Managerial Finance

  1. Describe briefly the legal rights and privileges of common stockholders. 

Common stockholders are entitled to various privileges and legal rights. They include voting power, ownership rights, right to sue, dividend as reward, and right to transfer ownership.  With regards to voting power, stockholders have the right to vote on major issues which range from electing directors and making fundamental changes like liquidation, mergers, and acquisition. Stockholders have the powers of electing directors who in turn can appoint the management team with an aim of increasing the stock price. On the other hand, the ownership right gives the stockholders the right and privilege of owning the company or entity. Also, stockholders have the rights of transfer of ownership whereby they can buy or sell securities on stock exchange which leads to transfer of ownership rights. Besides, stockholders are entitled to dividends as rewards n form of profits for investing in a venture. Stockholders can distribute the profits as dividend or reinvent the amount in the venture. Furthermore, stockholders have the authorities to inspect books and records in form of annual reports and public filings of the company. When it a private company, the right to inspect books and records is more important. Lastly, stockholders have the rights to sue for wrongful acts committed against the company. 

  1.  What is free cash flow (FCF)? What is the weighted average cost of capital? What is the free cash flow valuation model? 

FCF are surplus cash flows available to be distributed among stakeholders of a company and can comprise of cash from capital expenditures and operations. Elsewhere,  Weighted Average Cost of Capital, WACC, is the rate of return that investors require frm an investment.WACC is an importanti parameter in evaluating project and value of an investment. To get the present value of FCF to a firm, WACC is used as a discpunting factor. On the other hand, when evaluating new projects, WACC is used as a tool to make deciosn on whther an invesmsnt is worthy or not. During the analysis and it is foud that WACC is less than internal rate of return (IRR), then the project is deemed viable and should be invested in. 

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Free cash flow valuation model is where a firm’s cash flow is used to value it. Future projections are used in the calculation of free cash flows from expenditure and income. Also, WACC can be used in the discounting of future free cash flows to arrive at a present value of FCF. The fair value of the firm is therefore obtained through the sum of all the present values of FCF.   

  1. Use a pie chart to illustrate the sources that comprise a hypothetical company’s total value. Using another pie chart, show the claims on a company’s value. How is equity a residual claim? 

Common stock = 5 * 2 = 10

Free cash flow = 24

Growth rate = 5%

Marketable securities = 100

Debt = 200

Preferred stock = 50

Value of the firm= free cash flow / (discount rate-growth rate)

= 24 / (0.11-0.05)

= 400

Discount rate is WACC 11%

Residual equity is calculated by subtracting the claims of bondholders and preferred shareholders from the company’s total Value.

Common stock                       50
Marketable securities                     100
debt                     200
  1. Suppose the free cash flow at Time 1 is expected to grow at a constant rate of forever. If , what is a formula for the present value of expected free cash flows when discounted at the WACC? If the most recent free cash flow is expected to grow at a constant rate of forever (and ), what is a formula for the present value of expected free cash flows when discounted at the WACC?

Present Value of expected FCF when discounted at WACC is given by the free cash flow expected in year =  0*(1+g)/(WACC-g)=

Therefore: Free cash flow expected in year = 1/(WACC-g)

References 

Dell’Acqua, A. (2018). Corporate debt management.

McDonald, M. (2018). Excel for Corporate Finance Professionals. Erscheinungsort nicht ermittelbar: lynda.com.Ross, S. A. (2018). Corporate finance: Core principles & applications.

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