NOMBRADO, SEAN LESTER

CBET – 01 – 303A
Review Questions
Concept review questions
Test questions
1.
A. Do you consider shareholder wealth maximization to be a valid objective for a commercial
firm? Give reasons for your answer.
Yes, in financial management theory, the objective of the business firm is to make the most
extreme incentive for its investors and this objective is commonly expressed as the maximization of
shareholder wealth or the maximization of shareholder value. with practical reason, shareholder
wealth maximization is a precise and clear decision as well as a suitable and operationally feasible
goal. Also, it has some advantages – the components of timing and threat must be considered by
directors or managers as they settle on a significant financial decision, for example capital
expenditures. Second, provision a corporation makes a decision that will keep the market price, it is a
good decision. Nevertheless, if a successful outcome is not obtained, this should not be taken (at least
not voluntarily). Finally, it is an impersonal goal to increase the resources of shareholders. If the
stockholders condemn the policies of the company, they will freely sell their shares and invest their
funds in other, but it is noticeable that the shares should be more beneficial than they are available
under any other marketing approach.
B. Is a commercial firm likely to have objectives other than shareholder wealth maximization?
Yes, it is understood that in addition to maximizing the wealth of its shareholders, even a
commercial, profit – seeking company would have other goals and priorities in practice. These other
goals and objectives may be financial and/or non – financial in nature. It is stated in the book that
financial objectives or goals will typically include the earnings per share, dividends per share, and
return on investment. On the part of financial goals, objective includes the welfare, health, safety of
the employee. The aims and objectives of an organization may also be expressed in the context of a
mission statement.
C. Is the objective of shareholder wealth maximization appropriate for not-for profit
organizations?
The principle of value maximization is also applicable in the case of non – profit
organizations (NPOs) and public sector organizations. Non-profit organizations even considered the
third sector of the economy (the first two is the public and private, or commercial). It is believed that
they have a special role in development of civil society. However, it is very problematic to identify
and quantify value in the sense of the non – profit sector; there is no share price to be used as
reference. The problem is partially related to the essence of the services offered in the non – profit
sector. They are also intangible such as health care, social care and education and it is notoriously
difficult to measure or calculate their benefits.
D. Do you think this objective is relevant to the owner-managers of small business enterprises
(SBEs)?
The objective is also relevant to the owner – manager of small business enterprises. For
example, it has been proven that many of the schools set up in the interior are because of non-profit
organizations. Apart from supplying children with educational facilities, the other big reasons that
non- profits have sprung up is to provide treatment for illnesses that have been a major problem in the
community. In addition, due to the mission of these non – profit organizations, many of the interior
communities have evolved in ways that now have passable roads that allow facilities and lighting in
and out of the community. Lastly, they play a major role in helping the people affected by natural
calamities like floods, earthquakes, tsunamis and more – in offering donation to them in form of food,
clothes, and shelter. This does not mean that the government does not help, but in supporting the
people, the non – profits organizations act as a second hand in helping people.
2. Why is profit maximization not considered a valid goal in financial management?
Based on financial management that the profit maximization is not considered as a valid goal.
Profitability objective may be stated in terms of profits, return on investment, or profit to sales ratios.
It is stated that the profit objective maximization – all actions, such as revenues and cost should be
pursued and any expected to have a detrimental effect on the performance of the business should be
avoided. Profit maximization is not an appropriate goal as it ignores the three factors. First, the timing
of returns – most of the shareholders likely to have an annual benefit in their funds rather than later,
as they could invest the funds earlier and thus accumulate more wealth. Second, profits do not
represent cash flows. It may be total profit before tax or after tax or profitability rate. Furthermore,
the word profit does not speak anything about the short-term and long-term profits. Lastly, profit
maximization ignores the concept of risk. The projected profits of various ventures are tied to
uncertainties of differing degrees. Many investors believe that they can only earn higher returns by
accepting higher levels of risk. If a low-risk investment is preferred, then a commensurate low level
of return will be expected.
3. (a) What are the fundamental concepts of financial management? (b) How do they relate to
the goal of the firm?
