Response to the following problem:
Suppose you decided (like Michael Dell) to start a computer company. You know from experience that many students, who are now required to own and operate a personal computer, are having difficulty setting up their computers, accessing various materials from the local college network and from the Internet, and installing new programs when they become available. Your immediate plan is to provide a service under which representatives of your company will help students set up their computers, show them how to access various databases, and offer an e-mail "help desk" for various problems that will undoubtedly arise. You will also provide a gateway Web page to the campus computer center and the campus Intranet. If things go well-and you think they will-you plan to purchase computers and offer them, with all required software fully installed, to students. Moreover, you plan to develop your Web site with links to various destinations students will like, and as traffic to your site builds, to offer advertising services (and to charge for links) to local businesses. For example, someone could go through your Web site to order pizza while studying for a finance exam. Once you have established your company and set up procedures for operating it, you plan to expand to other colleges in the area, and eventually to go nationwide. At some point, probably sooner rather than later, you plan to go public with an IPO, then to buy a yacht and take off for the South Pacific.
With these issues in mind, you need to answer for yourself, and potential investors, the following questions.
a. Why is corporate finance important to all managers?
b. What should be the primary objectives of managers? (1) Do firms have any responsibilities to society at large? (2) Is stock price maximization good or bad for society? (3) Should firms behave ethically?
c. What three aspects of cash flows affect the value of any investment?
d. What are free cash flows? What are the three determinants of free cash flows?
e. What is the weighted average cost of capital? What affects it?
f. What are the components of the interest rate?
g. How do free cash flows and the weighted average cost of capital interact to determine a firm's value? h. When you first begin operations, assuming you are the only employee and only your money is invested in the business, would any agency problems exist? Explain.
i. If you expanded, and hired additional people to help you, might that give rise to agency problems?
j. If you needed capital to buy an inventory of computers to sell to students, or to develop software to help run the business, might that lead to agency problems? Would it matter if the new capital came in the form of an unsecured bank loan, a bank loan secured by your inventory of computers, or from new stockholders (assuming you incorporate)?
k. Would potential agency problems increase or decrease if you expanded operations to other campuses? Would agency problems be affected by whether you expanded by licensing franchisees or by direct expansion, where your company actually owned the businesses on other campuses and operated them as divisions of your original company?
l. If you were a bank lending officer looking at the situation, can you think of any action or actions that might make a loan to the company feasible?
m. As the founder-owner-president of the company, what action or actions can you think of that might mitigate agency problems if you expanded beyond your home campus? Would going public in an IPO increase or decrease agency problems?
n. If you had an IPO and became a public company, would agency problems be more likely if you (1) bought the yacht and took off or (2) stayed on as CEO and ran the company?
o. Why might you want to (1) inflate your reported earnings or (2) use off-balance sheet financing to make your financial position look stronger? What are the potential consequences of doing this?
p. If the company were successful, what kind of compensation program might you use to minimize agency problems?