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 functions and responsibilities of a company’s board of directors and its committees

CFA Level 1 – Corporate Finance Reading 31 Introduction to Corporate Governance and Other ESG Considerations Describe functions and responsibilities of a company’s board of directors and its committees

Board of directors’ act as shareholders’ monitoring tool. Many corporate governance frameworks require the board of directors to represent a diverse mix of expertise, backgrounds and competencies. 

One-tier boards have executive and non-executive directors. Non-executive directors may be independent if they do not have any material relationship with the company. In the two-tier structure, supervisory and management boards are independent of each other, i.e. there are no overlapping members or there is a limit to the number of people who can serve on both boards. 

While in many countries, particularly the US, CEOs typically were also chairpersons of the board of directors (CEO duality), there is a trend away from this practice recently. 

Some boards are staggered in that some of the directors retire and are re-elected each year instead of all directors retiring and being re-elected at the same time.

Function and responsibilities of the board

A board is elected by shareholders to act on their behalf, but they have a responsibility to consider the interests of all stakeholders. They owe a duty of care and duty of loyalty to the company and its shareholders. The board’s main role is to provide strategic direction, oversee implementation of strategy, evaluation performance and compensation of senior management, review the company’s performance, ensure succession planning of management. They delegate the day to day operations to the management. They also play a central role in ensuring effectiveness of a company’s audit and control systems, reviewing reports by external and internal auditors, financial statements, etc. and checking compliance with corporate and other laws and regulations. They are also responsible for establishing an enterprise risk management system, reviewing proposals for corporate transactions such as mergers and acquisitions, restructuring, etc.

Board of directors committees

A company’s board of directors typically delegates some functions to committees constituted for the purpose, who report their recommendations to the board. But this does not absolve the board of its responsibilities. Popular committees include:

  • Audit committee is responsible for overseeing the audit and control system of a company, i.e. monitoring of financial reporting process; supervision of internal audit, presentation of annual audit plan to board and ensuring its implementation; recommending external auditor for appointment and its remuneration; reviewing reports by internal and external auditors and suggesting remedial action. 
  • Governance committee ensures adoption, constant updating and implementation of a company’s corporate governance framework, code of ethics, board charter, etc.; further, it ensures compliance with relevant laws, and may be responsible for undertaking an evaluation of the board, its structure and activities.
  • Remuneration or compensation committee is mainly responsible for proposing remuneration policies for directors and key executives for approval by board/shareholders. They may also handle relevant employment contracts, define performance evaluation criteria, evaluate managers, establish HR policies, and oversee implementation of employee benefit plans.
  • Nomination committee nominates/recommends qualified individuals for elections to the board. They also set nomination policies and procedures, define independence criteria, etc.
  • Risk committee oversees a company’s enterprise risk management, helps the board in formulating risk policy, risk profile, and oversees the risk management function of a company. It is most important in the case of banks and financial institutions.
  • Investment committee critically reviews investment proposals (both expansion and divestiture) submitted by management. It is also typically responsible for establishing/revising investment strategy of a company. 

Different jurisdictions have different requirements/recommendations regarding committees and their composition. However, many frameworks require only independent directors to handle matters of conflict of interest. For example, LSE and NYSE require that audit and compensation committees be composed solely of independent directors.

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