Question

Assume that you recently graduated and have just reported to work as an investment advisor at the brokerage firm of Balik and Kiefer Inc. One of the firm’s clients is Michelle DellaTorre, a professional tennis player who has just come to the United States from Chile. DellaTorre is a highly ranked tennis player who would like to start a company to produce and market apparel she designs. She also expects to invest substantial amounts of money through Balik and Kiefer. DellaTorre is very bright, and she would like to understand in general terms what will happen to her money. Your boss has developed the following set of questions you must answer to explain the U.S. financial system to DellaTorre.

Why is corporate finance important to all managers?

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.

How do corporations go public and continue to grow? What are agency problems? What is corporate governance?

What should be the primary objective of managers?

Do firms have any responsibilities to society at large?

Is stock price maximization good or bad for society?

Should firms behave ethically?

What three aspects of cash flows affect the value of any investment?

What are free cash flows?

What is the weighted average cost of capital?

How do free cash flows and the weighted average cost of capital interact to determine a firm’s value?

Who are the providers (savers) and users (borrowers) of capital? How is capital transferred between savers and borrowers?

What do we call the cost that a borrower must pay to use debt capital? What two components make up the cost of using 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?

What are some economic conditions that affect the cost of money?

What are financial securities? Describe some financial instruments.

List some financial institutions.

What are some different types of markets?

Along what two dimensions can we classify trading procedures?

What are the differences between market orders and limit orders?

Explain the differences among dealer-broker networks, alternative trading systems, and registered stock exchanges.

Briefly explain mortgage securitization and how it contributed to the global economic crisis.

Answer 1

• Corporate Finance is the field of finance that deals with the source of finance, and the capital structure. It helps to take decisions to increase the shareholder’s value. It has two components :

1. Capital Budgeting: Which deals with the decisions of taking projects that needs investments and to finance the investments as debt or equity capital .
2. Working capital management: Which deals with the decisions as well as operations of short term assets and liability.

Corporate finance is necessary for all managers:

1. Helps at planning phase as it clears many aspects.
2. Raising capital is one of the most important task
3. Capital budgeting helps in taking investment decisions.
4. Working capital management helps in maintaining short term assets and liabilities.

• Primary objective of a Manager:

1. To get the work done through others effectively and efficiently.
2. Increasing the Efficiency of factors of Production.
3. Increase the wealth of owners or stockholders.
4. To use the factors of production efficiently.

• The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm's cost of capitaL.

WACC= (E/V) *RE + (D/V)*RD* (1-TC)

Where,

Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D = total market value of the firm’s financing (equity and debt)
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

?

• Financial securities are that instruments that holds a monetary value and can be traded.These can be divided into two ; equity securities and debt securities.Where quity bonds have stock, options etc. , Debt securities have bonds, debentures etc.