Eric Perner Homework 1 Tuesday April 9, 2013

(1-3) What is a firm’s fundamental, or intrinsic, value? What might cause a firm ’s intrinsic value to be different than its actual market value? A company’s market price incorporates the information available to investors. If the market price reflects all relevant information, then the observed price is also the intrinsic, or fundamental, price. If it does not then the market price can be just be a representation of supply and demand market forces determining the market price.

(1–4) Edmund Enterprises recently made a large investment to upgrade its technology. Although these improvements won’t have much of an impact on performance in the short run, they are expected to reduce future costs significantly. What impact will this investment have on Edmund Enterprises ’s earnings per share this year? What impact might this investment have on the company’s intrinsic value and stock price? Earnings per share will be lower for the year because the expenditures on the equipment would reduce income available to shareholders for the year. Intrinsically the price per share might

(1–9) NYSE and NASDAQ The NYSE has a physical location exchange where the traders actually meet and trade in a specific part of a specific building. Nasdaq trades a number of U.S. stocks, and is a network of linked computers A.

Corporate finance is a basic component of how a business is run. All managers should keep this in mind to direct funds to the optimal division or product in a company. In addition, managers should understand how their company is financed and whether it has a risk of bankruptcy.
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.

Sole Proprietorship. Sole owner of a business. The manager and the owner is the same person. The sole proprietorship has unlimited liability. You pay taxes as owner and for the business ones. The advantage is the ease with which it can be establish and the lack of regulation s governing it. Partnership. Business owned by two or more persons who are personal responsible for all its liabilities. The partners pay personal income tax on their share of these profits. Each partner has unlimited liabilities for all the business’s debts.

EXECUTIVES OF MOST MAJOR FIRMS IN THE UNITED STATES BELIEVE THAT FIRMS DO TRY TO MAINTAIN HIGH ETHICAL STANDARDS IN ALL OF THEIR BUSINESS DEALINGS. SO THE PROFIT MOTIVE LEADS TO NEW TECHNOLOGY. TO AVOID POLLUTING THE AIR OR WATER. The firm finds out that it’s advantageous to raise funds directly from investors. A corporation is legally distinct from its owners. What three aspects of cash flows affect the value of any investment? amount of expected cash flows. AND TO NEW JOBS. THERE IS NO ROOM FOR UNETHICAL BEHAVIOR IN THE BUSINESS WORLD. such as share of stocks. ADEQUATE STOCKS OF MERCHANDISE. THE MOST SIGNIFICANT COST-INCREASING ACTIONS WILL HAVE TO BE PUT ON A MANDATORY RATHER THAN A VOLUNTARY BASIS TO ENSURE THAT THE BURDEN FALLS UNIFORMLY ON ALL BUSINESSES. WHICH ARE NECESSARY FOR PROFITS. Corporate governance is the set of processes. laws D. policies. they are not the same person.Corporations. C. STOCK PRICE MAXIMIZATION NECESSITATES EFFICIENT AND COURTEOUS SERVICE. and (3) riskiness of the cash flows. What should be the primary objective of managers? To increase the value of the company (1) Do firms have any responsibilities to society at large? FIRMS HAVE AN ETHICAL RESPONSIBILITY TO PROVIDE A SAFE WORKING ENVIRONMENT. ALSO. it needs more capital. AND TO PRODUCE SAFE PRODUCTS. customs. 4 Should firms behave ethically? YES. e. STOCK PRICE MAXIMIZATION REQUIRES THE DEVELOPMENT OF PRODUCTS AND SERVICES THAT CONSUMERS WANT AND NEED. AND WELL-LOCATED BUSINESS ESTABLISHMENTS--FACTORS THAT ARE ALL NECESSARY TO MAKE SALES. Business owned by stockholders who are not personally liable for the business‘s liabilities. (2) timing of the cash flow stream. It is owned by stockholders and it has limited liability. MOST EXECUTIVES BELIEVE THAT THERE IS A POSITIVE CORRELATION BETWEEN ETHICS AND LONG-RUN PROFITABILITY. This is when the firm is ready to sell new financial assets. TO NEW PRODUCTS. LOW-COST OPERATIONS THAT PRODUCE HIGH-QUALITY GOODS AND SERVICES AT THE LOWEST POSSIBLE COST. COMPANIES MUST DEAL WITH THESE CONFLICTS ON A REGULAR BASIS. (2) Is stock price maximization good or bad for society? THE SAME ACTIONS THAT MAXIMIZE STOCK PRICES ALSO BENEFIT SOCIETY. HOWEVER. A corporation pays taxes on its own. There is a separation between owners and managers. AND A FAILURE TO HANDLE THE SITUATION PROPERLY CAN LEAD TO HUGE PRODUCT LIABILITY SUITS AND EVEN TO BANKRUPTCY. to the public. FURTHERMORE. . Agency problems are the conflict of interest between the firm’s owner and the managers. STOCK PRICE MAXIMIZATION REQUIRES EFFICIENT. How do corporations go public and continue to grow? What are agency problems? What is corporate governance? As a firm grows. CONFLICTS OFTEN ARISE BETWEEN PROFITS AND ETHICS.

interest rates. What are free cash flows? free cash flows are the cash flows available for distribution to all investors (stockholders and creditors) after paying expenses (including taxes) and making the necessary investments to support growth. converted into today’s dollars i. How do free cash flows and the weighted average cost of capital interact to determine a firm’s value? A firm’s value is the sum of all future expected free cash flows. or the general level of interest rates. in the economy? p. and the market’s overall attitude toward risk. the firm’s risk. (2) operating expenses. and (3) capital expenses. h. Briefly explain mortgage securitization and how it contributed to the global economic crisis.f. . Who are the providers (savers) and users (borrowers) of capital? How is capital transferred between savers and borrowers? j. 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 company’s investors (stockholders and creditors). It is affected by the firm’s capital structure. 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. g. Three factors determine cash flows: (1) current level and growth rates of sales.