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Fundamental Concepts of Corporate Finance

1.) What is a firm's fundamental, or intrinsic, value? What might cause a firm's intrinsic value to be different than its actual market value?

2.) Edmund Enterprises recently made a large investment to upgrade its technology. Although these improvements won't have much of an impact on performance in the short run, they are expected to reduce future costs significantly. What impact will this investment have on Edmund Enterprises' earnings per share this year? What impact might this investment have on the company's intrinsic value and stock price?

3.) What are financial intermediaries, and what economic functions do they perform?

4.) Is an initial public offering an example of a primary or a secondary market transaction?

5.) If a "typical" firm reports $20 million of retained earnings on its balance sheet, can the firm definitely pay a $20 million cash dividend?

6.) Explain the following statement: "Whereas the balance sheet can be thought of as a snapshot of the firm's financial position at a point in time, the income statement reports on operations over a period of time."

7.) What is operating capital, and why is it important?

8.) Explain the difference between NOPAT and net income. Which is a better measure of the performance of a company's operations?

9.) What is free cash flow? Why is it the most important measure of cash flow?

10.) If you were starting a business, what tax considerations might cause you to prefer to set it up as a proprietorship or a partnership rather than as a corporation?

Solution Preview

The fundamental value of a firm is also called intrinsic value. The intrinsic value is where the true value of a company exceeds the current market value of the company. This occurs when the market value of the firm is less than the actual value of the firm. The firm falls out of favor with the market and the stock price drops but the actual value of the firm doesn't change (The information was obtained at

The earnings per share price will be impacted because the change in the Net Income, which is calculated by the Total Revenue - Total Expenses. The total expenses will increase because of the significant investments (The information was obtained at ( Earnings per share is calculated by subtracting the Dividends on Preferred Stock from the Net Income, which is divided by the Average Outstanding Shares [EPS = (Net Income - Dividends on Preferred Stock) / Average Outstanding Shares] (The information was obtained at The intrinsic value of Edmund Enterprise will increase because the cost reductions will increase the value of the firm. However, the stock price will go down because the Net Income and Earnings Per Share will be lower.

Financial intermediaries serve as a middle man by raising money from investors. A financial intermediary will borrow money from savers and lend money to companies and individuals, ...

Solution Summary

The fundamental concepts of corporate finances are examined.