MBA

Managerial Finance

Group 2C Online Wednesday

Mid Term

Ahmed Mohamed Mohamed Ibrahem

ID : 20122069
 MINI CASE 1

a. Why is corporate finance important to all managers?

Corporate finance is important when deals with financial prediction, monetary management, fund
procurement, budgeting, credit administration and investment appraisal. Investment analysis, or as
popularly known as capital budgeting determines the amount of investment in value-adding

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 Advantages ❑ Simplicity of formation ❑ Subject to few regulations ❑
No corporate taxes Disadvantages ❑ Limited Life ❑ Unlimited Liability ❑ Difficult to raise
capital to support growth.
 Partnership has approximately the same advantages and disadvantages as a sole
proprietorship.
 Corporation Advantages ❑ Unlimited life ❑ Easy transfer of ownership ❑ Limited Liability
❑ Simplicity of raising capital.
 Disadvantages ❑ Double taxation ❑ High Cost of set-up and reporting.
c. How do corporations go public and continue to grow? What are agency problems? What is
corporate governance?

corporation can go public through an initial public offering (IPO) allowing anyone to purchase
shares of the company on open stock exchanges. A company continues to grow by demonstrating
increasing value. Value is continued generation of cash flows and/or consistently decreasing the
cost of capital.

❑ Agency Problem:(Principal &Agent Relation) managers may act in their own interests and not
on behalf of owners (stockholders).
❑ Corporate Governance: is the set of rules that control a company’s behaviour towards its
directors, managers, employees, shareholders, creditors, customers, competitors, and
community
d. What should be the primary objective of managers?
Manager’s primary objective is stockholder wealth maximization. Normatively, managers should
always have the best interests of all stakeholders in mind with each decision they make on
behalf of the firm
(1) Do firms have any responsibilities to society at large?

Yes, they have, the managers who make the actual decisions are interested in their own personal
satisfaction, in their employees’ welfare, and in the good of the community and of society at large.
 (2) Is stock price maximization good or bad for society?

Stock price maximization is the goal to increase publicly traded stock prices as high as possible.
The increase of a stock price itself has no moral ground. The decisions that management might
make in the effort to achieve stock price maximization could be bad or good for society. An
economist would argue increasing stock prices can increase the purchasing power of a nation as
well as standards of living effectively benefiting society. Or the economist could be smart and
not argue this and keep it to himself

(3) Should firms behave ethically?

To avoid bankruptcy that corporations might face in case of unethical work.

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 operations, investing
and financing.

f. What are free cash flows?

(1) Sales revenues, (2) operating costs and taxes, and (3) required new investments in operating capital.

g. What is the weighted average cost of capital?

The weighted average cost of capital is the rate of return required by investors. The lower the
weighted average cost of capital is, potentially
h. How do free cash flows and the weighted average cost of capital interact to
determine a firm’s value?
The greater the free cash flows, and the lower the weighted average cost of capital is the more a
company is valued. Free cash flows are divided by the WACC to determine a company’s value

i. Who are the providers (savers) and users (borrowers) of capital? How is capital transferred
between savers and borrowed?
In aggregate, individuals are net savers… nonfinancial corporations are net borrowers in the
aggregate. There are three ways savers transfer money to borrowers: Direct transfers of money
and securities. Indirect transfers often through investment banks underwrite financial
instruments on behalf of borrowers and sell them to savers. Lastly, financial intermediaries, such
as banks or mutual funds transfer money from savers to borrowers simply by performing
profitable business.

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 economic conditions (including international aspects) that affect the cost of money are: “(1)
Federal Reserve policy; (2) the federal budget deficit or surplus; (3) the level of business
activity.
(4) international factors, including the foreign trade balance, the international business
climate, and exchange rates.
 k. What are some economic conditions (including international aspects) that affect the cost of
money?

Government Reserve Policy: controls the money supply. If the Fed wants to stimulate the economy,
it increases growth in the money supply. The initial effect would be to cause interest rates to decline.
However, a larger money supply may also lead to an increase in expected inflation, which would
push interest rates up. The reverse holds if the Fed tightens the money supply

Budget Deficits or Surpluses: Thus, the larger the federal deficit, other things held constant, the
higher the level of interest rates

Business Activity: that is shaped by the Consumer demand, companies’ behavior, are both causes
ups and downs of prices and interest rates, where the government is also active during recessions,
trying to stimulate the economy.

International Trade Deficits or Surpluses: Higher rates abroad lead to higher rates in the country,
and vice versa.

International Country Risk: International risk factors may increase the cost of money that is invested
abroad. Country risk is the risk that arises that arises from investing or doing business in a country.

This risk depends on the country’s economic, political, and social environment. Countries with stable
economic, social, political, and regulatory systems provide a safer climate for investment, and
therefore have less country risk than less stable nations.

International Exchange Rate Risk International: securities usually are denominated in a currency
other than the dollar, which means that the value of your investment depends on what happens to
exchange rates.

l. What are financial securities? Describe some financial instruments

Financial securities are instruments that are sold by financial institutions to variety of clients,
institutional, retail, private, and otherwise. Financial securities can be generalized into three
different types (1) debt,
(2) equity, (3) derivatives.

Some financial instruments are: Treasury bills, certificates of deposits (cd’s), and money market
accounts are all lower interest (rate of return) instruments which are low risk and can be FDIC
insured guaranteeing no loss of principal.

Mortgages, Muni Bonds, Corporate bonds, consumer credit cards, and

commercial loans and the most common type of equity is common stocks.

m. List some financial institutions.

(1) Commercial Banks

(2) Investment Banks
(3) Financial Services Corporations
(4) Mutual savings Banks & Credit unions
n. What are some different types of markets?

❑ Primary Market: Market where new securities are sold, and funds go to

issuing unit. New issue (IPO or Capital Increase. Issuer will receive the proceeds

from the sale)

❑ Secondary Market: Market where outstanding securities are bought and sold

by investors. The issuing unit does not receive any funds in a secondary market

transaction in another word existing owner sells to another party, such as

Egyptian Stock Market. Issuer: Doesn’t receive proceeds and is not directly

involved.

❑ Third Market: The Term third market involves dealers and brokers who trade

shares that are listed on the stock market but away from the exchange. In other

words, the third market involves listed securities that are being traded over the

counter (OTC) between brokers/dealers and large institutional investors.

o. How are secondary markets organized?

In the secondary markets, the individual investor can sell securities to another investor without the
presence and involvement of the firm that issued the securities. Such type of secondary trading
takes place on the organized stock exchanges, Like Egyptian Stock Market.

(1) List some physical location markets and some computer/telephone

networks.

The New York Stock Exchange

The Nasdaq Stock Market (The National Association of Securities Dealers (NASD)

(2) Explain the differences between open outcry auctions, dealer markets, and

electronic communications networks (ECNs).

(NOT COVERED)