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📘 What three decisions define corporate finance?

Corporate finance is the branch of finance concerned with how corporations raise capital and deploy it into

5
lessons
~25 min
to learn
Adults
level
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What you’ll learn

  1. What Corporate Finance Is: The Three Decisions and the Goal of the FirmDefine corporate finance as the study of how firms make investment, financing, and payout decisions to maximize firm value, and identify the agency problems that complicate that goal.Corporate finance studies three linked decisions: which assets to invest in (capital budgeting), how to pay for them (capital structure), and how to return cash to owners (payout policy). The standard normative objective is to maximize the market value of the firm, which under well-functioning markets aligns with maximizing shareholder wealth. Because managers (agents) act on behalf of dispersed owners (principals), agency conflicts arise, and governance mechanisms exist to realign incentives. Throughout this course you will act as the financial manager of a fictional firm, making each of these decisions in a running simulation.
  2. Time Value of Money and the Investment DecisionApply discounted cash flow analysis to value cash flows across time and use the NPV and IRR rules to accept or reject capital investment projects.A dollar received today is worth more than a dollar received later, so cash flows occurring at different times must be made comparable by discounting them to present value. Net present value (NPV) sums the present values of all incremental after-tax cash flows and accepts a project when NPV is positive, because a positive NPV means the project earns more than the opportunity cost of capital. The internal rate of return (IRR) is the discount rate that sets NPV to zero and usually agrees with NPV for a single conventional project, but NPV is the reliable rule when projects are mutually exclusive or cash flows change sign. Payback and other rules can supplement but should not override NPV.
  3. Risk, Return, and the Cost of CapitalExplain how diversification distinguishes systematic from specific risk, use the CAPM to estimate the cost of equity, and combine component costs into a weighted average cost of capital (WACC).Investors require higher expected returns for bearing more risk, but only risk that cannot be diversified away (systematic, or market, risk) is rewarded; firm-specific risk is eliminated by holding a diversified portfolio. The Capital Asset Pricing Model expresses the required return on equity as the risk-free rate plus beta times the market risk premium, where beta measures sensitivity to market movements. A firm funded by both debt and equity has an overall cost of capital equal to the weighted average of the after-tax cost of debt and the cost of equity, the WACC, with weights based on market values. The WACC is the appropriate discount rate for projects whose risk matches the firm's overall business risk.
  4. Capital Structure and Payout PolicyUse the Modigliani-Miller propositions and the trade-off and pecking-order theories to reason about how debt-equity mix and payout choices affect firm value.Modigliani and Miller showed that in a frictionless world with no taxes or bankruptcy costs, firm value is independent of capital structure, and leverage merely rebalances risk and return between debt and equity holders. Introducing corporate taxes adds value from the interest tax shield, while the threat of financial distress and bankruptcy costs creates an offsetting penalty, giving rise to the trade-off theory of an interior optimum. The pecking-order theory, grounded in information asymmetry, instead predicts firms prefer internal funds, then debt, then equity as a last resort. Payout policy concerns returning cash through dividends or repurchases; in idealized markets payout form is irrelevant, but taxes, signaling, and clientele effects make it matter in practice.
  5. Capstone: Build Your Corporate Finance Simulation ArtifactIntegrate capital budgeting, cost of capital, and financing decisions into a single one-page mini financial plan for your simulated firm and defend each decision with the relevant principle.In this capstone you assemble the tools from the course into one coherent artifact: a one-page mini financial plan for your fictional firm. You will estimate a project's incremental cash flows and NPV, derive the discount rate from CAPM and WACC, choose a financing mix justified by capital-structure theory, and specify a payout approach. The deliverable is a structured worksheet plus a short written rationale linking each number to a principle. Your simulation score reflects internal consistency, correct use of the tools, and the quality of your reasoning rather than a single right answer.

Questions this course answers

Which set best describes the three core decisions of corporate finance?

Corporate finance is conventionally organized around the investment decision (which assets to acquire), the financing decision (how to fund them), and the payout decision (how much cash to return to shareholders).

Why is maximizing firm value generally preferred over maximizing reported accounting profit as the objective of the firm?

Market value capitalizes expected future cash flows discounted for risk and timing. Accounting profit relies on accruals and non-cash items and can diverge from the cash a decision actually produces, so it is an incomplete objective.

The agency problem in a corporation arises primarily because:

When dispersed shareholders (principals) delegate control to managers (agents), managers may pursue their own interests. Governance mechanisms such as boards, incentive pay, monitoring, and the takeover market exist to mitigate this conflict.

A project has a positive net present value when discounted at the firm's opportunity cost of capital. According to the NPV rule, the firm should:

A positive NPV means the present value of the project's cash flows exceeds the cost of capital, so the project is expected to add that amount of value to the firm. The NPV rule says accept positive-NPV projects.

What is the internal rate of return (IRR) of a project?

The IRR is defined as the discount rate that makes the project's net present value equal to zero, representing the project's own implied rate of return.

Two mutually exclusive projects rank differently under NPV and IRR. Which criterion should govern the decision and why?

For mutually exclusive projects, IRR can favor a project that adds less value. NPV measures value creation directly in currency terms, so NPV should govern when the two rules conflict.

Grounded in trusted sources

  • Brealey, Myers, and Allen, Principles of Corporate Finance
  • Ross, Westerfield, and Jaffe, Corporate Finance
  • Modigliani–Miller capital-structure propositions (classic papers / textbook treatments)
  • Damodaran online resources on cost of capital and corporate finance
  • SEC / investor education notes on capital raising and payouts

Every Wunder lesson is built from real, reputable sources — never invented.

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