Answer 5 and 6 Mini CaseYour answers must be in your own wor

Answer 5 and 6• Mini Case-Your answers must be in your own words to earn credit. Assume that you recently graduated and have just reported to work as an investment advisor at the brokerage firm of Balik and Kiefer Inc. One of the firm’s clients is Michelle DellaTorre, a professional tennis player who has just come to the United States from Chile. DellaTorre is a highly ranked tennis player who would like to start a company to produce and market apparel she designs. She also expects to invest substantial amounts of money through Balik and Kiefer. DellaTorre is very bright, and she would like to understand in general terms what will happen to her money. Your boss has developed the following set of questions you must answer to explain the U.S. financial system to DellaTorre. 1. What are free cash flows? 2. What is the weighted average cost of capital? 3. How do free cash flows and the weighted average cost of capital interact to determine a firm’s value? 4. What do we call the cost that a borrower must pay to use debt capital? What two components make up the cost of using equity capital? What are the four most fundamental factors that affect the cost of money, or the general level of interest rates, in the economy? 5. What are some economic conditions that affect the cost of money? 6. What are the differences between market orders and limit orders?

Solution

As per rules I will answer the first four sub parts of this question.

1. Free cash flows refer to the amount of cash generated by a business through its operations after deducting the expenditure on assets. It depicts the efficiency of the company in generating cash. In consideration of free cash flows non cash expenses such as depreciation are added back.

2. The weighted average cost of capital is an estimation of the cost of funds used by the business. Generally companies use a combination of debt and equity and financing its operations. Companies may also use preferred stocks for financing. The weighted average cost of capital is calculated by multiplying the cost of each capital component by its weight and adding them up.

3. The value of a business can be determined by adding the present value of free cash flows. The free cash flows are discounted to the present value using weighted average cost of capital. This represents the today\'s value of future cash flows and determines the value of the business.

4. The cost of debt capital is called interest rate. The price of equity is dividend + capital gains. The four fundamental factors which affect the cost of money are expected inflation and risk as well as time preferences and production opportunities.