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Corporate Finance - Management

Discussion 1
• Assume that you recently received your MBA and now work as an assistant to the CFO of a large corporation. Your boss has asked you to prepare a financial forecast for the coming year. Address the following questions:
• How would you set up the model to be presented to the executives? How many scenarios would you choose? What other information would you provide? What would you not include and why?
• What are the pros and cons of being able to examine the results of changing dividend policy and capital structure policy?
• What are the values of financial forecasting? What is your opinion of the most important points to keep in mind when creating financial forecasts?

Discussion 2
• Why is the NPV method for budgeting accepted as the most valuable budgeting tool? If you were not allowed to use NPV for a budget you were developing, what other method(s) would you use? Explain your choices.
• Project S has a cost of $10,000 and is expected to produce cash flows of $3,000 per year for 5 years. Project L costs $25,000 and is expected to generate cash flows of $7,400 per year for 5 years.
• What is the NPV, IRR, MIRR, and PI for each project, assuming a 12 percent cost of capital?
• Which project would you select, assuming they are mutually exclusive, using each ranking? Why? Which project should you actually choose? Why?
• How do simulation analysis and scenario analysis differ in the way they treat very bad and very good outcomes? What does this imply about using each technique to evaluate risk?

Discussion 3
Franco Modigliani and Merton Miller are considered the architects of capital structure theory. They had many ideas regarding capital structure and the implications of that structure on a firm's performance. Since their first article was published in 1958, many financial theorists have attempted to test the validity of existing capital theories. This assignment will allow you to take a look at some major capital structure theories and how they influence finance.
• What does the following statement mean to you? "One type of leverage affects both EBIT and EPS. The other type affects only EPS."
• What conclusions did Modigliani and Miller draw regarding the effect of capital structure on a firm's value and cost of capital, assuming no corporate taxes?
• How do their conclusions change when each introduces corporate taxes? Explain.
• If a firm's managers thought that Modigliani and Miller were exactly right, what capital structure would they choose to maximize their firm's value? Why?
• Choose two criticisms of the MM models of capital structure. Write an argument positing that those criticisms do not outweigh the benefits of those theories.

Discussion 4
• Have you ever wanted to go into business for yourself? Why or why not?
• What tradeoffs does the entrepreneur face?
• Why is entrepreneurship so important in a market economy?

Solution Preview

Discussion 1
• Assume that you recently received your MBA and now work as an assistant to the CFO of a large corporation. Your boss has asked you to prepare a financial forecast for the coming year. Address the following questions:
• How would you set up the model to be presented to the executives? How many scenarios would you choose? What other information would you provide? What would you not include and why?
Answer:
The forecasted financial statements (FFS) method will be used to project a complete set of financial statements. Because financial statements contain numerous accounts, forecasting is almost always done using computer software such as Excel.

Scenarios
Status Quo Scenario: assumes that the firm in coming year has essentially the same operating and financial ratios as it had in last year

Best-Case Scenario: assumes that the firm is able to achieve above average operating results

Worst-Case Scenario: assume a continued long, bad recession, in which case the growth rate would be negative and the operating and financial ratios would be poor

Final Scenario: realistic forecast based on operating executives' opinions

Information to be included
Operating items on the income statement and balance sheet; these
include sales, costs, operating assets, and spontaneous operating liabilities.
Items that depend on the firm's choice of financial policies, such as the
dividend payout policy and the planned financing from debt and equity.

Information not to be included
Long dated forecasts e.g. over ten-year projections
Non-quantifiable items e.g. specific customers relationships, suppliers relationships,etc.

• What are the pros and cons of being able to examine the results of changing dividend policy and capital structure policy?
Answer:
Pros
Dividend policy and capital structure policy are two key financial policies. Hence, incorporation the change of dividend policy and capital structure policy allow the forecasting to be more accurate and comprehensive.
Management can consider various possibilities e.g. increase the dividend, repurchase stock and repay debt, etc.

Cons
The complexity of the model rises as one attempt to deal with more and more different issues within the model.

• What are the values of financial forecasting? What is your opinion of the most important points to keep in mind when creating financial forecasts?
Answer:
The greatest benefit of the financial forecasting is its use in planning to optimize operations ...

Solution Summary

Guidance on some typical Corporate Finacne questions, such as capital strucutre, calculation of NPV, IRR, MIRR for projects, financial forecasting

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