Fin515 Week 1

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Homework Assignment: Week 1

Mini-Case
a. Why is corporate finance important to all managers?
Corporate finance is important to all managers because you need to be aware of the tools needed to evaluate the firm’s value and be able to accurately make decisions to maximize wealth. b. Describe the organizational forms a company might have as it evolves from a start-up to a major corporation. List the advantages and disadvantages of each form.

A business may start as a sole proprietorship, or a partnership. These are where the business is owned by one person, or partners. The advantages that lie with these types are that they are easily formed, they are subject to few government regulations, and its income is not subject to corporate taxation (Ehrhardt,7). The disadvantages to these are that it may be difficult to raise capital to grow, the proprietor or the partners have personal liabilities for the business’ debt and the business is limited to the life of the proprietors (Ehrhardt, 7)). As the need for more capital rises business may decide to incorporate. The advantages to this are unlimited life, easy transferability of ownership interest and limited liability. The disadvantages to having a corporation is that corporate earnings may be taxed at double the rate, the process to set up a corporation is more complex and time-consuming than other types (Erhardt, 8). c. How do corporations go public and continue to grow? What are agency problems? What is corporate governance?

Corporations go public and raise more capital through an initial public offering or IPO, which is where corporations start to sell their stock to the public. They can then borrow funds from banks or selling more stock. Agency problems are what the corporation can run into by hiring managers. You want to make sure that the managers are acting in the best interest of the corporation. A corporation can solve these problems by having a corporate governance which is a set of which is the set of rules that control the company’s behavior towards its directors, managers, employees, shareholders, creditors, customers, competitors, and community, (Erhardt, 9). d. What should be the primary objective of managers? (1) Do firms have any responsibilities to society at large? (2) Is stock price maximization good or bad for society? (3) Should firms behave ethically?

The primary objective of managers is to maximize stockholder wealth. (1) Yes, firms do have responsibilities to the society at large. (2.) stock price maximization is good for the society. As many American household hold shares of stock as the stock price rises, many Americans due better as a whole. (3)Firms should definitely behave ethically, as mentioned earlier many households are directly affected by the decisions of managers. e. What three aspects of cash flows affect the value of any investment?

Sales revenues, operating costs and taxes, and required new investments in operating capital f. What are free cash flows?
Free cash flows are cash flows that are available for distribution to all of the company’s investors, including creditors and stockholders. g. What is the weighted average cost of capital?
The weighted average cost of capital is the rate of return required by investors. h. How do free cash flows and the weighted average cost of capital interact to determine a firm’s value?
Both of these factors let potential investors evaluate the creditworthiness of the firm. i. Who are the providers (savers) and users (borrowers) of capital? How is capital transferred between savers and borrowers?

Providers are the people or firms that loan the capital to businesses. They are usually banks and investors. The users are the people that need the capital, like the corporation. The capital can be transferred directly, through investment banking or through a financial intermediary. (Erhardt,15). j. What do we call the price that a borrower must pay for debt capital? What is...
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