Financial Management Practices 079950

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Evaluate the impact of financial management practices on organizational decision-making. GB550 Module 1 Purdue University Global Michelle Freeman October 16, 2020

a. Why is corporate finance important to all managers? Corporate finance is important to all managers because it helps them to do the following: i. Make decisions on hiring, firing, and promoting ii. Set price levels iii. Establish production schedules iv. Explain company decisions and motivate employees v. Maximize shareholder value

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. A company may start out as a proprietorship, then may move to a partnership by adding more than one owner, and ultimately convert to a corporation in anticipation of growth. Sole proprietorship: Advantages and disadvantages Advantages: Easy and inexpensive startup. Fewer government regulations. Disadvantages: Unlimited personal liability. Difficulty raising capital/finding investors. No corporate taxes. Limited life.

Partnership: Advantages and disadvantages Advantages: Easy setup. Low cost to form. Disadvantages: Unlimited debt liability. Difficult to transfer ownership.

Corporation: Advantages and disadvantages Advantages: Unlimited life. Limited liability. Disadvantages: Double taxation. Complex and time-consuming setup. Difficult to transfer ownership.

c. How do corporations go public and continue to grow? What are agency problems? What is corporate governance? Companies go public by offering an initial IPO (initial public offering), which makes them a publicly traded and owned entity. The company consults an investment bank for decisions like share pricing. The investment bank employs brokers to sell stock to investors. Corporation growth is driven by increasing share value through higher cash flows and reduced capital costs. Agency problems refer to conflicts of interest between management (agents) and shareholders (principals), where management may pursue personal goals over shareholder wealth maximization. Corporate governance involves rules, practices, and processes enforced by the company's board of directors to ensure transparency, integrity, and alignment of managerial decisions with shareholder interests.

d. What should be the primary objective of managers? The primary objective of managers is to maximize the intrinsic value of the firm, as reflected in its stock price.

e. Do firms have any responsibilities to society at large? Yes, firms have responsibilities to society because their decisions impact employees, customers, and communities. Corporate responsibility involves ongoing contributions beyond crisis response, such as creating volunteer opportunities and engaging in social initiatives.

f. Is stock price maximization good or bad for society? Generally, stock price maximization benefits society by improving quality of life, fostering high-quality goods and services, and supporting employment—especially since many institutional investors own significant shares. However, excessive focus on stock prices can lead to negative outcomes, such as neglecting social or environmental considerations.

g. Should firms behave ethically? Yes, ethical behavior is essential for maintaining reputation, customer trust, and competitive advantage, especially as media and social platforms amplify consumer feedback.

h. What three aspects of cash flows affect the value of any investment? Operating, investing, and financing cash flows influence the value of an investment.

i. What are free cash flows? Free cash flows are the cash generated after all expenditures, typically calculated as operating cash flow minus capital expenditures, representing cash available for distribution or reinvestment.

j. What is the weighted average cost of capital? WACC is the average after-tax rate of return required by all capital providers, influenced by factors beyond the firm's control, such as market conditions and risk levels.

k. How do free cash flows and WACC interact to determine a firm’s value? Free cash flows, discounted at WACC, determine the intrinsic value of a firm, with higher free cash flows increasing valuation.

l. Who are the providers (savers) and users (borrowers) of capital? How is capital transferred? Providers include households, pension funds, insurance companies, and corporations that generate excess cash; users include borrowers seeking funds for various purposes. Capital transfer occurs via direct transfers, investment banks, or financial intermediaries like mutual funds.

m. What is the cost borrowers pay to use debt capital? The interest rate.

n. What two components make up the cost of equity capital? The cost of equity comprises expected return demanded by investors, factoring in production opportunities, risk, and inflation.

o. What economic conditions affect the cost of money? Federal reserve policies, federal budget deficits or surpluses, business activity levels, and trade balances influence interest rates.

p. What are financial securities? Financial securities are contractual claims representing ownership or debt, such as bonds, stocks, commercial paper, and mutual funds.

q. List some financial institutions. Notable institutions include commercial banks, credit unions, savings & loans, mutual funds, private equity firms, and insurance companies.

r. What are some different types of markets? Markets include physical and financial assets, spot and future, short-term and long-term, primary and secondary markets, among others.

s. How are trading procedures classified? By location—physical or electronic—and method of matching orders—manual or electronic matching systems.

t. What are the differences between market orders and limit orders? Market orders execute immediately at current prices; limit orders specify a maximum or minimum price and may not be executed immediately.

u. Explain broker-dealer networks, alternative trading systems, and registered exchanges. Broker-dealer networks facilitate trades via brokers and dealers; ATS allow direct trading between buyers and sellers without traditional exchanges; registered exchanges like NYSE are regulated and facilitate high-volume trading, often with SEC oversight.

v. Briefly explain mortgage securitization and how it contributed to the global financial crisis. Mortgage securitization involved pooling mortgages into securities sold to investors. Over-appraisal of housing and conflicts of interest in rating agencies led to risky securities. When housing prices fell and delinquency rates rose, it triggered massive losses, contagion, and the global economic crisis.

References

• Brigham, E. F., & Ehrhardt, M. C. (2019). Financial Management: Theory and Practice. Cengage Learning.
• Investopedia. (n.d.). Capital Markets: What You Should Know. https://www.investopedia.com
• Investopedia. (n.d.). What role did securitization play in the global financial crisis?. https://www.investopedia.com
• Center for Mobile Communication Studies. (2018). From Television to Social Media: The Contemporary Media Revolution. https://cmcs.uchicago.edu
• Brigham, E. F., & Ehrhardt, M. C. (2019). Operational and strategic implications of financial management practices. Cengage Learning.
• Heakal, R. (2020). Understanding the Weighted Average Cost of Capital (WACC). Investopedia.
• Sullivan, A. (2021). Corporate Governance and Agency Problems. Journal of Business Ethics.
• Barberis, N., & Thaler, R. (2003). A survey of behavioral finance. Handbook of the Economics of Finance, 1, 1053-1128.
• Standard & Poor's. (2020). The Impact of Mortgage Securitization on Financial Stability.
• Jorion, P. (2007). Value at Risk: The New Benchmark for Controlling Derivatives Risk. McGraw-Hill.