Richelle Cooper GB550: Financial Management Unit 1 Assignment 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 firms 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. a. Why is corporate finance important to all managers? The main goal of managers is to improve the wealth of shareholders and/or owners. Through understanding corporate finance, managers obtain the skills needed to understand what tools or strategies would be best for additional value to the company. It is also important for managers to understand return on investment when it comes to corporate finance. This will aid managers in investing funds and generate profits more effectively (Victor, 2013). 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. There are three main components of an organization, sole proprietorships, partnerships, and corporations. The three important advantages of a sole proprietorship, these advantages include: (1) easily and inexpensively formed, (2) subject to minimal government regulations, and (3) not subject to corporate tax codes. There are also three important disadvantages (1) difficulty obtaining large sums of capital, (2) unlimited personal liability for the organizations debts, and (3) life expectancy is limited to the life of the individual who created it (Brigham & Ehrardt, 2014). The key advantage of a partnership pertains to its ease of formation and low cost. The disadvantages of a partnership are seemingly close to those of a proprietorship. Those disadvantages include (1) unlimited liability, (2) limited life of the organization, (3) transfer of ownership difficulty, and (4) difficulty obtaining large amounts of capital (Brigham & Ehrardt, 2014). Corporations also have three key advantages: (1) unlimited life, (2) easy to transfer ownership, and (3) limited liability. While these advantages are key, corporations also have two key disadvantages (1) corporate earnings may be subject to double taxation and (2) due to the set-up and filings of the various required federal and state reports; corporations can be difficult to establish initially (Brigham & Ehrardt, 2014).

c. How do corporations go public and continue to grow? What are agency problems? What is corporate governance? An organization goes public via an IPO, the initial sale of their stock. As the organization grows it may sell additional stock. An agency problem is when managers act according to their own self-interest and not that of the shareholders. Corporate governance is the collection of rules that regulate an organizations behavior towards directors, managers, employees, shareholders, creditors, consumers, competitors and community (Brigham & Ehrardt, 2014). d. What should be the primary objective of managers? The primary objective of managers is to increase stockholders wealth which transforms to maximizing the price of the organizations common stock. (1) Do firms have any responsibilities to society at large? Yes, firms have an ethical responsibility to society at large. Firms should conduct themselves in an ethical manner to supply a working environment that is safe, avoid water and air pollution, abide by labor laws and produce safe products (2) Is stock price maximization good or bad for society? Typically, stock price maximization is good for the society if an organization attempts to maximize its fundamental stock price. Investors benefit by receiving large capital gains when stock prices rise. Maximization of share value increases investors standard of living and income. An organization can maximize the share value only if it produces good profits. In the end, consumers of the society benefit from low cost organizations generating high quality goods at lower prices (Ilmu, 2008). When demand for an organizations products increase due to its high quality and low cost, the labor demand will rise thus resulting in additional employment. When an organization develops efficiently with competitive profits, it also raises the income of existing employees by increasing salaries and/or bonuses. On the other hand, accounting fraud, safety code violation, and exploiting of monopoly power, etc. should be prevented, as they are illegal actions that do not benefit society.

(3) Should firms behave ethically? Firms should definitely behave ethically. Firms fulfill the wants and needs of consumers by producing goods and services and they create jobs. They also contribute to education, health care and public services. However, when tied to growth and profits, behaving ethically can be risky as firms need to keep up with the requests of society or it could isolate consumers, stakeholders and shareholders (The Times 100, 2013).

