Introduction to Business Finance (1415)
Q. 1 Describe
the role of financial manager in a corporation. Also narrate, what are the two
primary activities of the financial manager that are related to the firm’s
balance sheet?
The
role of a financial manager in a corporation is multifaceted and essential for
the financial well-being of the organization. Financial managers are
responsible for making strategic financial decisions, managing financial
resources, and ensuring the company's financial stability and growth. They play
a crucial role in analyzing financial data, formulating financial plans, and
implementing strategies to achieve the organization's financial objectives.
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One
primary activity of the financial manager related to the firm's balance sheet
is managing the company's assets. Assets represent the economic resources owned
or controlled by the company, which can generate future economic benefits.
Financial managers are responsible for optimizing the allocation of these
assets to maximize the company's profitability while minimizing risk.
The
financial manager begins by conducting a thorough analysis of the company's
asset base. This analysis involves evaluating the performance, value, and
potential risks associated with each asset. Financial managers assess various
investment opportunities and determine which projects or assets are viable and
aligned with the company's goals.
Once
potential investments are identified, the financial manager employs financial
modeling techniques and financial evaluation tools to assess the expected
returns, risks, and cash flows associated with each investment option. They
consider factors such as the net present value (NPV), internal rate of return
(IRR), payback period, and risk-adjusted return on investment to make informed
decisions.
Based
on this analysis, the financial manager decides on capital budgeting,
determining which projects to undertake and how to allocate financial resources
effectively. They consider factors such as the expected profitability, the time
value of money, and the company's risk tolerance. By making optimal investment
decisions, financial managers aim to maximize the company's long-term value and
enhance shareholders' wealth.
Additionally,
financial managers monitor the performance of existing assets and evaluate
whether they should be retained, sold, or replaced. They assess the efficiency
and productivity of assets, ensuring they contribute to the company's
profitability. Financial managers also consider factors such as depreciation, obsolescence,
and technological advancements when managing assets.
The
second primary activity related to the firm's balance sheet is managing the
company's liabilities and equity. Liabilities represent the company's
obligations to external parties, such as creditors and suppliers, while equity
represents the ownership interest of shareholders.
Financial
managers are responsible for determining the appropriate capital structure of
the company, which involves deciding the optimal mix of debt and equity financing.
They assess the company's financing needs and evaluate different sources of
capital. This includes analyzing the costs and benefits of issuing stocks or
bonds, taking loans, or attracting investments.
Financial
managers also consider the company's risk profile, cost of capital, and the
impact of leverage on the company's financial position. They aim to strike a
balance between debt and equity financing that minimizes the company's cost of
capital while maintaining an acceptable level of financial risk.
Furthermore,
financial managers monitor the company's debt levels and ensure they are within
manageable limits. They analyze debt ratios, such as debt-to-equity ratio and
interest coverage ratio, to assess the company's ability to meet its debt
obligations. By effectively managing liabilities, financial managers contribute
to the company's financial stability and solvency.
Equity
management is another crucial aspect of the financial manager's role. They work
closely with shareholders and investors to attract and retain capital.
Financial managers analyze the company's financial performance, communicate
financial information to stakeholders, and implement strategies to enhance
shareholder value.
Financial
managers also play a vital role in managing working capital, which refers to
the company's short-term assets and liabilities. They ensure the company has
sufficient liquidity to meet its operational needs and obligations. This
involves managing cash flows, optimizing inventory levels, and monitoring
accounts receivable and accounts payable.
By
effectively managing assets, liabilities, and equity, financial managers aim to
maintain a healthy balance sheet that accurately reflects the company's
financial position, liquidity, and solvency. A strong balance sheet enhances
the company's ability to access capital markets, attract investors, and pursue
growth opportunities.
In
conclusion, financial managers in a corporation play a critical role in
managing the company's financial activities and decisions. They are responsible
for optimizing the allocation of assets, making investment decisions, and
managing the company's liabilities and equity. By effectively managing these
aspects, financial managers contribute to the company's financial stability,
growth, and value creation.
Q.2 a What
is the financial services area of finance? DescrASQDSibe the field of
managerial finance.
Define agency costs, and explain why firms
incur them. How can management structure management compensation to minimize
agency problems? What is the current view with regard to the execution of many
compensation plans?
a) The financial services area
of finance refers to the sector that provides various financial products and
services to individuals, businesses, and governments. It encompasses a wide
range of activities, including banking, investment management, insurance, brokerage,
financial planning, and advisory services. Financial institutions, such as
banks, credit unions, insurance companies, asset management firms, and
brokerage firms, are key players in the financial services sector.
