Corporate Finance Fundamentals: The Complete Guide (2026) | Capital Structure, WACC & More
Master corporate finance fundamentals for interviews. Learn capital structure, working capital, WACC, capital budgeting, and financing decisions.
Updated for 2026. Corporate finance is the foundation of every finance role. Whether you're advising on M&A, investing in PE, or managing a company's treasury, you need to understand how companies make financial decisions: how to raise capital, how to allocate it, and how to measure value creation.
This guide covers the core concepts tested in finance interviews: capital structure, working capital management, cost of capital, capital budgeting, and dividend policy.
What is Corporate Finance?
Corporate finance answers three fundamental questions:
- What long-term investments should the firm make? (Capital Budgeting)
- How should the firm raise money to fund these investments? (Capital Structure)
- How should the firm manage its day-to-day cash flows? (Working Capital Management)
Note
Every decision in corporate finance comes down to value creation. Does this decision increase the value of the firm?
Working Capital Management
Working capital is the lifeblood of a company's operations. It's the difference between current assets (cash, receivables, inventory) and current liabilities (payables, accrued expenses).
Working Capital = Current Assets - Current LiabilitiesAlso known as Net Working Capital (NWC). Positive working capital means you can cover short-term obligations.
Change in NWC = Increase in Current Assets - Increase in Current LiabilitiesAn increase in NWC is a CASH OUTFLOW (you're tying up more cash). A decrease in NWC is a CASH INFLOW.
The Working Capital Components
Working Capital Drivers
| Term | Definition | Note |
|---|---|---|
| Accounts Receivable (AR) | ↑ AR = Cash tied up (bad for cash flow) | Measured by Days Sales Outstanding (DSO) |
| Inventory | ↑ Inventory = Cash tied up (bad for cash flow) | Measured by Days Inventory Outstanding (DIO) |
| Accounts Payable (AP) | ↑ AP = Cash retained (good for cash flow) | Measured by Days Payable Outstanding (DPO) |
Cash Conversion Cycle (CCC) = DSO + DIO - DPOMeasures how long cash is tied up in operations. Lower is better. Negative CCC (like Amazon) means you collect from customers before paying suppliers.
Why Working Capital Matters in Interviews
- PE/LBO models: Changes in working capital directly impact cash flow and returns
- M&A deals: Buyers often adjust purchase price for working capital changes
- Corporate finance roles: Managing working capital is a core treasury function
Test Yourself
Interview Question
A company increases Days Sales Outstanding (DSO) from 30 to 45 days while keeping everything else constant. What happens to cash flow and working capital?
Capital Structure: Debt vs Equity
Capital structure is the mix of debt and equity a company uses to finance its operations. This is one of the most important strategic decisions a CFO makes.
The Trade-off Theory
Debt vs Equity Trade-offs
| Term | Definition | Note |
|---|---|---|
| Cost | Debt is cheaper (tax-deductible interest) | Equity is more expensive (no tax benefit) |
| Risk | Debt increases financial risk (fixed obligations) | Equity is flexible (no required payments) |
| Control | Debt doesn't dilute ownership | Equity dilutes existing shareholders |
| Flexibility | Debt has covenants and restrictions | Equity has no mandatory payments |
The Modigliani-Miller Theorem
M&M Theorem (1958) states that in a perfect market without taxes, capital structure doesn't affect firm value. But in reality, taxes exist, creating the interest tax shield:
Interest Tax Shield = Interest Expense × Tax RateEvery €1 of interest saves (Tax Rate) in taxes. This is why debt can increase firm value — up to a point.
Optimal Capital Structure
The optimal capital structure balances:
- Tax benefits of debt (interest tax shield)
- Costs of financial distress (bankruptcy risk, covenant restrictions)
- Agency costs (debt disciplines management, but too much debt restricts flexibility)
Test Yourself
Interview Question
A company replaces €100m of equity with €100m of debt. Assuming the Modigliani-Miller theorem holds WITHOUT taxes, what happens to the company's overall value (WACC stays constant)?
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Cost of Capital (WACC)
The Weighted Average Cost of Capital (WACC) is the average rate a company must pay to finance its assets. It's used as the discount rate in DCF models and as the hurdle rate for capital budgeting.
