Corporate Finance and Ethics
Two halves of one paper
Corporate finance: investment appraisal (NPV, IRR, payback, adjusted present value), cost of capital and CAPM, gearing and capital structure, dividend policy, working capital management, business valuation and risk management. Ethics and governance: agency theory, stakeholder versus shareholder primacy, the governance code (in Kenya, Mwongozo), insider dealing, conflicts of interest, whistleblowing and the professional code's fundamental principles.
Concepts to hold firmly
NPV is king: it measures value added and is additive across projects; IRR can mislead on scale, timing and multiple sign changes. WACC: market-value weights, cost of equity from CAPM, after-tax cost of debt kd(1−t). Use a project-specific discount rate for projects of different business risk. Gearing: increases expected return to shareholders and financial risk; the tax shield is valuable but distress costs offset it. Valuation: free cash flow to firm discounted at WACC, or free cash flow to equity at cost of equity - do not mix. Ethics: the fundamental principles are integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour; apply a conceptual framework of identify, evaluate, address threats.
Traps that appear in questions
Using book values instead of market values in WACC. Applying the company's existing WACC to a diversification project. Including sunk costs or allocated head-office overhead in project cash flows. Ignoring working capital and tax in incremental cash flows. Confusing a self-interest threat with an intimidation threat. Recommending disclosure of confidential client information because it is 'in the public interest' without a legal or professional duty.
Worked example
Equity market value KES 600m, debt KES 400m, ke 16%, kd 10%, tax 30%. WACC = (0.6 × 16%) + (0.4 × 10% × 0.7) = 9.6% + 2.8% = 12.4%.