MINI CASE
a. Why is corporate finance important to all managers?
Corporate finance is important to all managers because it provides managers the skills needed to identify and select the corporate strategies and individual projects that add value to their firm and forecast the funding requirements of their company and devise strategies for acquiring those funds.
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.
The organizational forms a company might have as it evolves from a start-up to a major corporation are proprietorship, partnership, or corporation.
The advantages of a proprietorship are:
• Easy and
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Failure to handle these situations properly can lead to huge product liability suits and even bankruptcy.
e. What three aspects of cash flows affect the value of any investment?
The three aspects of cash flows the affect the value of any investment are the amount of expected cash flows, the timing of the cash flow stream, and the risk of the cash flows.
f. What are free cash flows?
Free cash flows are the monies available for distribution to all investors after paying current expenses, taxes, and making the investments necessary for growth.
g. What is the weighted average cost of capital?
The weighted average cost of capital is the rate that a company is expected to pay on average to all its security holders to finance its assets.
h. How do free cash flows and the weighted average cost of capital interact to determine a firm’s value?
Free Cash Flow = Sales Revenues – Operating Costs and Taxes – Required Investments in Operating Capital. Weighted Average Cost of Capital (WACC) is affected by market interest rates, market risk aversion, cost of debt, cost of equity, firm’s debt/equity mix, and firm’s business risk. Therefore, free cash flows and the weighted average cost of capital interact to determine a firm’s value by the following equation:
Value = FCF1 + FCF2 + … + FCF00 (1 + WACC)1 (1 + WACC)2 (1 + WACC)00
i. Who are the providers (savers) and users (borrowers) of capital? How is capital
The three aspects of cash flows that affect the value of any investment are the amount of cash flows, the timing of the cash flows, and the risk involved with the cash flows.
10. What is the correct capital structure and weighted average cost of capital for discounting the investment’s free cash flow. Assume a 35% tax rate. A correct response requires that you define capital structure and Weighted Average Cost of Capital (WACC) with a formula. When defining a term with a formula be sure that all the variables are also defined.
n. WACC has market interest rates and market risk aversion, firms debt/equity mix and firm’s business risk which all go to cost of debt and cost of equity which both areas end up at the value.
The mixture of debt-equity mix is important so as to maximize the stock price of the Costco. However, it will be significant to consider the Weighted Average Cost of Capital (WACC) as well so that it can evaluate the company targeted capital structure. Cost of capital (OC) may be used by the companies as for long term decision making, so industries that faced to take the important of Cost of capital seriously may not make the right choice by choosing the right project(Gitman’s, ).
1. Determine the Weighted Average Cost of Capital (WACC) based on using retained earnings in the capital structure.
Discounted cash flow analysis in Exhibit 12 We do not know the beta for Interco’s equity. Therefore, it is not possible for us to estimate the weighted average cost of capital (WACC) for Interco. Note that here WACC method is appropriate because Interco is not
* Compute the value with leverage, VL, by discounting the free cash flows of the investment using the WACC.
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
Moreover, let’s calculate the Weighted Average Cost of Capital (WACC). And in order to calculate it we need to know the capital structure of the company. Knowing the capital structure of the
The free cash flow method is used to gauge “a company’s cash flow beyond that necessary to grow at the current rate… [to ensure companies] make capital expenditures to continue to exist and to grow” (Drake, n.d.). Calculation of free cash flows utilizes various components, including a firm’s value, cash flow forecasts, a firm’s capital structure, the cost of capital, and/or discounted cash flows.
3) What is the weighted average cost of capital and why is it important to estimate it? Is the
Weights of Debt and equity are 8.3 and 91.7%. Now, plugging all the values in, we can derive company’s Weighted Average Cost of Capital.
The above formula isolates free cash flows to the firm from earnings before interest and tax (EBIT). It can be noted that FCFF are after tax (1-T) but prior to interest expense. This initial overstatement of due tax is by design; the tax deductibility of interest payments will be accounted for when incorporating the after-tax cost of debt in the weighted average cost of capital (WACC) to determine the present value of free cash flows.
WACC (Weighted Average Cost of Capital) is a market weighted average, at target leverage, of the cost of after tax debt and equity.
Weighted Average Cost of Capital (WACC) is a fiscal barometer to gauge a business cost of capital. In this sense, the WACC supplies at discount