These
institutions offer services that facilitate the management, investment, and
protection of money and assets. They provide banking services like deposits,
loans, and payment processing. Investment management services include asset
allocation, portfolio management, and investment advisory. Insurance companies
offer coverage against various risks, such as life, health, property, and
liability. Brokerage firms facilitate the buying and selling of securities,
such as stocks and bonds. Financial planning and advisory services assist individuals
and businesses in managing their finances, planning for retirement, and making
investment decisions.
The
financial services area of finance plays a crucial role in the economy by
facilitating the efficient allocation of capital, managing risk, and promoting
economic growth. It provides individuals and businesses with access to funds,
investment opportunities, insurance protection, and financial advice. The
sector also contributes to the stability and functioning of financial markets
by providing liquidity, facilitating transactions, and managing financial
risks.
b) Agency costs refer to the
expenses and conflicts of interest that arise when there is a separation
between ownership and control in a firm. In large corporations, shareholders
(the owners) delegate the day-to-day management of the company to professional
managers (agents). However, there may be a misalignment of interests between
shareholders and managers, leading to agency problems and associated costs.
Firms
incur agency costs due to several factors. First, managers may prioritize their
own self-interests over the interests of shareholders. This can result in
decisions that maximize personal benefits, such as excessive compensation,
perquisites, or pursuing projects that enhance the manager's reputation rather
than shareholder value.
Second,
information asymmetry can lead to agency costs. Managers usually possess more
information about the company's operations, financial position, and future
prospects than shareholders. This information advantage can be exploited by
managers to their advantage, potentially leading to actions that harm
shareholders' interests.
To
minimize agency problems, management can structure management compensation in a
way that aligns the interests of managers with those of shareholders. This can
be achieved through various mechanisms, such as performance-based incentives,
stock options, restricted stock units, and long-term incentive plans. By tying
a portion of management compensation to the company's performance and stock
price, managers are incentivized to make decisions that enhance shareholder
value.
Furthermore,
corporate governance mechanisms, such as independent boards of directors, can
provide oversight and ensure that management acts in the best interests of
shareholders. Regular monitoring, transparency, and accountability can help
mitigate agency costs by reducing the opportunities for managerial opportunism.
Regarding
the execution of many compensation plans, there is growing recognition of the
need for a balanced approach. Excessive executive compensation and certain
compensation structures that incentivize excessive risk-taking have been
criticized. This criticism intensified after the global financial crisis of
2008, where some financial institutions were accused of rewarding executives
for short-term gains while ignoring long-term risks.
Regulatory
bodies and shareholders have pushed for greater transparency and accountability
in executive compensation practices. There is an emphasis on aligning compensation
with long-term sustainable performance and risk management. Shareholders'
say-on-pay votes and increased disclosure requirements aim to ensure that
compensation plans are reasonable, performance-driven, and promote long-term
shareholder value.
In
recent years, there has also been a focus on broader stakeholder interests
beyond just shareholders. Some companies have started considering
environmental, social, and governance (ESG) factors when designing executive
compensation plans. This approach aims to align compensation with sustainable
business practices, social responsibility, and the long-term interests of all
stakeholders.
Overall,
the current view on management compensation is to strike a balance between
incentivizing performance, aligning interests with shareholders, and addressing
societal concerns regarding fairness and risk management. The goal is to design
compensation structures that promote long-term value creation, mitigate agency
problems, and consider the broader impact of business decisions on various
stakeholders.
Q.3 Hayes
Enterprises began 2023 with a retained earnings balance of Rs. 928,000.
During
2023, the firm earned Rs. 377,000 after taxes. From this amount, preferred
Stockholders
were paid Rs. 47,000 in dividends. At year-end 2023, the firm’s retained
earnings totaled Rs. 1,048,000. The firm had 140,000 shares of common stock
outstanding during 2023.
a Prepare
a statement of retained earnings for the year ended December 31,2023 for Hayes
Enterprises. (Note: Be sure to calculate and include the amount of cash
dividends paid in 2023.)
b. Calculate
the firm’s 2023 earnings per share (EPS).
c. How
large a per-share cash dividend did the firm pay on common stock during 2023?
Hayes Enterprises Statement of Retained
Earnings for the year ended December 31, 2023:
Beginning
Retained Earnings (January 1, 2023): Rs. 928,000
Net
Income: Rs. 377,000
Less:
Preferred Stock Dividends: Rs. 47,000
Ending
Retained Earnings (December 31, 2023): Rs. 1,048,000
To
understand the changes in retained earnings for Hayes Enterprises during 2023,
we need to consider the beginning retained earnings balance, net income, and
any dividends paid.
Beginning
Retained Earnings represents the accumulated earnings from previous periods
that were not distributed as dividends. In this case, the beginning retained
earnings balance is Rs. 928,000.
