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Present Values

Corporate Financial Decisions, Firm Value, and Equity Value
If the objective function in corporate finance is to maximize firm value, it follows that firm value must be linked to the three corporate finance decisions outlined—investment, financing, and dividend decisions. The link between these decisions and firm value can be made by recognizing that the value of a firm is the present value of its expected cash flows, discounted back at a rate that reflects both the riskiness of the projects of the firm and the financing mix used to finance them. Investors form expectations about future cash flows based on observed current cash flows and expected future growth, which in turn depend on the quality of the firm�s projects (its investment decisions) and the amount reinvested back into the business (its dividend decisions). The financing decisions affect the value of a firm through both the discount rate and potentially through the expected cash flows.

        This neat formulation of value is put to the test by the interactions among the investment, financing, and dividend decisions and the conflicts of interest that arise between stockholders and lenders to the firm, on one hand, and stockholders and managers, on the other. We introduce the basic models available to value a firm and its equity, and relate them back to management decisions on investment, financial, and dividend policy. In the process, we examine the determinants of value and how firms can increase their value.