Corporate Finance (also called Corporate Issuers in recent CFA curricula) carries a 6-9% weight at Level 1. It’s one of the lighter sections by weight, but don’t let that fool you into deprioritizing it. Corporate Finance is among the most logical and intuitive sections in the entire exam — which means it offers some of the easiest points if you study it properly.
The core question Corporate Finance answers is this: How should a company invest its money, how should it raise capital, and how should it return value to shareholders? If you understand these three decisions, you understand the entire section.
What Corporate Finance Covers
Capital Budgeting
This is the process companies use to evaluate potential investments and projects. It’s the heart of Corporate Finance and the most heavily tested area.
Net Present Value (NPV): The gold standard of capital budgeting. NPV calculates the present value of all expected future cash flows from a project, minus the initial investment. If NPV is positive, the project creates value. If negative, it destroys value.
Internal Rate of Return (IRR): The discount rate that makes NPV equal to zero. If the IRR exceeds the required rate of return (hurdle rate), the project is acceptable. IRR is intuitive — it tells you the project’s effective rate of return.
Other methods you need to know:
- Payback period and discounted payback period
- Profitability index
- When NPV and IRR give conflicting signals (and why NPV should prevail)
Crucial understanding: NPV and IRR can conflict when comparing mutually exclusive projects of different sizes or different time horizons. The CFA exam tests this concept regularly. The answer is always: follow NPV. It maximizes shareholder wealth directly.
Cost of Capital
Before you can do an NPV calculation, you need a discount rate. That rate is typically the Weighted Average Cost of Capital (WACC).
WACC = (E/V) x Re + (D/V) x Rd x (1 - Tax Rate)
Where:
- E/V = proportion of equity financing
- D/V = proportion of debt financing
- Re = cost of equity
- Rd = cost of debt
- Tax Rate = corporate tax rate (debt gets a tax shield)
Cost of equity estimation:
- Capital Asset Pricing Model (CAPM): Re = Rf + Beta x (Rm - Rf)
- Dividend Discount Model approach: Re = (D1/P0) + g (this connects directly to the valuation models covered in Equity Investments)
- Bond yield plus risk premium approach
Why the tax adjustment on debt matters: Interest payments are tax-deductible, so the after-tax cost of debt is lower than the pre-tax cost. This tax shield is a genuine economic benefit of debt financing and is a concept the exam tests explicitly.
Capital Structure
How should a company mix debt and equity? This section covers the theoretical frameworks for answering that question.
Key concepts:
- Modigliani-Miller propositions (with and without taxes)
- The trade-off theory (balancing tax benefits of debt against bankruptcy costs)
- Pecking order theory (companies prefer internal financing, then debt, then equity)
- Target capital structure
MM Proposition I (no taxes): Capital structure doesn’t matter — the value of the firm is the same regardless of financing. This seems unrealistic, and it is. It’s a starting point that shows what assumptions you need to relax for capital structure to matter.
MM Proposition I (with taxes): Debt creates value through the tax shield. The value of a levered firm equals the value of an unlevered firm plus the present value of the tax shield.
Corporate Governance
This section covers the systems and processes that direct and control companies:
- Stakeholder theory vs. shareholder theory
- Board of directors — composition, independence, committees
- Executive compensation and alignment of interests
- ESG (Environmental, Social, and Governance) considerations
Corporate governance questions tend to be qualitative and test your understanding of best practices and potential conflicts of interest.
Working Capital Management
How companies manage their short-term assets and liabilities:
- Cash conversion cycle
- Inventory management
- Receivables management
- Short-term financing options
Why Corporate Finance Is a Strategic Subject
High ROI study time: Corporate Finance concepts are logical and build on each other naturally. Most candidates can master this section in relatively few study hours, making it one of the best returns on study time investment.
Cross-topic connections: NPV uses time value of money from Quant. WACC uses CAPM from Portfolio Management. Capital structure analysis requires understanding financial leverage from FRA. Corporate Finance ties together threads from across the curriculum.
Practical relevance: These are the exact frameworks used by CFOs and corporate treasurers worldwide. Understanding NPV, IRR, and WACC isn’t just exam preparation — it’s professional competence that directly supports careers in investment banking and corporate strategy.
