Shareholder Wealth and Profit Maximization Please answer the following 17 questions. (2 to 3 sentences per questions)
- What is the difference, if any, between profit maximization, shareholder wealth maximization, and stakeholder welfare maximization?
- How can financial ratios be useful? When are they useless?
3… What is liquidity?
- What are some differences between debt securities (bonds) and equity securities (common stock)? What are some advantages and disadvantages to the corporation of using each source of financing?
- How can we value bonds? How can we value stocks? Which is harder to value and why?
- What is the default risk? What is the interest rate risk? What is the reinvestment rate risk? Which types of bonds are exposed to more of these risks?
- What is a callable bond? Who does it “really” benefit: the issuer or the investor? Why would the other
- What is a sinking fund? Why does the bond indenture often include a sinking fund provision?
- Be able to apply our discussion of bond ratings and conflicts of interests.
- Be able to choose the “best” investment from a set of alternatives under the assumption of risk aversion.
- Standard deviation; coefficient of variation
- What is a portfolio? What is an unsystematic risk? What is a systematic risk? What type of risk is reduced when multiple assets are added to a portfolio? What type of risk cannot be eliminated? Which risk do investors care about (in other words, forbearing which type of risk do investors expect to be compensated for)?
- Be able to explain what a beta of a particular number (e.g., 1.5) means in words
- What is meant by the cost of capital? What is meant by the weighted average cost of capital (WACC)?
- Describe how a person could go about estimating the WACC for a publicly traded corporation?
- Should a corporation always use its WACC as the discount rate to evaluate a new capital expenditure project? Why or why not? Explain.
- Briefly describe the trade-off theory of capital structure (also called optimal capital structure theory).
- Briefly describe the pecking order theory of capital
structure.
