations compared to NPV (Vernimmen et al., 2025).
• Proper estimation of cash flows involves considering initial investment costs, operating cash flows, taxes, and terminal values, ensuring a comprehensive assessment of project profitability (Vernimmen et al., 2025).

💡 Key Takeaway

Investment analysis through capital budgeting and cash flow evaluation enables firms to select projects that maximize value, with NPV serving as the most reliable criterion for long-term investment decisions.

📖 5. Cost of Capital

🔑 Key Concepts & Definitions

• Cost of Capital: The minimum return that a company must earn on its investments to satisfy its investors and maintain its value, reflecting the opportunity cost of capital (see Vernimmen et al., 2025).
• Cost of Debt (R_debt): The required rate of return demanded by lenders, typically expressed as an interest rate, representing the cost for the firm to borrow funds (see Vernimmen et al., 2025).
• Cost of Equity (R_equity): The return required by shareholders, representing the compensation for the risk of investing in the company’s equity, often estimated using models like the Capital Asset Pricing Model (CAPM) (see Vernimmen et al., 2025).
• Weighted Average Cost of Capital (WACC): The average rate of return a firm must pay to finance its assets through a combination of debt and equity, weighted by their respective proportions in the capital structure (see Vernimmen et al., 2025).

📝 Essential Points

• The cost of capital encompasses both the cost of debt and cost of equity, which are fundamental in investment appraisal and valuation (see Vernimmen et al., 2025).
• The WACC is calculated as:
  $\text{WACC} = \left(\frac{E}{V} \times R_{equity}\right) + \left(\frac{D}{V} \times R_{debt} \times (1 - T)\right)$
  where $E$ is equity, $D$ is debt, $V$ is total capital (E + D), and $T$ is the corporate tax rate (see Vernimmen et al., 2025).
• The WACC is used as a discount rate in valuation models and investment decisions, reflecting the minimum acceptable return for projects (see Vernimmen et al., 2025).
• The cost of debt is often observed from the yield on existing bonds or bank loans, adjusted for tax benefits, since interest expenses are tax-deductible (see Vernimmen et al., 2025).
• The cost of equity can be estimated via the CAPM:
  $R_{equity} = R_f + \beta \times (R_m - R_f)$
  where $R_f$ is the risk-free rate, $\beta$ measures the stock’s volatility relative to the market, and $R_m - R_f$ is the market risk premium (see Vernimmen et al., 2025).

💡 Key Takeaway

The cost of capital, especially the WACC, is a crucial metric in corporate finance that guides investment decisions and valuation by representing the minimum return required to satisfy both debt holders and equity investors.

📖 6. Time Value of Money

🔑 Key Concepts & Definitions

Time Value of Money (TVM):
AUTHOR (date): The fundamental financial principle stating that a sum of money today is worth more than the same sum in the future due to its potential earning capacity. This concept underpins investment and financing decisions.

Present Value (PV):
AUTHOR (date): The current worth of a future cash flow or series of cash flows discounted at an appropriate rate, reflecting the opportunity cost of capital and the time value of money.

Future Value (FV):
AUTHOR (date): The amount to which a present sum of money will grow over a specified period at a given interest rate, considering compounding.

Discounting:
AUTHOR (date): The process of determining the present value of a future cash flow by applying a discount rate, effectively reversing the compounding process to reflect the current worth.

Compounding:
AUTHOR (date): The process of calculating the future value of a present sum by applying interest over multiple periods, reflecting the accumulation of earnings on both initial principal and accumulated interest.

📝 Essential Points

• The Time Value of Money principle is central to corporate finance, influencing valuation, investment analysis, and capital budgeting. It asserts that money has the potential to earn returns, making it more valuable today than in the future.
• Present Value (PV) calculations allow firms to assess the current worth of future cash flows, enabling comparison and decision-making based on discounted cash flows.
• Future Value (FV) calculations project the growth of current investments, informing savings and investment strategies.
• Discounting involves applying a discount rate (often the cost of capital) to future cash flows, translating them into present value terms. This process is crucial for valuation models like NPV.
• Compounding reflects how invested funds grow over time when interest is reinvested, emphasizing the importance of the interest rate and the number of periods.
• The relationship between PV and FV is governed by the formulas for discounting and compounding, which are inverse processes.

💡 Key Takeaway

The time value of money principle emphasizes that the value of money depends on when it is received or paid, making discounting and compounding essential tools for valuation and financial decision-making in corporate finance.

