Corporate Finance – BA303

Tutorial 1 (Answers)
Corporate Finance – BA303

1. Why is the goal of maximizing owners’ wealth helpful in analyzing capital investment
decisions? What other goals should also be considered?
Answer:
The goal of maximizing owners’ wealth is the normally accepted economic objective for
resource allocation decisions. Rather than concentrate on the organization, it evaluates
investments from the viewpoint of the organization’s owners – usually shareholders. Any
investment that increases their stock of wealth (the present value of future cash flows) is
economically acceptable.
In practice, many of the assumptions underlying this goal do not always hold (e.g.
shareholders are only interested in maximizing the market value of their shareholdings). In
addition, owners are often far removed from managerial decision-making, where capital
investment takes place. Accordingly, it is common to find that more easily measurable
criteria are used, such as profitability and growth goals. There are also non-economic
considerations, such as employee welfare and managerial satisfaction, which can be
important for some decisions.
2. Identify the tangible real assets, intangible assets and financial assets. Who has financial
claims on these assets?

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 Corporate Finance – BA303

Answer:

Tangible real assets: machinery and equipment, vehicles, stock

Intangible assets: patents
Financial assets: debtors, cash and building society deposits
Financial claims: trade creditors, loans, shareholders’ equity
3. ‘Managers and owners of businesses may not have the same objectives.’ Explain this
statement, illustrating your answer with examples of possible conflicts of interest. How can
these conflicts be resolved in the best interest of the shareholders?
Answer:
This statements move towards the issue of agency problem. Whenever a manager disagrees
with a shareholder or there is a conflict in their interests, a potential agency problem exists.
It can be resolved in the following ways:
• Market forces such as major shareholders and the threat of a hostile takeover act
to keep managers in check.
• Agency costs are the costs borne by stockholders to maintain a corporate
governance structure that minimizes agency problems and contributes to the
maximization of shareholder wealth.
• A stock option is an incentive allowing managers to purchase stock at the market
price set at the time of the grant.
• Performance plans tie management compensation to measures such as EPS
growth; performance shares and/or cash bonuses are used as compensation under
these plans.

4. What is corporate governance and why is it so important for corporations to practice?

Answer:
Corporate Governance is the system used to direct and control a corporation. Corporate
governance is the system of rules, practices and processes by which a company is directed
and controlled. Corporate governance essentially involves balancing the interests of a
company's many stakeholders, such as shareholders, management, customers, suppliers,
financiers, government and the community. Since corporate governance also provides the
framework for attaining a company's objectives, it encompasses practically every sphere of
management, from action plans and internal controls to performance measurement and
corporate disclosure without which a company would collapse.

5. Explain the steps in the financial decision making process.

Answer:
Step 1: Define objectives
Step 2: Identify possible courses of action

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Step 3: Assemble data relevant to the decision

Step 4: Assess the data and reach a decision
Step 5: Implement the decision
Step 6: Monitor the effects the of decision

6. What are two major decisions under financial management? What does it involve?
Answer:

• The investment decision, sometimes referred to as the capital budgeting decision, is the
decision to acquire assets.
➢ Real assets may be tangible (e.g. land and buildings, plant and equipment, and
stocks) or intangible (e.g. patents, trademarks and ‘know-how’).
➢ Financial assets in the form of short-term securities and deposits.

• The financing decision addresses the problems of how much capital should be raised
to fund the firm’s operations (both existing and proposed).

7. Describe the role of the Financial Manager.

Answer:
• Strategic investment and financing decisions. Raise the finance to fund growth and
assist in the appraisal of key capital projects.
• Dealing with the capital markets. As the intermediary, must develop good links with
the company’s bankers and other major financiers, and be aware of the appropriate
sources of finance for corporate requirements.
• Managing exposure to risk. Ensure that exposure to adverse movements in interest
and exchange rates is adequately managed. Various techniques for hedging (a term
for reducing exposure to risk) are available.
• Forecasting, coordination and control. Assist in and, where appropriate, coordinate
and control activities that have a significant impact on cash flow.