Study Strategy for Corporate Finance
Master NPV and IRR first
These two concepts account for a disproportionate share of Corporate Finance exam questions. You should be able to:
- Calculate NPV given a set of cash flows and a discount rate
- Calculate IRR using your financial calculator
- Explain why NPV is preferred over IRR for mutually exclusive projects
- Identify when IRR gives multiple solutions (non-conventional cash flows)
Spend your first 8-10 hours on capital budgeting alone.
Build WACC calculation from components
Don’t just memorize the WACC formula. Understand each component:
- First, calculate the cost of equity (using CAPM or DDM)
- Then, calculate the after-tax cost of debt
- Then, determine the weights (market values, not book values)
- Finally, combine everything
This component-based approach is how the exam tests WACC. Questions often give you partial information and ask you to solve for a missing piece.
Don’t skip Modigliani-Miller
Many candidates find MM propositions abstract and skip the details. This is risky — MM questions appear on the exam and are straightforward if you understand the logic. The key is understanding how each proposition changes when you introduce taxes. With taxes, debt becomes valuable because of the tax shield. Without taxes, it doesn’t matter.
Connect governance to Ethics
Corporate governance overlaps significantly with the Ethics section. Many governance principles (acting in the best interest of shareholders, avoiding conflicts of interest, ensuring transparency) mirror the CFA Standards of Professional Conduct. Study them together for reinforcement.
Common Mistakes in Corporate Finance
Mistake 1: Using book values instead of market values for WACC weights. WACC should use market values of debt and equity, not book values. This distinction gets tested frequently, and candidates who default to book values lose easy marks.
Mistake 2: Forgetting the tax shield on debt. The after-tax cost of debt is Rd x (1 - Tax Rate), not just Rd. The tax deductibility of interest is a central concept in Corporate Finance.
Mistake 3: Confusing NPV and IRR recommendations for mutually exclusive projects. When two projects are mutually exclusive and NPV and IRR disagree, always follow NPV. IRR can mislead when project sizes or time horizons differ.
Mistake 4: Misidentifying cash flows in NPV analysis. Use incremental after-tax cash flows, not accounting profits. Include opportunity costs and externalities. Exclude sunk costs and financing costs (financing costs are captured in the discount rate).
Mistake 5: Not understanding the pecking order theory. This theory predicts that companies prefer internal financing first, then debt, then equity — because of information asymmetry and signaling effects. The exam may present a company’s financing behavior and ask you to identify which theory explains it.
Practical Exam Tips
Tip 1: For NPV questions, always check whether cash flows are annual or have a different frequency. Mismatching cash flow frequency with the discount rate is a common error.
Tip 2: When calculating IRR on your BA II Plus, use the CF worksheet. Enter CF0, then each subsequent cash flow, then press IRR and CPT. Practice this sequence until it’s automatic.
Tip 3: Governance questions often have two answers that seem correct. Look for the answer that most directly addresses the specific governance principle being tested — don’t overthink it.
Tip 4: For working capital questions, remember that the cash conversion cycle = Days of Inventory + Days of Receivables - Days of Payables. A shorter cycle is generally better.
Time Allocation
Corporate Finance requires 25-35 hours of study:
- Capital budgeting (NPV, IRR): 8-10 hours
- Cost of capital (WACC): 6-8 hours
- Capital structure (MM, trade-off theory): 4-6 hours
- Corporate governance and ESG: 3-4 hours
- Working capital management: 2-3 hours
- Practice problems: 5-7 hours
Final Thoughts
Corporate Finance rewards logical thinking over memorization. The concepts follow a clear narrative — companies need to decide which projects to pursue, how to finance them, and how to govern the process. Once you see this narrative, the individual topics connect naturally.
This is a section where smart study yields fast results. Many candidates report that Corporate Finance was one of their strongest sections on exam day, simply because the concepts are intuitive and the question types are predictable.
If you want personalized help connecting Corporate Finance concepts to your professional background or career goals, reach out for free mentorship. Understanding how companies create value isn’t just exam knowledge — it’s a career-defining skill.