Question

1. Why should stockholders care about maximizing firm value rather than just the value of the equity?
2. How does financial leverage affect firm value and weighted average cost of capita (WACC) without taxes? With taxes? With Bankruptcy cost?
3. Explain the tradeoff, signaling, agency cost, and pecking order theoriesof capital structure.
4. Explain why share repurchases are an alternative to dividends, and why mightinvestors prefer them?

Answer 1

question 1:
Stock holders should care about maximizing firms value because:

Wealth Maximization is the primary goal of any business-
The wealth of a firm is interpreted is the current market price of the firms.

The market price of a firm represents 1.The judgment of all market participants about what should be the value of the particular firm.
2. It takes into account
a. earnings per share,
b. risk of these earnings
c. dividend policy.

and many other factors.

It's is Financial Managers Goal to Maximize the Wealth of the firm.

Wealth maximization takes into consideration the time value of money and it is focused on long term.

Wealth maximization is a continuous process. If today's wealth is improved then tomorrow/future wealth is already taken care of positively. That's why the main focus is on today than in future.
If today a company lives a healthy life and it ensures it every day then the future is probably safe. There is less risk until unless there is a cyclic or structural problem or systematic problem.

Q2&3 Refer comment.

Extra: For help:
Q4: The share repurchase is considered a positive signal and investors prefer it because:
1. Tax benefit: normally share buyback is taxed at the capital gain tax rate. Which is lower than the ordinary Income tax rate (for Dividends)
2. . Share repurchases are done at a higher price then it's market price, hence driving up the stock price. It's good for investors. It gives a boost to share price.
The reason for a higher price is that Management believes that share price is undervalued.
3. It shows that the company has enough cash reserve for its future commitments and projects. Company has belief in itself.
4. Share repurchase shows an overall improvement in shareholders value. Because as no.of shares are reduced then earnings per share increases.