Chapter 1 - Introduction to Corporate Finance

Question 1

<p>Which are the 5 themes that is crucial for Corporate Finance?</p>

Answer 1

<p>1. Corporate Finance is all about maximixing value</p>

<p>2. The opportunity cost of capital sets the standard for investment decisions</p>

<p>3. A safe dollar worth more than a risky dollar</p>

<p>4. Smart investment decisions create more value than smart financing decisions</p>

<p>5. Good governance matters</p>

Question 2

<p>What is capital budgeting or capital expenditure (CAPEX)? </p>

Answer 2

<p>The investment decisions are often referred to as capital budgeting or capital expenditure (CAPEX).</p>

Question 3

<p>Explain "capital structure decision".</p>

Answer 3

<p>A corporation can raise money fromlenders or from shareholders. If it borrows, the lenders contribute the cash,and the corporation promises to pay back the debt plus a fixed rate of interest. If the shareholders put up the cash, they do not get a fixed return, but they hold shares of stock and therefore get a fraction of duture profits and cash flows. The shareholders are equity investors, who contribute <strong>equity financing</strong>. The choice between debt and equity financing is called the capital structure decision. Capital refers to the firm's sources of long-term financing.</p>

Question 4

<p>Who can corporations raise equity financing?</p>

Answer 4

<p>1. They can issue new shares of stock. 2. The corporation can take the cash flow generated by this existing assets and reinvest in new assets.</p>

Question 5

<p>What happens when a corporation does not reinvest all of the cash flow generated bu its existing assets?</p>

Answer 5

<p>It may hold the cash in reserve for future investment, orit may pay the cash back to its shareholders. The decision to pay dividends or repurchase shares is called the <strong>payout decision</strong>.</p>

Question 6

What is market capitalization or market cap?

Answer 6

Is the number of shares outstanding multiplied by the market share value.

Question 7

What each stockholder want?

Answer 7

1. To be rich as possible, that is, to maximize his or her current wealth
2. To transform that wealth into the most desirable time pattern of consumption either by borrowing to send now or investing to spend later
3. To manage the risk characteristics of that consumption plan

Question 8

Describe “cost of capital” or “hurdle rate”.

Answer 8

Is the minimum rate of return for a project. For example Venosan wants to invest in one new factory, and suppsse that Venosan new roject is just about as risky as the Bovespa and that investment in the stock market offers a 10% expected rate of return. If the Venosan new project offers a superior rate of return, the stockholders would be happy to let Venosan keep the cash and invest in the new factory. So the cost of capital is 10%. It is really an opportunity cost of capital because it depends on the investment opportunities available to investors in financial market. Whenever a corporation invests cash in a new project, its shareholders lose the opportunity to invest the cash on their own. Corporation increase value by accepting all investments projectsthat earn more than the opportunity cost of capital.