You are on page 1of 4

Agency Problem

Agency Problem are conflicts between shareholders’ and managers’ objectives.
Agency problem arises when the managers, as agents of the shareholders may act
in their own interest rather than maximizing firm’s value.
Agency cost
Therefore, agency cost is incurred when managers do not attempt to maximize
firm value and shareholders need to incur cost to monitor the managers and
constraint their actions.
Real Assets
• Are assets used to produce goods and services.
Financial Assets
• Are financial claims to the income generated by the firm’s real assets.
Investment decision involves purchase of real assets. For instance,
Capital Budgeting Decision, which is the
• decision to invest in tangible or intangible assets.
• …also called the Investment Decision
• …also called Capital Expenditures or (CAPEX)

• Financing decision
• Involves sale of financial assets.
• By issuing bonds or securities, or take a loan from a bank.

The role of financial manager
 Stands between firms and outside investors.
 Helps manage the firm’s operation , by helping to make good investment
decisions.
 Deals with investors , not just shareholders but also with financial institutions
such as banks and with financial market, such as BURSA.
Each stockholder wants three things:
1. To be as rich as possible, that is, to maximize his or her current wealth.
2. To transform that wealth into the most desirable time pattern of
consumption either by borrowing to spend now or investing to spend later.
3. To manage the risk characteristics of that consumption plan.
Investment trade-off
Hurdle rate / cost of capital is the minimum rate of return required by the
investors for a particular project.
Opportunity cost of capital is the expected rate of return forgone by bypassing of
other potential investment activities for a given capital.
Whenever a corporation invests cash in a new project, its shareholders loses the
opportunity to invest the cast their own.
Corporation increases value by accepting all investment projects that earn more
than the opportunity cost of capital.
Each stockholder wants three things:
1. To be as rich as possible, that is, to maximize his or her current wealth.
2. To transform that wealth into the most desirable time pattern of
consumption either by borrowing to spend now or investing to spend later.
3. To manage the risk characteristics of that consumption plan.
Random walk theory
• The movement of stock prices from day to day DO NOT reflect any pattern.
• Statistically speaking, the movement of stock prices is random – the price
changes are independent of one another (skewed positive over the long
term).

Three forms of market effieciency
• Weak Form Efficiency
• Market prices reflect all historical information
• If past price changes could be used to predict future price changes,
investors could make easy profits.
• But in competitive markets easy profits don’t last.
• Investors try to take advantage of the information in past prices, prices
adjust immediately until the superior profits disappear.
• Thus all information in past prices will be reflected in today’s stock
price, not tomorrow.
• Semi-Strong Form Efficiency
• Market prices reflect all publicly available information
• If markets are competitive, today’s stock price reflects all the published
information available to investors.
• If so, securities will be fairly priced and security return will be
unpredictable.


• Strong Form Efficiency
• Market prices reflect all information, both public and private
• Prices reflect all the information that can be acquired by painstaking
analysis of the company and the economy.
Payback Period
• The payback period of a project is the number of years it takes before the
cumulative forecasted cash flow equals the initial outlay.
• The payback rule says only accept projects that “payback” in the desired time
frame.
• This method is flawed, primarily because it ignores later year cash flows and
the the present value of future cash flows.

Capital Rationing - Limit set on the amount of funds available for investment.
Soft Rationing - Limits on available funds imposed by management.
Hard Rationing - Limits on available funds imposed by the unavailability of
funds in the capital market.
Project analysis
Sensitivity Analysis - Analysis of the effects of changes in sales, costs, etc. on
a project.
Scenario Analysis - Project analysis given a particular combination of
assumptions.
Simulation Analysis - Estimation of the probabilities of different possible
outcomes.
Break Even Analysis - Analysis of the level of sales (or other variable) at which
the company breaks even