The number one goal of managers is to increase the wealth of owners or shareholders. By understanding corporate finance, managers gain the skills they need to know what strategies or tools would be best for adding value to the organization.
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.
1. Easily and Inexpensively Formed
2. Few government regulations
3. Not subject to corporate tax code
1. Difficult to obtain large amounts of capital
2. Unlimited personal liability for the proprietor
3. The life of the business may be limited to the life of the proprietor. Partnerships-Advantages: Same advantages as Sole-Proprietorships Disadvantages:
1. Unlimited liability
2. Limited life of the organization
3. Difficulty transferring ownership
4. Difficult to obtain large amounts of capital Corporations Advantages:
1. Unlimited life
2. Easy to transfer ownership
3. Limited liability of those who invest
1. Double taxation
2. Difficult to initially establish
c. How do corporations go public and continue to grow?
A company goes public through an IPO, this is the initial sale of their stock.
The company may issue additional stock as they grow
What are agency problems?
An agency problem is when a manager puts their own interests in front the company’s interests.
What is corporate governance?
The set of rules that control a company’s behavior toward its directors, managers, employees, shareholders, creditors, customers, competitors, and community
d. What should be the primary objective of managers?
To increase the wealth of owners or stockholders
(1) Do firms have any responsibilities to society at large?
Companies should function in an ethical manner, including providing a safe environment for employees, abide by labor laws and respect the environment
(2) Is stock price maximization good or bad for society? Stock price maximization requires companies to be as efficient as possible while producing quality goods and staying price competitive. I think it’s good for society as it requires companies to do what’s best for their consumers in an effort to maintain or increase market share.
(3) Should firms behave ethically?
There is no question that firms should behave ethically. However sometimes the ethical choice is not always clear, especially when tied to profits
e. What three aspects of cash flows affect the value of any investment?
1. Expected amount
2. Cash flow timing
3. Level of risk
f. What are free cash flows?
The cash flow actually available for distribution to all investors after the company has made all investments in fixed assets and working capital necessary to sustain ongoing operations
g. What is the weighted average cost of capital?
The weighted average of the after-tax component costs of capital-debt, preferred stock, and common equity each weighting factor is the proportion of that type of capital in the optimal, or target, capital structure.
h. How do free cash flows and the weighted average cost of capital interact to determine a firm’s value?
Value is the present value of the firm’s expected free cash flows, discounted at the weighted average cost of capital. Value = FCF1/(1+WACC)1 + FCF2/(1+WACC)2 +FCF3/(1+WACC)3
i. Who are the providers (savers) and users (borrowers) of capital? How is capitaltransferred between savers and borrowers?
Households are net savers. Non-financial corporations are net borrowers. Governments are net borrowers, although the U.S. government is a net saver when it runs a surplus. Non-financial corporations (i.e., financial intermediaries) are slightly net borrowers, but they are almost breakeven. Capital is transferred through: (1)...