CFA Level 1 – Corporate Finance

Study Session 12: Corporate Finance (1)
Reading 31 Introduction to Corporate Governance and Other ESG Considerations
11 LOSs | 3 Quizzes
Describe corporate governance
Describe a company’s stakeholder groups and compare interests of stakeholder groups
Describe principal–agent and other relationships in corporate governance and the conflicts that may arise in these relationships
Describe stakeholder management
Describe mechanisms to manage stakeholder relationships and mitigate associated risks
Describe functions and responsibilities of a company’s board of directors and its committees
Describe market and non-market factors that can affect stakeholder relationships and corporate governance
Identify potential risks of poor corporate governance and stakeholder management and identify benefits from effective corporate governance and stakeholder management
Describe factors relevant to the analysis of corporate governance and stakeholder management
Describe environmental and social considerations in investment analysis
Describe how environmental, social, and governance factors may be used in investment analysis
Reading 31 Introduction to Corporate Governance and Other ESG Considerations – Quiz 1
Reading 31 Introduction to Corporate Governance and Other ESG Considerations – Quiz 2
Reading 31 Introduction to Corporate Governance and Other ESG Considerations – Quiz 3
Reading 32 Capital Budgeting
 7 LOSs | 3 Quizzes
Describe the capital budgeting process and distinguish among the various categories of capital projects
Describe the basic principles of capital budgeting
Explain how the evaluation and selection of capital projects is affected by mutually exclusive projects, project sequencing, and capital rationing
Calculate and interpret net present value (NPV), internal rate of return (IRR), payback period, discounted payback period, and profitability index (PI) of a single capital project
Explain the NPV profile, compare the NPV and IRR methods when evaluating independent and mutually exclusive projects, and describe the problems associated with each of the evaluation methods
Contrast the NPV decision rule to the IRR decision rule and identify problems associated with the IRR rule
Describe expected relations among an investment’s NPV, company value, and share price
Reading 32 Capital Budgeting – Quiz 1
Reading 32 Capital Budgeting – Quiz 2
Reading 32 Capital Budgeting – Quiz 3
Reading 33 Cost of Capital
 12 LOSs | 3 Quizzes
Calculate and interpret the weighted average cost of capital (WACC) of a company
Describe how taxes affect the cost of capital from different capital sources
Describe the use of target capital structure in estimating WACC and how target capital structure weights may be determined
Explain how the marginal cost of capital and the investment opportunity schedule are used to determine the optimal capital budget
Explain the marginal cost of capital’s role in determining the net present value of a project
Calculate and interpret the cost of debt capital using the yield-to-maturity approach and the debt-rating approach
Calculate and interpret the cost of noncallable, nonconvertible preferred stock
Calculate and interpret the cost of equity capital using the capital asset pricing model approach, the dividend discount model approach, and the bond-yieldplus risk-premium approach
Calculate and interpret the beta and cost of capital for a project
Describe uses of country risk premiums in estimating the cost of equity
Describe the marginal cost of capital schedule, explain why it may be upward sloping with respect to additional capital, and calculate and interpret its break-points
Explain and demonstrate the correct treatment of flotation costs
Reading 33 Cost of Capital – Quiz 1
Reading 33 Cost of Capital – Quiz 2
Reading 33 Cost of Capital – Quiz 3
Study Session 11: Corporate Finance (2)
Reading 34 Measures of Leverage
 5 LOSs | 2 Quizzes
Define and explain leverage, business risk, sales risk, operating risk, and financial risk and classify a risk
Calculate and interpret the degree of operating leverage, the degree of financial leverage, and the degree of total leverage
Analyze the effect of financial leverage on a company’s net income and return on equity
Calculate the breakeven quantity of sales and determine the company’s net income at various sales levels
Calculate and interpret the operating breakeven quantity of sales
Reading 34 Measures of Leverage – Quiz 1
Reading 34 Measures of Leverage – Quiz 2
Reading 35 Working Capital Management
 7 LOSs | 3 Quizzes
Describe primary and secondary sources of liquidity and factors that influence a company’s liquidity position;
Compare a company’s liquidity measures with those of peer companies
Evaluate working capital effectiveness of a company based on its operating and cash conversion cycles and compare the company’s effectiveness with that of peer companies
Describe how different types of cash flows affect a company’s net daily cash position
Calculate and interpret comparable yields on various securities, compare portfolio returns against a standard benchmark, and evaluate a company’s short-term investment policy guidelines
Evaluate a company’s management of accounts receivable, inventory, and accounts payable over time and compared to peer companies
Evaluate the choices of short-term funding available to a company and recommend a financing method
Reading 35 Working Capital Management – Quiz 1
Reading 35 Working Capital Management – Quiz 2
Reading 35 Working Capital Management – Quiz 3
Corporate Finance – Exam
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Describe factors relevant to the analysis of corporate governance and stakeholder management