WACC = (E/V × Re) + (D/V × Rd × (1-Tc))E = Equity Value, D = Debt Value, V = E + D (Total Value), Re = Cost of Equity, Rd = Cost of Debt, Tc = Corporate Tax Rate
Calculating Cost of Equity (CAPM)
Re = Rf + β × (Rm - Rf)Rf = Risk-free rate (10-year Treasury), β = Beta (stock volatility vs market), Rm - Rf = Equity risk premium (~6-7% historically)
Calculating Cost of Debt
Rd = Interest Expense / Total DebtOr use the yield to maturity on the company's bonds. Remember to use the AFTER-TAX cost: Rd × (1 - Tax Rate)
WACC Intuition for Interviews
- More debt → Lower WACC (debt is cheap) → But only up to a point (financial distress risk increases)
- Higher beta → Higher cost of equity → Higher WACC → Lower valuation in DCF
- Higher tax rate → More valuable tax shield → Lower WACC (debt becomes more attractive)
Test Yourself
Interview Question
A company's stock price drops significantly due to market sentiment (company fundamentals unchanged). What happens to the company's cost of equity?
Capital Budgeting: NPV vs IRR
Capital budgeting is the process of evaluating long-term investments. Should we build this factory? Buy this equipment? Acquire this company?
Net Present Value (NPV)
NPV = Σ [CFt / (1 + WACC)^t] - Initial InvestmentSum of discounted cash flows minus the initial investment. NPV > 0 means the project creates value.
Decision Rule: Accept all projects with NPV > 0. If projects are mutually exclusive, choose the one with the highest NPV.
Internal Rate of Return (IRR)
IRR = Discount rate where NPV = 0The break-even return. If IRR > WACC, the project creates value.
NPV vs IRR: Which is better?
NPV vs IRR Comparison
| Term | Definition | Note |
|---|---|---|
| NPV | ✅ Measures value in absolute dollars | ✅ Always gives the correct answer |
| IRR | ✅ Easy to communicate ('20% return') | ❌ Can give multiple solutions |
Interview Answer
"NPV is theoretically superior because it directly measures value creation in dollar terms. IRR can be misleading for mutually exclusive projects or projects with multiple sign changes in cash flows. However, IRR is useful for quick comparisons and communication with non-finance stakeholders."
Test Yourself
Interview Question
Project A has NPV of €10m and IRR of 15%. Project B has NPV of €8m and IRR of 20%. The company's WACC is 10%. Which project should the company choose?
Dividend Policy & Capital Allocation
How should a company return cash to shareholders? This decision involves trade-offs between dividends, share buybacks, debt repayment, and reinvestment.
Dividend Policy Theories
1. Dividend Irrelevance Theory (M&M)
In a perfect market, dividend policy doesn't matter. Investors can create their own "dividends" by selling shares.
2. Bird in the Hand Theory
Investors prefer dividends (certain) over capital gains (uncertain). Dividend-paying stocks should trade at a premium.
3. Tax Preference Theory
Capital gains are tax-advantaged vs dividends in many jurisdictions, so companies should retain earnings rather than pay dividends.
4. Signaling Theory (Most Relevant)
Dividend increases signal confidence. Management is saying: "We have stable cash flows and don't need this cash for growth opportunities."
Dividends vs Share Buybacks
Dividends vs Buybacks
| Term | Definition | Note |
|---|---|---|
| Commitment | Dividends create expectation of continuity | Buybacks are flexible, one-time |
| Tax Treatment | Dividends often taxed as income | Buybacks taxed as capital gains (often lower) |
| Signal | Dividends signal stability | Buybacks signal undervaluation |
| EPS Impact | No direct EPS impact | Buybacks increase EPS by reducing shares |
Interview Insight
High-growth companies (tech) rarely pay dividends — they reinvest for growth. Mature companies (utilities, consumer staples) pay stable dividends because they have limited growth opportunities.
Test Yourself
Interview Question
A mature, profitable company with limited growth opportunities announces a large dividend increase. What signal does this typically send to the market?
The Capital Allocation Framework
When a company has excess cash, it can:
- Reinvest in the business (R&D, capex, M&A)
- Best when: High-return opportunities available (ROIC > WACC)
- Pay down debt
- Best when: Company is over-leveraged or interest rates are high
- Return cash to shareholders (dividends or buybacks)
- Best when: No attractive reinvestment opportunities
- Hold as cash
- Best when: Uncertainty, upcoming needs, or strategic optionality
The Golden Rule of Capital Allocation
Deploy capital where it earns the highest risk-adjusted return. If internal ROIC > WACC, reinvest. If not, return cash to shareholders.
Financial Distress & Bankruptcy
When a company can't meet its debt obligations, it faces financial distress. Understanding this is crucial for debt investors, restructuring roles, and PE interviews.
