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In pursuing the firms goal of maximizing the stock

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Unformatted text preview: ast cash flows. Riskier cash flows are discounted at higher rates, resulting in lower present values than less risky expected cash flows, which are discounted at 338 PART 2 Important Financial Concepts lower rates. The value of the firm’s common stock is therefore driven by its expected cash flows (returns) and risk (certainty of the expected cash flows). In pursuing the firm’s goal of maximizing the stock price, the financial manager must carefully consider the balance of return and risk associated with each proposal and must undertake only those that create value for owners—that is, increase share price. By focusing on value creation and by managing and monitoring the firm’s cash flows and risk, the financial manager should be able to achieve the firm’s goal of share price maximization. REVIEW OF LEARNING GOALS Differentiate between debt and equity capital. Holders of equity capital (common and preferred stock) are owners of the firm. Typically, only common stockholders have a voice in management through their voting rights. Equity holders have claims on income and assets that are secondary to the claims of creditors, there is no maturity date, and the firm does not benefit from tax deductibility of dividends paid to stockholders, as is the case for interest paid to debtholders. LG1 Discuss the rights, characteristics, and features of both common and preferred stock. The common stock of a firm can be privately owned, closely owned, or publicly owned. It can be sold with or without a par value. Preemptive rights allow common stockholders to avoid dilution of ownership when new shares are issued. Not all shares authorized in the corporate charter are outstanding. If a firm has treasury stock, it will have issued more shares than are outstanding. Some firms have two or more classes of common stock that differ mainly in having unequal voting rights. Proxies transfer voting rights from one party to another. Dividend distributions to common stockholders are made at the discretion of the firm’s board of directors. Firms can issue stock in foreign markets. The stock of many foreign corporations is traded in the form of American depositary receipts (ADRs) in U.S. markets. Preferred stockholders have preference over common stockholders with respect to the distribution of earnings and assets and so are normally not given voting privileges. Preferred stock issues may have certain restrictive covenants, cumulative dividends, a call feature, and a conversion feature. LG2 LG3 Describe the process of issuing common stock, including in your discussion venture capital, go- ing public, the investment banker’s role, and stock quotations. The initial nonfounder financing for business startups with attractive growth prospects typically comes from private equity investors. These investors can be either angel capitalists or venture capitalists (VCs), which are more formal business entities. Institutional VCs can be organized in a number of ways, but the VC limited partnership is the most common. VCs usually invest in both early...
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