CFA Level 1 – Corporate Finance Reading 31 Introduction to Corporate Governance and Other ESG Considerations Describe factors relevant to the analysis of corporate governance and stakeholder management

Corporate governance considerations occupy center-stage in today’s fundamental analysis. An analyst needs to know/inquire about a company’s ownership and voting structure, composition of its board of directors, relationships between its execution compensation and company performance, its major shareholders, robustness of shareholders’ rights, and management of long-term risks.

Ownership and voting structure

When voting rights are decoupled from economic ownership, an analyst needs to study its implications. It is most commonly the case when a dual structure exists, in which there are two classes of common shares, one held typically by insiders carrying disproportionately higher voting rights, and the other carrying no or low voting rights. Another mechanism is when both classes of shares carry equal voting rights, but one is entitled to elect a majority of directors. Proponents of dual-class structure say that it promotes stability while opponents argue that it creates conflicts of interest. Since it is impossible to dismantle a dual-class structure, an investor/analyst needs to study the motivations of controlling shareholders, generational dynamics, succession planning, relationship between management and shareholders, etc. It may also impact valuation because such shares may trade at a discount.

Composition of board of directors

Analysts must assess independence, tenure, experience, and diversity of the board of directors. When there are too many related party transactions, independence may be impaired. When the tenure is quite long, it may add experience but may also create diversity and adaptability problems.

Remuneration and company performance

While availability and quality of executive compensation disclosure is not uniform, an analyst needs to check its composition, i.e. base salary vs cash bonus vs equity-based incentive compensation and assess whether the contingent compensation is linked with factors which actually drive the company’s performance. Potential considerations include:

  • Little aligned between executive compensation and shareholder rights.
  • Little variation in compensation over time despite variation in operating/financial performance.
  • Excessive payout in comparison with comparable companies with comparable performance.
  • Whether the plan is linked with some strategic event (not necessarily bad, but an analyst needs to assess whether it is aligned with the company’s objectives).
  • Plan based on incentive from an earlier period (for example compensation based on revenue growth when the company has already exited the high growth phase).

Investors in the company

Examining the composition of a company’s investor base may help an analyst uncover cross-shareholders, affiliated shareholders and activist shareholders. Both cross-shareholders and affiliated shareholders may shield a company from the effect of takeover attempt and voting by outside shareholders respectively. Activist investors may result in a rapid change in investor composition of a company because their actions garner interest by other investors. However, analysis of investor composition must be taken in the context of the market because in some markets concentrated cross-holding of affiliated shareholders may be considered necessary for long-term stability of the company.

Strength of shareholders rights

An analyst needs to assess whether shareholders’ rights as contained the company’s charter and bylaws are strong, average or weak when compared to other companies following the same corporate governance frameworks. It is because many corporate governance frameworks, particularly in the developed markets, allow a company to either comply with some rules of publicly disclose the reason in case of non-compliance.

Managing long-term risks

An analyst needs to consider how a company manages various long-term issues such as environmental risks, human capital, transparency, etc. It is because improper management of such risks can adversely affect a company’s value. If a company has a persistent pattern of fines, accidents, regulatory actions, etc.

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