Course Review: FINA 395 Theory of Finance II
By: Yashaswi Vig
This course introduces and teaches concepts that are important for most FINA 400-level courses. It is key to develop a solid understanding of core concepts covered in COMM 308 which include time value of money, valuation, net present value, and capital budgeting. As FINA 395 is an advanced version of COMM 308, these key concepts are explored in greater detail in this course.
FINA 395 is introduced with basic concepts like present value, discounting, growing perpetuity, and annuity in order to refresh students' knowledge and prepare them for the advanced topics to come. Some topics in Finance are so complex that they can’t be fully covered in one course. The concept of Net Present Value is among them. In COMM 308, NPV analysis is introduced as one of the only ways to value a project. FINA 395 points out the problems with this method and introduces real options (expand, abandon, and delay), which allows one to value a project despite the inconsistencies and uncertainties that surround it. There are many types of investment projects which have become easier to value correctly through real options.
One of the most important yet difficult concepts in Finance is covered in detail in this course: the cost of capital. Since COMM 308 is an introductory course, cost of capital is taught as an overview. Only the weighted average cost of capital and cost of equity was covered, which is a small part of the cost of capital. FINA 395 introduces the cost of capital of a levered and unlevered firm which is used to value both types of firms. Understanding these concepts are crucial as they are the focus of three to four chapters that are covered after the midterm. It is important to know that a company’s cost of capital is dependent on both its capital structure and the type of NPV projects it chooses to invest in. So, if a company finances its projects only based on equity, then cost of equity would be its measure of risk. Whereas, if a company chooses to add leverage and finance its project with both debt and equity, tedious calculation would be needed to compute cost of capital that will be used to value a levered firm. The cost of capital is a measurement of risk that is involved in a project, where the type of method used depends on the project.
Overall, FINA 395 is an intensive course that requires a lot of practice as it teaches the most important concepts that help build a foundation for other FINA 400-level classes. It is crucial to understand the concept of cost of capital for both levered and unlevered firms, because it is used to value firms, create leverage buyout charts, and make investment decisions. Theory of Finance II is my favourite course at JMSB because I learned some of the most challenging and important concepts (and other rules) of Finance. This course is very demanding, as there are many calculations involved for almost all topics. I would highly recommend everyone to spend a considerable amount of time learning the concepts of this course in order to achieve an excellent grade in not only FINA 395 but all other FINA 400-level classes.