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 market and non-market factors that can affect stakeholder relationships and corporate governance

CFA Level 1 – Corporate Finance Reading 31 Introduction to Corporate Governance and Other ESG Considerations Describe market and non-market factors that can affect stakeholder relationships and corporate governance

Factors that affect stakeholder relationships and corporate governance are classified as market factors, which originate from capital markets, and non-market factors, which do not.

Market factors

Market factors include shareholder engagement, shareholder activism and competitive forces.

  • Shareholder engagement: companies have realized it is useful to continuously engage shareholders year-round, and not just in annual general meetings. This can help companies fight out short-term activist investors, proxy battles, etc.
  • Shareholder activism refers to strategies used by shareholders to compel a company and its management to act in a desired manner. Even though it may have social or political factors, the primary goal is to increase shareholder value. Shareholder activists engage in proxy battles, propose shareholder resolutions, create awareness, initiate shareholder derivative lawsuits—lawsuits against a company’s management or board of directors (which may be restricted in certain jurisdictions). Hedge funds have greater room to act as activist shareholders.
  • Competitions and takeovers: when there is competition, management realizes that they must perform well or else lose their jobs. Similarly, when there is an active takeover market, management knows that shareholders may replace them with another group if they do not do well. Corporate takeovers can be executed via proxy contest (proxy fight) in which shareholders are persuaded to vote for directors of a new group of investors seeking controlling positions, or tender offer, in which shareholders sell their shares to the controlling group, or hostile takeover, in which a company attempts to acquire another company without approval of its management.

However, these market forces may have counterproductive effects too. For example, management may adopt anti-takeover measures, such as staggered board, because all of the directors may be replaced in a single election, shareholders rights plan (poison pill), in which a company entitles its shareholders to buy shares at a discount if a company is taken over. This increases the cost of takeover and reduces its likelihood.

Non-market factors

Non-market factors include a company’s legal environment, the role of the media, and the corporate governance industry.

  • Legal environment: countries with common law (UK, US) generally offer better protection to shareholders and creditors than the civil law countries. It is because in civil law jurisdictions, a judge cannot create a law but must follow a statute solely; while in common law countries, a court’s decision is based on both statues and/or judicial opinions. In the common law system, shareholders or creditors may appeal to judge against management actions. Regardless of the legal system, creditors generally have better success in enforcing their rights because their relationship is not as complex as those of shareholders. 
  • Media: media has enabled fast dissemination of information which has reduced the cost of monitoring management activities. Further, it has motivated politicians and regulators to promulgate and implement new laws and regulations. Social media has been particularly disruptive because it has enabled all stakeholders to voice their opinions.
  • The corporate governance industry: as a result of increased focus on corporate governance, an industry has developed which includes companies that provide governance monitoring, governance ratings and proxy advice. Since this industry is concentrated, companies must pay attention to what they have to say.
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