Types of Financial Distress
- Liquidity Crisis: Short-term cash shortage (can't pay bills)
- Insolvency: Liabilities exceed assets (balance sheet problem)
Bankruptcy Options
Bankruptcy Processes (US)
| Term | Definition | Note |
|---|---|---|
| Chapter 11 | Reorganization | Company continues operating, restructures debt |
| Chapter 7 | Liquidation | Company ceases operations, assets sold to pay creditors |
Costs of Financial Distress
- Direct costs: Legal fees, advisory fees, court costs
- Indirect costs: Lost customers, suppliers demand cash, employees leave
These costs are why 100% debt financing is never optimal, even with the tax shield. The expected costs of distress offset the tax benefits at high leverage levels.
Common Corporate Finance Interview Questions
"Walk me through the balance sheet"
Answer: "The balance sheet has three sections: Assets (what the company owns), Liabilities (what it owes), and Equity (the residual value for shareholders). Assets must equal Liabilities + Equity. It's a snapshot at a point in time."
"What's the difference between EBIT and EBITDA?"
Answer: "EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization. EBIT = Earnings Before Interest and Taxes. The difference is D&A. EBITDA is often used as a proxy for cash flow, but it ignores capital intensity."
"Why do we use WACC as the discount rate in DCF?"
Answer: "WACC represents the blended cost of capital for all investors (debt and equity). We use it to discount unlevered free cash flows (which are available to all investors) to get Enterprise Value. It's the opportunity cost of capital."
"Should a company always take on more debt to get the tax shield?"
Answer: "No. While the interest tax shield adds value, too much debt increases financial distress costs and reduces flexibility. The optimal capital structure balances these benefits and costs."
Key Corporate Finance Formulas (Memorize These)
Working Capital = Current Assets - Current LiabilitiesMeasure of short-term financial health and operational efficiency
WACC = (E/V × Re) + (D/V × Rd × (1-Tc))Weighted average cost of capital - the discount rate for DCF
NPV = Σ [CFt / (1 + r)^t] - Initial InvestmentNet Present Value - the gold standard for capital budgeting decisions
Cash Conversion Cycle = DSO + DIO - DPOHow long cash is tied up in operations. Lower is better.
Interest Tax Shield = Interest Expense × Tax RateThe value created by debt financing due to tax deductibility of interest
ROIC = NOPAT / Invested CapitalReturn on Invested Capital - measures how efficiently a company uses its capital. Should exceed WACC.
3-Week Corporate Finance Mastery Plan
Your Corporate Finance Interview Prep Timeline
Week 1: Foundations
Master working capital components (AR, Inventory, AP). Memorize DSO, DIO, DPO formulas and CCC. Practice 50 working capital questions. Understand how changes in NWC affect cash flow.
Week 2: Capital Structure & Cost of Capital
Learn M&M Theorem and its limitations. Calculate WACC manually for 3 companies. Understand CAPM and cost of equity calculation. Study capital structure decisions and optimal leverage.
Week 3: Capital Budgeting & Integration
Practice NPV and IRR calculations. Understand when each method is appropriate. Study dividend policy and capital allocation frameworks. Run 2 mock interviews covering all topics. Do 100+ drill questions.
Related Resources
Continue your corporate finance interview prep with these specialized guides:
- How the 3 Financial Statements Link Together — Foundation for corporate finance
- WACC Explained Simply — Deep dive on cost of capital
- Walk Me Through a DCF — Capital budgeting in action
- Company Valuation Methods: Complete Guide — All valuation approaches
FAQ
What's the most important corporate finance concept for interviews?
Working capital and how it impacts cash flow. This shows up in PE/LBO models, M&A analysis, and corporate finance case studies. Master the cash conversion cycle and how changes in NWC affect operating cash flow.
Do I need to memorize all the formulas?
Yes. At minimum: WACC formula, NPV formula, working capital formula, CCC formula, and EV calculation. These are table stakes for finance interviews.
What's the difference between ROIC and ROE?
ROIC (Return on Invested Capital) measures returns on all capital (debt + equity) and is capital structure neutral. ROE (Return on Equity) measures returns only to equity holders and is affected by leverage. ROIC is better for comparing companies with different capital structures.
Why is NPV better than IRR?
NPV directly measures value creation in dollars and always gives the correct answer. IRR can be misleading with non-conventional cash flows, multiple solutions, or when comparing projects of different scales. When NPV and IRR conflict, always trust NPV.
Key Takeaways
Key Takeaway
- Corporate finance is about three decisions: What to invest in (capital budgeting), how to finance it (capital structure), and how to manage daily cash (working capital)
- Working capital management is crucial — changes in NWC directly impact cash flow in LBO models and M&A deals
- Optimal capital structure balances the tax benefits of debt against financial distress costs
- NPV is king for capital budgeting decisions — IRR is useful but can be misleading
- WACC is the discount rate for DCF and the hurdle rate for investments — must exceed this to create value
- Dividend policy signals management's confidence and view of future opportunities