Net
Income represents the earnings generated by the company during the year after
deducting taxes and other expenses. For Hayes Enterprises, the net income for
2023 is Rs. 377,000.
Preferred
Stock Dividends are the dividends paid to preferred stockholders, who have a
priority claim on the company's earnings. In this case, the preferred
stockholders were paid Rs. 47,000 in dividends.
To
calculate the ending retained earnings, we add the net income and subtract the
preferred stock dividends from the beginning retained earnings.
Beginning
Retained Earnings: Rs. 928,000
Net
Income: Rs. 377,000
Less:
Preferred Stock Dividends: Rs. 47,000
Ending
Retained Earnings = Beginning Retained Earnings + Net Income - Preferred Stock
Dividends
Ending
Retained Earnings = Rs. 928,000 + Rs. 377,000 - Rs. 47,000
Ending
Retained Earnings = Rs. 1,258,000
Therefore,
the ending retained earnings for Hayes Enterprises on December 31, 2023, is Rs.
1,258,000.
In
terms of the earnings per share (EPS) for Hayes Enterprises in 2023, we need to
divide the net income attributable to common stockholders by the average number
of common shares outstanding during the year.
Net
Income: Rs. 377,000
Average
Number of Common Shares Outstanding: 140,000
Earnings
per Share (EPS) = Net Income / Average Number of Common Shares Outstanding
EPS =
Rs. 377,000 / 140,000
EPS =
Rs. 2.69 per share
Hence,
the earnings per share for Hayes Enterprises in 2023 is Rs. 2.69.
To
determine the per-share cash dividend paid on common stock during 2023, we need
to divide the total cash dividends paid to common stockholders by the number of
common shares outstanding.
Total
Cash Dividends Paid to Common Stockholders: Net Income - Preferred Stock Dividends
Total
Cash Dividends Paid = Rs. 377,000 - Rs. 47,000
Total
Cash Dividends Paid = Rs. 330,000
Number
of Common Shares Outstanding: 140,000
Per-Share
Cash Dividend = Total Cash Dividends Paid / Number of Common Shares Outstanding
Per-Share
Cash Dividend = Rs. 330,000 / 140,000
Per-Share
Cash Dividend = Rs. 2.35 per share
Therefore,
the per-share cash dividend paid on common stock during 2023 for Hayes
Enterprises is Rs. 2.35.
In
summary, Hayes Enterprises started 2023 with a retained earnings balance of Rs.
928,000. They earned Rs. 377,000 after taxes during the year, out of which Rs.
47,000 was paid as dividends to preferred stockholders. The ending retained
earnings on December 31, 2023, totaled Rs. 1,258,000. The firm had 140,000
shares of common stock outstanding during the year. The earnings per share
(EPS) for 2023 was Rs. 2.69, and the per-share cash dividend paid on common
stock was Rs. 2.35.
Q.4 What
is the purpose of the cash budget? What role does the sales forecast play in
its preparation?
a. Briefly
describe the basic format of the cash budget.
b. How
can the two “bottom lines” of the cash budget be used to determine the firm’s
short-term borrowing and investment requirements?
c. What
is the cause of uncertainty in the cash budget, and what two techniques can be
used to cope with this uncertainty?
a) The purpose of a cash budget
is to forecast and plan the inflows and outflows of cash for a specific period,
typically on a monthly or quarterly basis. It helps businesses manage their
cash flows effectively, ensuring that they have sufficient cash on hand to meet
their obligations and make necessary investments.
The
sales forecast plays a crucial role in the preparation of the cash budget. The
sales forecast estimates the expected sales revenue for the budgeted period,
serving as a foundation for projecting the cash inflows. The accuracy of the
sales forecast directly affects the accuracy of the cash budget since sales
revenue is a significant driver of cash inflows.
b) The basic format of a cash
budget typically includes the following components:
1. Cash Inflows: This
section includes all the sources of cash coming into the business, such as cash
sales, accounts receivable collections, loans, or investments. It considers the
timing of cash receipts based on the sales forecast and other revenue sources.
2. Cash Outflows: This
section includes all the cash payments that the business needs to make, such as
inventory purchases, operating expenses, payroll, loan repayments, and taxes. It
considers the timing and amount of each cash outflow based on the budgeted
expenses and payment terms.
3. Net Cash Flow: This
section calculates the difference between total cash inflows and total cash
outflows for each period. It provides an indication of whether the business is
generating positive or negative cash flow.
4. Beginning Cash Balance: This
section includes the cash balance at the beginning of the budgeted period.
5. Ending Cash Balance: This
section calculates the cash balance at the end of each period by adding the net
cash flow to the beginning cash balance.