📖 7. Capital Budgeting

🔑 Key Concepts & Definitions

• Capital Budgeting Techniques: Methods used to evaluate and select investment projects based on their potential to create value for the firm, primarily focusing on cash flows and profitability. These techniques help managers decide whether to accept or reject investment proposals (see Part 4, "Investment rules for investment in real assets").

• Investment Rules: Criteria or standards applied to determine the acceptability of a project, guiding decision-making in capital budgeting. Examples include the Net Present Value (NPV) rule and other methods such as the Internal Rate of Return (IRR), Payback Period, and Profitability Index (see Part 4, "Capital budgeting - Investment rules for investment in real assets").

• Net Present Value (NPV) Method: A valuation technique that calculates the difference between the present value of cash inflows and outflows associated with a project, discounted at the firm’s cost of capital. A positive NPV indicates the project is expected to add value to the firm and should be accepted (see Part 4, "NPV (Session 7)").

• Other Investment Decision Rules: Alternative methods to NPV for evaluating projects, including:

  • Internal Rate of Return (IRR): The discount rate that makes the NPV of a project zero; used to assess profitability.
  • Payback Period: The time required for the project's cash inflows to recover the initial investment.
  • Profitability Index (PI): The ratio of the present value of cash inflows to the initial investment, used to rank projects when capital is limited.

📝 Essential Points

• Capital budgeting involves selecting projects that maximize shareholder value by investing in assets with positive net present value, considering the time value of money (see section 6).
• The NPV method is the most comprehensive and theoretically sound investment rule, as it directly measures value creation by discounting future cash flows at the firm’s weighted average cost of capital (WACC).
• Other investment rules, such as IRR and Payback Period, are often used as supplementary or quick screening tools but have limitations, especially regarding reinvestment assumptions and ignoring the scale of projects.
• The choice of discount rate (usually WACC) is crucial in NPV calculations, reflecting the project’s risk and the firm’s cost of capital.
• The acceptance criterion for NPV is: accept projects with NPV > 0; for IRR, accept if IRR exceeds the required rate of return; for Payback, accept if the payback period is within an acceptable threshold.

💡 Key Takeaway

Capital budgeting techniques, especially the NPV method, are essential for making informed investment decisions that align with long-term value creation, with other rules serving as supplementary evaluation tools.

📖 8. Debt and Equity Financing

🔑 Key Concepts & Definitions

Capital structure decisions: The strategic choice between debt and equity financing to fund a firm's operations and growth, balancing risk and return to optimize the firm's value (Vernimmen et al., 2017).

Equity financing methods and equity issuance: Techniques by which a company raises capital through issuing shares, such as initial public offerings (IPOs), seasoned equity offerings (SEOs), or private placements, to increase shareholders’ equity (Vernimmen et al., 2017).

Debt financing including bank loans and bonds: Raising funds through borrowing, where bank loans are short- or long-term credit agreements with financial institutions, and bonds are debt securities issued to investors, both obligating the firm to repay principal plus interest (Vernimmen et al., 2017).

Long-term financing issues: Challenges related to securing and managing funds with maturities exceeding one year, including interest rate risks, refinancing risks, and maintaining optimal debt levels to support sustainable growth (Vernimmen et al., 2017).

📝 Essential Points

• Capital structure decisions fundamentally influence a firm's risk profile and cost of capital, impacting overall valuation (Vernimmen et al., 2017).
• Equity issuance dilutes existing ownership but does not require repayment, making it suitable for financing growth without increasing leverage (Vernimmen et al., 2017).
• Debt financing, especially through bonds and bank loans, provides tax advantages via interest deductibility but increases financial risk due to fixed repayment obligations (Vernimmen et al., 2017).
• Long-term financing issues include managing interest rate fluctuations, refinancing risks, and maintaining an optimal debt-to-equity ratio to balance financial flexibility and risk (Vernimmen et al., 2017).
• The choice between debt and equity depends on market conditions, the firm's creditworthiness, and strategic considerations such as control and financial stability (Vernimmen et al., 2017).

💡 Key Takeaway

Deciding on the optimal mix of debt and equity financing is crucial for balancing risk, minimizing the cost of capital, and maximizing shareholder value over the long term.

📖 9. Valuation Models

🔑 Key Concepts & Definitions

Dividend Discount Model (DDM):
A valuation technique that determines the intrinsic value of a stock by summing the present value of expected future dividends. AUTHOR (Gordon, 1959): "The DDM assumes that the value of a stock is the present value of all future dividends, discounted at the required rate of return."

