Solutions Manual

CHAPTER 1
NATURE, PURPOSE, AND
SCOPE OF FINANCIAL MANAGEMENT

I. Questions
1. The goal of financial management is to make money and add value for
the owner. The kinds of activities that financial management deals with
relate the three financial decisions that finance managers must make
namely, investing, financing and dividend decisions.

2. Refer to page 8 Relationship between Financial Management and

Accounting.

3. The owners perspective holds that the only appropriate goal is to

maximize shareholder wealth. The competing viewpoint is from the
stakeholders perspective, which emphasizes social responsibility over
profitability. This view maintains that managers must maximize the total
satisfaction of all stakeholders in a business. While strong arguments
speak in favor of both perspectives, financial practitioners and academics
now tend to believe that the managers primary responsibility should be
to maximize shareholder wealth and give only secondary consideration
to other stakeholders welfare. The invisible hand of the market, acting
through compensation and the free price system, would ensure that only
those activities most efficient and beneficial to society as a whole would
survive in the long run. Thus, those same activities would also profit the
individual most. When companies try to implement a goal other than
profit maximization, their efforts tend to backfire. Consider the firm that
tries to maximize employment, the high number of employees raises
costs. Soon the firm will find that its costs are too high to allow it to
compete against more efficient firms, especially in a global business
environment. When the firm fails, all employees are let go and
employment ends up being minimized, not maximized.
4. Financially stable firms are good for stakeholders, such as employees,
managers, customers and local communities.
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Chapter 1

Nature, Purpose and Scope of Financial Management

5. Theoretically, managers work for shareholders. In reality, because

shareholders arent involved in day-to-day firm activities, managers
control the firm. Managers might be tempted to operate the firm in such a
way as to benefit themselves more than the shareholders. Corporate
governance is the system of incentives and monitors that tries to
overcome this agency problem. Shareholders can align managers interest
with stockholder interests by making managers part owners of the firm.
Then, various monitors follow the firm and report on its activities.
6. Capital budgeting (deciding whether to expand a manufacturing plant),
capital structure (deciding whether to issue new equity and use the
proceeds to retire outstanding debt), and working capital management
(modifying the firms credit collection policy with its customers).
7. To maximize the current market value (share price) of the equity of the
firm (whether its publicly-traded or not).
II. Multiple Choice Questions
1.
2.
3.
4.
5.

C
B
B
C
D

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