Summary 33

intrinsic, stock price. Legal actions that maximize stock prices usually increase social welfare. Firms increase cash flows by creating value for customers, suppliers, and employees. Free cash flows (FCFs) are the cash flows available for distribution to all of a firms investors (shareholders and creditors) after the firm has paid all expenses (including taxes) and made the required investments in operations to support growth. The value of a firm depends on the size of the firms free cash flows, the timing of those flows, and their risk. The weighted average cost of capital (WACC) is the average return required by all of the firms investors. It is determined by the firms capital structure (the firms relative amounts of debt and equity), interest rates, the firms risk, and the markets attitude toward risk. Afirms fundamental, or intrinsic, value is defined by: Transfers of capital between borrowers and savers take place (1) by direct transfers of money and securities; (2) by transfers through investment banking houses, which act as middlemen; and (3) by transfers through financial intermediaries, which create new securities. Capital is allocated through the price systema price must be paid to rent money. Lenders charge interest on funds they lend, while equity investors receive dividends and capital gains in return for letting firms use their money. Four fundamental factors affect the cost of money: (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation. There are many different types of financial securities. Primitive securities represent claims on cash flows, such as stocks and bonds. Derivatives are claims on other traded securities, such as options. Major financial institutions include commercial banks, savings and loan associations, mutual savings banks, credit unions, pension funds, life insurance companies, and mutual funds. One result of ongoing regulatory changes has been a blurring of the distinctions between the different financial institutions. The trend in the United States has been toward financial service corporations that offer a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking. There are many different types of financial markets. Each market serves a different region or deals with a different type of security. Physical asset markets, also called tangible or real asset markets, are those for such products as wheat, autos, and real estate. Financial asset markets are for primitive securities and derivative securities. Spot markets and futures markets are terms that refer to whether the assets are bought or sold for on-the-spot delivery or for delivery at some future date. _ FCF3 11 _ WACC2 3 _... _ FCF_ 11 _ WACC2 _ . Value _ FCF1 11 _ WACC2 1 _ FCF2 11 _ WACC2 2