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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