Mini Case: Francisco Leongrantham University Principles

Mini Casefrancisco Leongrantham Universityfin307 Principles Of Finance

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 firm’s 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. Why is corporate finance important to all managers? 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. How do corporations go public and continue to grow?

What are agency problems? What is corporate governance? What should be the primary objective of managers? Do firms have any responsibilities to society at large? Is stock price maximization good or bad for society?

Should firms behave ethically? What three aspects of cash flows affect the value of any investment? What are free cash flows? What is the weighted average cost of capital? How do free cash flows and the weighted average cost of capital interact to determine a firm’s value?

Who are the providers (savers) and users (borrowers) of capital? How is capital transferred between savers and borrowers? What do we call the cost that a borrower must pay to use debt capital? What two components make up the cost of using 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?

What are some economic conditions that affect the cost of money? What are financial securities? Describe some financial instruments. List some financial institutions. What are some different types of markets?

Along what two dimensions can we classify trading procedures? What are the differences between market orders and limit orders? Explain the differences among dealer-broker networks, alternative trading systems, and registered stock exchanges. Briefly explain mortgage securitization and how it contributed to the global economic crisis.

Paper For Above instruction

Understanding the fundamentals of corporate finance is essential for managers, investors, and financial advisors alike. It provides insight into how companies operate financially, how they grow, and how they create value while addressing societal responsibilities and ethical considerations. For Michelle DellaTorre—an aspiring entrepreneur and athlete—the knowledge of corporate finance principles will be crucial in guiding her investments and business decisions in the U.S. financial landscape.

Importance of Corporate Finance to Managers

Corporate finance plays a vital role for managers as it involves making decisions that maximize shareholder value. It encompasses capital budgeting, capital structure, and working capital management—critical for growing and sustaining a business. Managers must evaluate investment opportunities, decide how to finance operations, and manage financial risks. Effective financial decision-making enhances operational efficiency and competitive advantage, thereby increasing the firm’s value (Brealey, Myers, & Allen, 2017).

Organizational Forms of a Company

As a company progresses from start-up to a major corporation, it can evolve through various organizational structures:

• Sole Proprietorship: Easiest startup form, owned and operated by one individual; advantages include simplicity and tax benefits, while disadvantages include unlimited liability and limited capital.
• Partnership: Owned by two or more individuals; advantages include shared resources and expertise, disadvantages include joint liability and potential conflicts.
• C Corporations: Separate legal entity; advantages include limited liability, access to capital markets, and perpetual life, but disadvantages include double taxation and regulatory complexity.
• S Corporations and LLCs: Offer liability protection while avoiding double taxation, blending features of partnerships and corporations.

To grow, corporations may go public through an initial public offering (IPO), allowing them to raise capital from the public and expand their operations (Ross, Westerfield, & Jaffe, 2019).

Agency Problems and Corporate Governance

Agency problems arise when managers (agents) do not act in the best interests of shareholders (principals). Corporate governance structures aim to mitigate these conflicts through board oversight, executive compensation, and transparent reporting. The primary objective of managers should be to maximize shareholder wealth, aligning their interests with those of owners (Jensen & Meckling, 1976).

Beyond shareholder interests, firms have societal responsibilities, including environmental sustainability, ethical conduct, and social contributions. Stock price maximization is often debated: while it promotes efficiency, potential negative externalities may harm society. Ethical behavior in firms fosters trust, sustainability, and long-term profitability (Freeman & Reed, 1983).

Cash Flows, Firm Valuation, and Capital Costs

The value of an investment depends on three aspects of cash flows: timing, magnitude, and risk. Free cash flows represent cash generated after operational expenses, reinvestment, and capital investments, available for distribution or growth. The weighted average cost of capital (WACC) combines the cost of debt and equity, weighted by their proportions, to determine the hurdle rate for investments (Damodaran, 2010). Free cash flows discounted at WACC help estimate a company’s overall value.

Capital Providers and Transfer Mechanisms

Savers, such as individuals and institutions, supply capital, while borrowers, including firms and governments, demand it. Capital is transferred through financial markets and institutions via securities like stocks and bonds. The cost a borrower pays for debt is the interest rate, influenced by credit risk and market interest rates. The cost of equity comprises the risk-free rate plus a risk premium, reflecting expected returns demanded by investors.

Factors affecting interest rates include inflation, monetary policy, economic growth, and fiscal policy. These fundamentals shape the general movement of investment costs and borrowing rates across the economy (Brigham & Ehrhardt, 2016).

Economic Conditions, Financial Instruments, and Markets

Economic conditions, such as inflation and economic growth, impact the cost of money. Financial securities—like stocks, bonds, derivatives, and mutual funds—are investment assets representing claims on future cash flows. Financial instruments serve as tools for hedging, speculation, and investment. Financial institutions, including banks, insurance companies, and investment firms, facilitate capital flow and provide financial services.

Markets can be classified based on trading procedures:

• Order Types: Market orders execute immediately at current prices, while limit orders specify a maximum or minimum price for execution.
• Trading Platforms: Dealer-broker networks involve dealers quoting prices, while alternative trading systems (ATS) offer electronic trading outside traditional exchanges. Registered stock exchanges, like NYSE or NASDAQ, organize and regulate market trading.

Mortgage securitization involves pooling mortgage loans into securities sold to investors. Although it increased liquidity and access to capital, it contributed significantly to the 2008 global financial crisis by creating complex derivatives and masking underlying risks (Gorton & Metrick, 2012).

Conclusion

Mastering the principles of corporate finance equips stakeholders with the tools necessary for informed decision-making, investment analysis, and ethical responsibility. For an athlete-entrepreneur like DellaTorre, understanding financial fundamentals helps navigate investment opportunities and foster long-term financial health in a complex financial environment.

References

• Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of Corporate Finance (12th ed.). McGraw-Hill Education.
• Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice (15th ed.). Cengage Learning.
• Damodaran, A. (2010). Applied Corporate Finance (3rd ed.). John Wiley & Sons.
• Freeman, R. E., & Reed, D. L. (1983). Stockholders and Stakeholders: A New Perspective on Corporate Governance. California Management Review, 25(3), 88-106.
• Gorton, G., & Metrick, A. (2012). Securitized banking and the run-on repo market. Journal of Financial Economics, 104(3), 425-451.
• Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
• Gorton, G., & Metrick, A. (2012). Securitized banking and the run-on repo market. Journal of Financial Economics, 104(3), 425-451.
• Additional credible sources from financial journals and industry reports can be included to support further research and analysis.