Corporate Finance and Financial Management
What this domain tests
Corporate Finance and Financial Management covers investment appraisal, the cost of capital, financing choices and working capital, and expects numerical judgement alongside an understanding of risk.
Core rules
- NPV discounts incremental after-tax cash flows at the WACC; accept if NPV > 0. IRR is the rate where NPV = 0. Payback ignores cash flows after the cut-off and the time value of money.
- CAPM: Ke = Rf + β(Rm − Rf). Beta measures systematic risk only; unsystematic risk is diversifiable and not rewarded.
- WACC = (E/V)Ke + (D/V)Kd(1 − t), using market values and the after-tax cost of debt.
- Working capital: the operating cycle = inventory days + receivable days − payable days; shortening it releases cash.
Worked example
Rf = 4%, market return = 10%, beta = 1.2, so Ke = 4 + 1.2(6) = 11.2%. Debt costs 6% pre-tax and tax is 25%, giving 4.5% after tax. With 60% equity and 40% debt by market value, WACC = 0.6 × 11.2% + 0.4 × 4.5% = 6.72% + 1.80% = 8.52%. A project with an NPV of +£40,000 at 8.52% adds value; one that only breaks even at 7% is value-destroying once risk-adjusted.
Traps that cost marks
- Discounting accounting profit instead of cash flow, or omitting tax and working-capital outflows.
- Using book values rather than market values for WACC weights.
- Mixing nominal cash flows with a real discount rate.