Reference no: EM133200197

Assignment - Corporate Finance Theory and Practice Discussion Questions

Question 1 - In a seminal article on portfolio theory, Markowitz (1952) illustrated that investors are not compensated for taking on firm specific or idiosyncratic risk; however, they are compensated for taking market or systemic risk. Use your understanding of the Capital Asset Pricing Model (CAPM), statistical concepts such as standard deviation and variance, and our ideas about market efficiency and indicate whether you believe that this is a good theory. Include at least two citations that support your response.

Question 2 - According to Berk and DeMarzo (2020) the primary goal of the firm is to maximize shareholder wealth (i.e., increase the value of the owner's shares). Some contend that maximizing stakeholder wealth is a better objective. Indicate whether you believe that maximizing shareholder wealth or maximizing stakeholder wealth is a more appropriate objective and why. Include at least two citations that support your response.

Question 3 - Berk and DeMarzo (2020) provide the following quotation (see below). Indicate what is implied in this quote and what ramifications it has for our understanding of finance and market efficiency. Include at least two citations that support your response.

A finance professor and a student are walking down a street. The student notices a $100 bill lying on the pavement and leans down to pick it up. The finance professor immediately intervenes and says, "Don't bother; there is no free lunch. If that were a real $100 bill lying there, somebody would already have picked it up!" (Berk & DeMarzo, 2020, p. 81)

Question 4 - In our segment on stock valuation, you were exposed to the dividend discount model (DDM) and Free Cash Flow (FCF) method to estimate a stock's price. What about these two methods of equity valuation is different and what about them is the same? Use Figure 9.2 to compare and contrast the estimates for Kenneth Cole Productions using various methods to estimate the stock price. Which method do you prefer and why? Include at least two citations that support your response.

Question 5 - To understand how bonds work and how they are priced, we have to have an understanding of what determines a bond's price. One of the most important factors to consider when pricing bonds is the prevailing market rate of interest for bonds of similar risk in terms of duration and quality. In your response to this question, you should highlight the relationship between bond prices and interest rates and indicate what risks are considered when we price bonds. Include at least two citations that support your response.

Question 6 - Table 2.4 in Berk and DeMarzo (2020) provide key financial ratios for large US firms updated in Spring of 2018. Within this table, the authors highlight the 25%, median, and 75% quartiles for each type of ratio. Using examples of firms, explain why there are significant differences between the 25% and 75% quartiles for large companies specifically focusing on the Net Profit Margin, Asset Turnover, and the Equity Multiplier. How would you explain the differences between firms in the lower and upper quartiles (hint: see the DuPont identity for guidance)? Include at least two citations that support your response.

Question 7 - One really important concept to understand in finance is the difference between simple and compounded interest. This simply concept has many ramifications for how we value different projects including how we discount a project's cash flows or how we value companies. Provide an example that highlights and amplifies the difference between simple and compound interest.

Question 8 - Berk and DeMarzo (2020) introduced us to some evidence that although in aggregate we believe that markets are efficient, when we examine individual behavior or even the behavior of people in groups, we find at times systemic departures from efficient market behavior. Highlight two biases (in bold) that they identified in this chapter and indicate what problems these biases may cause for the Capital Asset Pricing Model (CAPM).