Eleni Anastasova

FINC 4336 500

February 2, 2016

Mini Case
a. Why is corporate finance important to all managers?
Corporate finance is important to all managers because it provides
them with a unique set of skills. It gives them the opportunity to identify and
select the corporate strategies and individual projects in order to add value
to their firm. Another important skill is that they are able to forecast the
funding requirements of their company, and develop strategies to acquire
those funds.
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.
The three main forms of business organization are sole proprietorships,
partnerships, and corporations.
Sole Proprietorship This is the simplest and most common
structure chosen to start a business. The business is owned and run by
one individual with no distinction between the business the owner. The
owner is entitled to all profits and is responsible for all the businesss
debts, losses and liabilities.
Advantages:
Ease of formation
Subject to few regulations
No double taxation
A sole proprietor has complete control and decision-making
power over the business.
Sale or transfer can take place at the discretion of the sole
proprietor.
Disadvantages:
Limited life
Unlimited liability

 Difficult to raise capital and support growth

Partnership This is a single business where two or more people
share ownership.
Advantages:
Easy to change the legal structure later on in time
Easy to establish and startup costs are low.
Limited external regulations
No double taxation
Disadvantages:
Unlimited liability
There is a risk of disagreements between the partners
If partners join or leave, you will probably have to value all
the partnership assets and this can be costly.
Corporation it is an independent legal entity that is owned by
shareholders. The corporation itself is legal for the actions and debts
the business incurs.
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation
Cost of set-up and report filling
c. How do corporations go public and continue to grow? What are
agency problems? What is corporate governance?
The way a company goes public is by selling stocks to the public in an
initial public as the firm grows. An agency problem occurs when the
managers of the firm act in their own self-interests and not in the interests of
the shareholders. Corporate governance is the set of rules that control a
companys behavior towards its directors, managers, employees,
shareholders, creditors, customers, competitors, and community. Corporate
governance can help control agency problems.
d. What should be the primary objective of managers?
The corporations primary goal is to maximize stockholder wealth.

1) Do firms have any responsibilities to society at large?

They have multiple responsibilities towards the society,
such as ethical responsibility to provide a safe working
environment, to avoid polluting the air or water, and to produce
safe products.
2) Is stock price maximization good or bad for society?
The maximization of stock prices also benefit society,
because it requires efficient, low-cost operations that produce
high-quality goods and services at the lowest possible cost. Also
requires the development of products and services that
consumers want and need, so the profit motive leads to new
technology, to new products, and to new jobs.
3) Should firms behave ethically?
Yes, because it is broadly believed that there is a positive
correlation between ethics and long-run profitability.
e. What three aspects of cash flows affect the value of any
investment?
The three aspects of cash flow that affect the value of an investment
are the amount of expected cash flows, timing of the cash flow stream, and
riskiness of the cash flows.
f. What are free cash flows?
Free cash flows are the cash flows available for distribution to all
investors after paying expenses (including taxes) and making the necessary
investments to support growth.
g. What is the weighted average cost of capital?
The weighted average cost of capital (WACC) is the average rate of
return required by all of the companys investors.
h. How do free cash flows and the weighted average cost of capital
interact to determine a firms value?
A firms value is the sum of all future expected free cash flows,
converted into todays dollars.

Value
Firms

FCF1
FCF2
FCF

.
.
.
.
(1 WACC )1 (1 WACC ) 2
(1 WACC )

i. Who are the providers (savers) and users (borrowers) of capital?

How is capital transferred between savers and borrowers?

For example households are net savers. Non-financial corporations are

net borrowers as well as governments. Non-financial corporations are slightly
net borrowers, but they are almost breakeven. Capital is transferred through
direct transfer (corporation issues commercial paper to insurance company),
an investment banking house (IPO) or a financial intermediary (individual
deposits money in bank).

j. What do we call the price that a borrower must pay for debt capital?
What is the price of equity capital? What are the four most
fundamental factors that affect the cost of money, or the general
level of interest rates, in the economy?
The interest rate is the price paid for borrowed capital, while the return on
equity capital comes in the form of dividends plus capital gains. The four
most fundamental factors that affect the cost of money are production
opportunities, time, inflation and risk. Production opportunities refer to the
returns that are available from investment in productive assets: the more
productive a producer firm believes its assets will be, the more it will be
willing to pay for the capital necessary to acquire those assets. Time
preference for consumption refers to consumers preferences for current
consumption versus savings for future consumption: consumers with low
preferences for current consumption will be willing to lend at a lower rate
than consumers with a high preference for current consumption. Inflation
refers to the tendency of prices to rise, and the higher the expected rate of
inflation, the larger the required rate of return. Risk, in a money and capital
market context, refers to the chance that a loan will not be repaid as
promised--the higher the perceived default risk, the higher the required rate
of return.
k. What are some economic conditions (including international
aspects) that affect the cost of money?
Economic conditions that affect the cost of money can be Federal
Reserve policies, level of business activity or international trade
deficits/surpluses. International conditions that affect the cost of money are
country risk and exchange rate risk.
l. What are financial securities? Describe some financial instruments.
Financial security is type of financial instruments that has to recognize
financial worth. Financial instruments can be debt securities such as bond,

debenture, and banknote or equity securities such as common stock and

preferred stock.
m.Briefly explain mortgage securitization and how it contributed to the
global economic crisis.
The banks that were issuing mortgage loans combined looking alike
loans into pools and sold them off to Fannie Mae. This way they transferred
the risk but still got payment for the mortgages. Due to the monthly
transfers, they charged fee in order to transfer the money and this was
known as mortgage securitization. When mortgages reset and borrowers
defaulted, the values of CDOs plummeted. Many of the credit default swaps
failed to provide insurance because the counterparty failed. Many originators
and securitizes still owned sub-prime securities, which led to many
bankruptcies, government takeovers, and fire sales.