e. What three aspects of cash flows affect the value of any investment? The three aspects of cash flows that affect the value of any investment are (1) expected amount of cash flows, (2) Cash flow timing, and (3) cash flows level of risk. f. What are free cash flows? Free cash flows are the cash flow available for distribution to all investors (creditors and stockholders) after paying expenses (including taxes) and making the appropriate investments to assist growth. Three factors determine cash flows (1) current level and growth rates of sales, (2) operating expenses and (3) capital expenses (Brigham & Ehrhardt, 2014). g. What is the weighted average cost of capital? The weighted average cost of capital also known as WACC is the rate of return, which providers of an organizations capital require h. How do free cash flows and the weighted average cost of capital interact to determine a firms value? Value is the present value of the firms expected free cash flows, reduced to the weighted average cost of capital. Value = FCF1/(1+WACC)1 + FCF2/(1+WACC)2 + FCF3/(1+WACC)3 (Brigham & Ehrhardt, 2014). i. Who are the providers (savers) and users (borrowers) of capital? How is capital transferred between savers and borrowers? Governments and non-financial corporations are net borrowers while households are net savers. When the U.S. government runs a surplus, it is considered a net saver. Capital is transferred between savers and borrowers via (1) direct transfer (corporation issues commercial paper to insurance company), (2) investment banking house (IPO, seasoned equity offering, or debt placement and (3) financial intermediary (individual deposits money in bank, bank makes commercial loan to company) 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 price paid for borrowed capital is the interest rate, while the return on equity is dividends plus capital gains. The four most fundamental factors are (1) production opportunities, (2) consumption time preference, (3) risk and (4) expected inflation (Brigham & Ehrhardt, 2014).

k. What are some economic conditions (including international aspects) that affect the cost of money? The cost of money can be persuaded by fiscal and foreign trade deficits, a specific countrys risk and federal policy l. What are financial securities? Describe some financial instruments. Financial securities are documents with contractual provisions that enable owners to specific claims and rights on particular cash flows and values. These documents might include Municipal Bonds, T-Bills, Preferred and Common Stocks, Negotiable CDs, and Corporate bonds (Brigham & Ehrhardt, 2014). m. List some financial institutions. Savings and loans, credit unions, life insurance firms, pension funds, commercial banks, and mutual savings banks. n. What are some different types of markets? A market is a process of exchanging an asset (particularly cash) for another asset. Different types of markets include commodity markets, physical assets vs. financial assets, insurance markets, spot vs. future markets, foreign exchange markets and capital markets (including bond and stock markets). o. How are secondary markets organized? Secondary markets are the financial markets where formerly issued instruments and securities are purchased and sold. Secondary markets are listed by location, electronic communications networks (ECNS) and according to the way orders from sellers and buyers are matched (Brigham & Ehrhardt, 2014). (1) List some physical location markets and some computer/telephone networks. Physical location markets consist of AMEX, CBOT and NYSE. Computer/telephone networks consist of government bond markets, foreign exchange markets and NASDAQ. (2) Explain the differences between open outcry auctions, dealer markets, and electronic communications networks (ECNs). Open outcry auctions are a system of coordinating buyers and sellers via face-to-face affirming a price that they will buy or sell. Concerning dealer markets, transactions take place among principles buyers and sellers for their own accounts. Electronic communication networks (ECNs) are computerized systems that match orders from sellers and buyers and automatically execute complete the trades (Brigham & Ehrhardt, 2014).

p. Briefly explain mortgage securitization and how it contributed to the global economic crisis. Once an organization loans money it makes a legal responsibility on an asset (for example a mortgage for a house). Banks receive interest payments related to debt when a house is sold. Over time, several debts could be accumulated and the organization could decide to sell a portion to build capital or improve its balance sheet liquidity. This is referred to as securitization. This contributed to the global economic crisis when various US companies loaned money for houses to individuals without the ability to continuously pay their mortgages on the assurance that the mortgage could be regenerated at favorable interest rates (less than rent) and wrongly inflated the values of the properties thus raising the debt to the consumer.

References: Brigham, E & Ehrhardt, M. (2014). Financial Management Theory and Practice (14th ed.). South-Western Publishing, Cengage Learning: Mason Ohio Ilmu, S. (2008). Stock Price Maximization and Social Welfare. Retrieved on October 30, 2013 from, http://ekonomiusu.blogspot.com/2010/01/stock-price-maximization-and-social.html The Times 100 (2013). Business ethics and corporate social responsibility. Retrieved on November 1, 2013 from, http://businesscasestudies.co.uk/anglo-american/business-ethics-andcorporate-social-responsibility/why-should-a-business-act-ethically.html#axzz2jQTfW8A7 Victor, J. (2013). Why is Corporate Finance Important to all Managers? Retrieved on October 31, 2013 from, http://www.ehow.com/info_7869863_corporate-finance-importantmanagers.html