Finance is an important concept for business owners to grasp. It includes any part of their
business, and even with the best product and marketing strategy in the world a business can still fail
without proper financial planning. In finance, there are several ideals that any small business owner
can get their heads around before making too many preparations to launch a small company. These
fundamental concepts of financial management are cash flow, risk and return, time value of money,
opportunity cost and value.
Cash flow is considered by many accountants and economists as the most important measure
of a firm’s performance. A healthy cash flow is essential for any organization’s survival and the more
risky or unpredictable cashflows are expected, the lower the investment return will be, given all other
variables remain stable. In terms of time value of money, the sooner the cash flow are expected to be
received, the greater will be their value and all other factors remaining constant. The lower the return
of an investment offers, relative to comparable assets with equivalent risk, the smaller the valuation.
In financial management, the value or worth of the firm is defined by the amount, timing, riskiness of
its expected future cash flows.
4. (a) How are risk and return related in financial decision-making? (b) When faced with an
identical risk-return relationship for an investment, are all managers or investors likely to
make the same decision?
Conducted within the framework of financial management, we mean the probability that the
real returns can vary from projected returns, and in finance a risky investment is one whose future
returns are anticipated to have a high degree of variation or volatility. The decision - maker simple
does not know what the real result would be when determining the probability of an investment.
However, the decision – making can be aided by the application of some statistical techniques, such
as probability theory, with that risk can be quantified by expressing in terms of probabilities.
Investment decision would be affected by the investor’s risk - taking tendency or the risk -
taking mindset. Investors can be classified according to their propensity for risk – taking. There are
investors who have low risk propensity, and they are regarded as risk – averse which means they do
want a preference for less risk while others have a high-risk propensity are referred as risk – taking.
5. Explain the difference between strategic and operational financial decisions.
Investment decision can be divided into two parts: strategic investment decisions and tactical
or operational investment decision. These can similarly be analyzed as strategic financing decisions
and tactical or operational financing decisions.
Strategic planning is the process by which members of an organization envision its future and
develop the necessary procedures and operations to achieve that future. Typically, it decides what is
the most appropriate mix or blend of equity and long – term debt finance in the firm’s capital
structure. This is also a process of defining the values, purpose, vision, mission, goals, and objectives
of the organizations. Through the planning process, a authority identifies the outcomes it wants to
achieve through its program and the specific means by which it tends to achieve these outcomes.
Strategic planning can be a process for setting future directions, a way to develop consensus among
managers and direct supports and serves as a framework for decisions or for securing
support/approval.
Once strategic planning is done, the organization is ready to move into to the next phase of
planning which is doing the operational or action planning. This turns into implementation of the
strategy. These concerns how you are going to carry out your strategic decisions. They are considered
medium-term decisions versus strategic long-term decisions. Like strategic decisions, they are
focused on growth, but they target the production process. They are “the how” of meeting your
strategic goals. Without operational plan, implementation is very difficult, work tends to be confused
and uncoordinated. Sometimes things do not go as planned.
6. What is the financial management process? Outline its various stages.
Financial Management Financial management is mainly concerned with the proper
management of funds. The finance manager must see that funds are procured in such a manner that
risk, cost and control considerations are properly balanced and there is optimum utilization of funds.
There are four financial management processes – financial analysis, financial decision – making,
financial planning, and financial control.
Financial analysis is the provisional, diagnostic stage which will include: a financial report
and a summary to assess the overall financial position and state of the company. An identification of
any financial problems, risks, constraints, or limitation; and an assessment of financial Strengths,
Weaknesses, Opportunities and Threats. The decision – making phase will include the determination
of the firm’s financial objectives. Financing decisions involve the acquisition of funds needed to
support long-term investments. While taking this decision, financial management weighs the
advantages and disadvantages of the different sources of finance. The business can either finance
from its shareholder funds which can be subdivided into equity share capital, preference share capital
and the accumulated profits. Borrowings from outsiders include borrowed funds like debentures and
loans from financial institutions. At the corporate level, the main aim of the process of managing
finances is to achieve the various goals a company sets at a given point of time. Financial Planning
Financial planning means deciding in advance how much to spend, on what to spend, according to the
funds at your disposal. Thus, there are two aspects of financial planning; How much funds are
required to finance current and fixed assets and future expansion project? From where will these
funds come? Financial planning takes into consideration the growth, performance, investments, and
requirement of funds for the business for a given period. For the last stage, which is the Financial
control, financial management can work efficiently only when it is controlled properly. Control is
also necessary for the economical use and channelization of resource so that there is little wastage,
and the limited financial resources can be put to maximize use. If things are not progressing as
planned, plans and objectives may need to be modified if this is considered appropriate.
