24-2 Give two reasons stockholders might be indifferent between owning

QUESTION

24-2 Give two reasons stockholders might be indifferent between owning the stock of a firm with volatile cash flows and that of a firm with stable cash flows.List six reasons risk management might increase the value of a firm.Why do options typically sell at prices higher than their exercise values?¦
24-2 3. Stockholders can eliminate the risk of volatile cash flows by diversifying their portfolios. However, if a company decided to hedge away the risks associated with the volatility of its cash flows, the company would have to pass on the costs of hedging to the investors. More educated investors can hedge risks themselves and thus they are indifferent as to who actually does the hedging. More volatile cash flows will generally be able to produce more growth options due to the greater liquid asset requirements and higher liquidity needed by a company with more volatile cash flows. However, a more stable cash flow may not have the same growth options or have the opportunity to grow as quickly due to the lower liquidity level of a company with a stable cash flow. Firms with high cash flow volatility maintain higher levels of financial slack than those firms with more stable cash flow volatility. Companies with more stable cash flows however, are generally safer to by stock in overall. Thus, these are a few reasons why stockholders might be indifferent between owning the stock of a firm with volatile cash flows and that of a firm with stable cash flows. 4. While there are not any studies that prove that risk management either adds or does not add value, there are 6 reasons why risk management may increase the value of¦

a firm. Risk management allows corporations to: 1) Increase their use of debt 2) Maintain their capital budget over time. 3) Avoid costs associated with financial distress 4) Utilize their comparative advantages in hedging relative to the hedging ability of individual investors 5) Reduce both the risks and costs of borrowing by using swaps 6) Reduce the higher taxes that result from fluctuating earnings. perfect answer! some more explanation: If the elimination of volatile cash flows through risk management techniques does not significantly change a firms expected future cash flows and WACC, investors will be indifferent to holding a company with volatile cash flows versus a company with stable cash flows. Note that investors can reduce volatility themselves: (1) through portfolio diversification, or (2) through their own use of derivatives. please dont forget to rate my answer

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