By
analyzing the two "bottom lines" of the cash budget, which are the
net cash flow and the ending cash balance, a business can determine its
short-term borrowing and investment requirements. If the net cash flow is
negative or the ending cash balance falls below a desired minimum, it indicates
a cash shortfall. In this case, the business may need to arrange short-term
borrowing, such as a line of credit or a bank loan, to cover the deficit and
meet its cash obligations. On the other hand, if the net cash flow is positive
and the ending cash balance is higher than expected, the business may have
excess cash that could be invested in short-term instruments or used to pay
down debt, reducing interest expenses.
c) The cause of uncertainty in
the cash budget arises from the inherent unpredictability of future cash flows
and the timing of inflows and outflows. Various factors can contribute to this
uncertainty, including changes in market conditions, customer behavior,
supplier terms, and economic factors.
To cope with this uncertainty, businesses
can employ two techniques:
1. Sensitivity Analysis: Sensitivity
analysis involves testing the impact of different scenarios on the cash budget.
By adjusting key assumptions, such as sales volumes, pricing, or timing of cash
flows, businesses can assess the potential effects on cash flows. This analysis
helps identify the sensitivity of the cash budget to changes in specific
variables, enabling management to make informed decisions based on different
scenarios.
2. Cash Reserves and Contingency Planning:
Building
cash reserves provides a cushion to handle unexpected fluctuations in cash
flows. By maintaining an adequate cash buffer, businesses can navigate through
uncertain periods without relying heavily on external financing. Additionally,
developing contingency plans that outline actions to be taken in case of cash
shortfalls or unexpected events helps businesses respond effectively and
mitigate the impact of uncertainty.
In
summary, the purpose of a cash budget is to forecast and plan cash inflows and
outflows. The sales forecast plays a significant role in its preparation as it
serves as a basis for projecting cash inflows. The cash budget's basic format
includes sections for cash inflows, cash outflows, net cash flow, beginning and
ending cash balances. The two "bottom lines" of the cash budget help
determine the firm's short-term borrowing and investment requirements. The
uncertainty in the cash budget arises from the unpredictable nature of cash
flows, and businesses can cope with this uncertainty through sensitivity
analysis and implementing cash reserves and contingency planning.
Q.5 Interest
rate for an annuity Anna Waldheim was seriously injured in an industrial
accident. She issued the responsible parties and was awarded a judgment of Rs.
2,000,000. Today, she and her attorney are attending a settlement conference
with the defendants. The defendants have made an initial offer of Rs. 156,000
per year for 25 years. Anna plans to counteroffer at Rs.255,000 per year for 25
years Both the offer and the counteroffer have a present value of Rs.
2,000,000,the amount of the judgment. Both assume payments at the end of each
year.
a. What
interest rate assumption have the defendants used in their offer (rounded to
the nearest whole percent)?
b.What interest rate assumption have Anna
and her lawyer used in their counteroffer (founded to the nearest whole
percent)?
c. Anna is willing to settle for an annuity
that carries an interest rate assumption of 9% what annual payment would be
acceptable to her?
a) To determine the interest
rate assumption used by the defendants in their offer, we need to calculate the
interest rate that equates the present value of their offer to the judgment
amount.
Present
Value of Defendants' Offer: Rs. 2,000,000
Annual
Payment: Rs. 156,000
Number
of Years: 25
Using
a financial calculator or spreadsheet, we can solve for the interest rate that
makes the present value equal to Rs. 2,000,000. In this case, the interest rate
assumption used by the defendants is approximately 7%.
b) Similarly, to determine the
interest rate assumption used by Anna and her lawyer in their counteroffer, we
need to calculate the interest rate that equates the present value of their
counteroffer to the judgment amount.
Present
Value of Counteroffer: Rs. 2,000,000
Annual
Payment: Rs. 255,000
Number
of Years: 25
Using
a financial calculator or spreadsheet, we can solve for the interest rate that
makes the present value equal to Rs. 2,000,000. In this case, Anna and her
lawyer used an interest rate assumption of approximately 12%.
c) To determine the annual
payment acceptable to Anna with an assumed interest rate of 9%, we need to
calculate the present value of the payment stream.
Present
Value: Rs. 2,000,000
Interest
Rate: 9%
Number
of Years: 25
Using
a financial calculator or spreadsheet, we can solve for the annual payment that
makes the present value equal to Rs. 2,000,000. In this case, the acceptable
annual payment for Anna would be approximately Rs. 217,849.
In
summary, the defendants used an interest rate assumption of approximately 7% in
their offer, while Anna and her lawyer used an interest rate assumption of
approximately 12% in their counteroffer. Anna would be willing to accept an
annual payment of approximately Rs. 217,849 with an assumed interest rate of
9%.
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