7. Profitability planning. WestWood Leisure is a rapidly growing company which owns a
number of health clubs and leisure centres. Presented below is summary financial
information for the current year for WestWood together with management’s financial plan
for the next three years. The company has an issued share capital of 1 million ordinary
shares, and this is not expected to change during the planning period.
The managing director has declared that two key financial objectives over the period are:
(1) to at least maintain current rates of return on investment, and (2) to achieve growth in
earnings per share of at least 10 per cent per year. As an assistant to the financial manager
you are required to carry out whatever financial calculations you consider necessary to
determine if management’s plans will achieve the managing director’s objectives. Comment
on your findings.

Return on Investment (ROI) is a performance measure used to evaluate the efficiency of

an investment or compare the efficiency of several different investments. ROI tries to directly
measure the amount of return on a particular investment, relative to the investment’s cost.
According to the forecast of WestWood Leisure, the investment from current to the third
year are rapidly increasing. This outcome will be successful if the strategic financing decision
enables to identify the risks of the organization such as analyzing its strengths and weaknesses in
addressing the identified problem, identify opportunities and threats in the environment that may
affect its work.
A strategy designed to reduce investment risk using call options, put options, short – selling,
or futures contracts. Its purpose is to reduce the volatility of a portfolio by reducing the risk of loss.
To create an effective profitability strategy, you need to forecast revenue over the length of the
project. A comprehensive revenue forecast is necessary when determining how much will be
available to pay your ongoing costs, and how much will remain as profit.
8. Liquidity planning. You have now been requested to calculate WestWood’s free cash flow
(FCF) for the current and future years. The following information is relevant:
• Depreciation is to be calculated at 15 per cent of administrative expenses.
• Dividends are calculated at 20 per cent of after tax profits.
• Capital expenditure (i.e. investment) in the current year is nil. Hint: it is only the annual
increase in investment expenditure which is relevant in calculating each year’s free cash flow.
 Do you think WestWood will have any difficulty in financing its investments and operations
over the planning term? Comment on your findings. For convenience and presentation round
your calculations to the nearest £000.
WESTWOOD FORECAST
LEISURE
YEAR CURRENT 1 2 3
YEAR
TURNOVER 2,562,000 3,074,000 3,689,000 4,427,000
DEPRECIATION 65,700 88,800 119,700 161,000
CAPITAL 0 358,000 393,000 216,000
EXPENDITURE
INTEREST 34,000 70,000 109,000 109,000
PAYABLE
TAXATION 211,000 224,000 233,000 250,000
DIVIDENDS 94,000 99,600 104,000 112,200
2,288,700 2,411,200 2,969,700 3,902,350

Liquidity reflects a financial institution’s ability to fund assets and meet financial
obligations. Liquidity is essential in all banks to meet customer withdrawals, compensate for
balance sheet fluctuations, and provide funds for growth. Funds management involves estimating
liquidity requirements and meeting those needs in a cost-effective way.
Based on findings, Westwood will have any difficult in financing its investments and
operation over the planning term. It is shown in the second table that the investment is lower than
the first one. There are many ways management can mitigate liquidity risk and maintain the
institution’s current and future liquidity positions within the risk tolerance targets established by
the board. For managing routine and stressed liquidity needs, institutions typically establish
diversified funding sources and maintain a cushion of high-quality liquid assets. For example,
diversified funding sources can reduce risks associated with funding concentrations, banks
generally benefit from considering the correlations between sources of funds and market
conditions and having available a variety of short-, medium-, and long - term funding sources.