Valuation techniques for firms:
Methods used to estimate the total value of a company, including approaches like discounted cash flow (DCF), comparable company analysis, and precedent transactions. These techniques help in assessing whether a firm is undervalued or overvalued in the market.

Use of valuation models in corporate finance:
Application of valuation methods to support decision-making such as mergers and acquisitions, capital raising, or investment appraisal. Valuation models provide an estimate of a firm's worth, guiding strategic and financial decisions.

📝 Essential Points

• The Dividend Discount Model (DDM) is especially relevant for firms with stable dividend policies, often used in equity valuation (see section 10 for equity valuation specifics).
• Valuation techniques for firms often combine multiple approaches to cross-verify the estimated value, with DCF being the most prominent in corporate finance.
• In practice, valuation models are used to inform corporate decisions like mergers, acquisitions, and capital structure adjustments, ensuring that investments are aligned with the firm's long-term value creation goals.
• The use of valuation models in corporate finance involves estimating the firm's future cash flows, discounting them at an appropriate rate (e.g., WACC), and adjusting for market conditions and firm-specific factors.
• The choice of valuation model depends on the firm's characteristics, data availability, and purpose of valuation (e.g., equity vs. firm valuation).

💡 Key Takeaway

Valuation models, especially the Dividend Discount Model and discounted cash flow techniques, are essential tools in corporate finance for estimating firm value and supporting strategic financial decisions. Their proper application ensures investments and corporate actions are aligned with long-term value creation.

📖 10. ESG and Corporate Governance

🔑 Key Concepts & Definitions

Environmental, Social, and Governance (ESG) (see section 6): A set of criteria used to evaluate a company's sustainability and ethical impact, influencing its long-term performance and risk profile.

Corporate governance structures (see section 3): The systems and practices by which a company is directed and controlled, primarily involving the board of directors, main shareholders, and executive roles such as the CEO, to ensure accountability and strategic oversight.

Board of Directors (see section 3): A group of elected individuals responsible for overseeing the company's management, making strategic decisions, and safeguarding shareholders’ interests, with increasing emphasis on integrating ESG considerations into governance.

Main shareholders (see section 3): The largest owners of a company's equity, whose influence can significantly shape governance policies, including the integration of ESG factors into corporate strategy and risk management.

ESG impact on financial performance and valuation (see section 13): The influence of ESG factors on a company's profitability, risk profile, and market valuation, with evidence suggesting that strong ESG practices can enhance financial outcomes and investor confidence.

📊 Synthesis Tables

⚠️ Common Pitfalls & Confusions

1. Confusing assets with liabilities; assets are resources, liabilities are claims against assets.
2. Misinterpreting ROCE as equivalent to net profit margin; ROCE considers operating efficiency relative to capital employed.
3. Overlooking the difference between current and fixed assets, leading to incorrect liquidity or asset management assessments.
4. Using PER without considering industry context or growth expectations, risking misvaluation.
5. Ignoring tax effects when calculating ROCE; forgetting to adjust EBIT for taxes.
6. Mistaking shareholders’ equity for total assets; they are different components of the balance sheet.
7. Assuming cash flow equals net income; cash flows are derived from cash flow statements, not just income statements.

✅ Exam Checklist

• Know the definition of corporate finance from Vernimmen et al., 2025 and its two main missions.
• Understand the importance of financial data coordination with economic data for strategic decision-making.
• Master the time value of money principle and its application in valuation and investment analysis.
• Explain the risk-return relationship and its influence on project selection and financing.
• Be able to calculate and interpret cash flows from financial statements.
• Describe the balance sheet structure, including assets, liabilities, and equity, and distinguish between current and fixed assets.
• Understand the components of shareholders’ equity and the concept of capital employed.
• Know the definition and calculation of ROCE, and its role in assessing value creation.
• Be familiar with financial ratios: PER, EPS, DPS, and their significance.
• Recognize the difference between assets and liabilities, and between current and fixed assets.
• Know key authors and their concepts: Vernimmen et al., 2025 for corporate finance, Vernimmen et al., 2025-2026 for balance sheet structure, Vernimmen et al., date for ratios.
• Understand the relationship between ROCE and WACC in value creation.
• Be able to interpret financial ratios in context, considering industry standards and company specifics.
• Recall the main components of financial statements and their relevance for analysis.