Sample of Questions

Q1- Discuss Briefly

1-The main differences between investment decisions and financing

decisions.
Return to course materials

 Investment Decisions: purchase of real assets

These investment decisions are often referred to as capital budgeting or capital expenditure
(CAPEX) decisions, because most large corporations prepare an annual capital budget listing
the major projects approved for investment.
Today’s capital investments generate future cash returns.
- Tangible Assets: i.e. expanding and buying new stores.
- Intangible Assets: i.e. Research and development for new drug.

 Financing Decisions: sale of financial assets

A corporation can raise money from: Lenders or from shareholders

1- Debt: Lenders, If it borrows, the lenders contribute the cash, and the corporation
promises to pay back the debt plus a fixed rate of interest.

Capital refers to the firm’s sources of long-term financing.

2- Corporations raise equity financing in two ways:

- First, they can issue new shares of stock. The investors (shareholders) who buy the
new shares put up cash in exchange for a fraction of the corporation’s future cash
flow and profits.
- Second, the corporation can take the cash flow generated by its existing assets and
reinvest the cash in new assets. In this case the corporation is reinvesting on behalf
of existing stockholders. No new shares are issued.

In some ways financing decisions are less important than investment decisions. Financial
managers say that “value comes mainly from the asset side of the balance sheet.” In fact the
most successful corporations sometimes have the simplest financing strategies.
2-The role of financial manager in modern corporations.
Return to course materials

Cash Flow between Financial Markets and Firm’s Operations

The figure traces how money flows from investors to the corporation and back to investors
.again. The flow starts when cash is raised from investors (arrow 1 in the figure)
3-The financial goal of the firm.
Return to course materials

:Stockholders Want Three Things -

 To maximize current wealth.

 To transform wealth into most desirable time pattern of consumption, either by
borrowing to spend now or investing to spend later.
 To manage risk characteristics of chosen consumption plan.

:Profit Maximization

:Not a well-defined financial objective cause of 2 reasons *

?Which year’s profits -1
A corporation may be able to increase current profits by cutting back on outlays for -
.maintenance or staff training, but those outlays may have added long-term value
Shareholders will not welcome higher short-term profits if long-term profits are -
.damaged
Company may increase future profits by cutting year’s dividend, investing freed-up -2
.cash in firm
Not in shareholders’ best interest if company earns less than opportunity cost of -
.capital

* Shareholders desire wealth maximization.

.”Managers have many constituencies, “stakeholders *
*

4-The agency problem

Return to course materials

“Agency Problems” represent the conflict of interest between management and owners.

• Agency Problems:
Managers, acting as agents for stockholders, may act in their own interests rather than
maximizing value.
 • Stakeholder:
Anyone with a financial interest in the firm.

 Agency Problems" Ownership versus Management":

Difference in Information
 Stock prices and returns.
 Issues of shares and other
securities.
 Dividends.
 Financing.
Different Objectives
 Managers vs. stockholders.
 Top management vs. operating management.
 Stockholders vs. banks and lenders.

• Agency costs are incurred when:

- Managers do not attempt to maximize firm value .
- Shareholders incur costs to monitor managers and constrain their actions.
• Tools to Ensure Management Pays Attention to the Value of the Firm:
- Manager’s actions subject to the scrutiny of board of directors.
- Shirkers are likely to find they are ousted by more energetic managers.
- Financial incentives provided, such as stock options.

5-Corporate governance
Return to course materials

- Definition: Corporate governance is the system of rules, practices, and

processes by which a firm is directed and controlled. Corporate governance
essentially involves balancing the interests of a company's
many stakeholders, such as shareholders, senior management executives,
customers, suppliers, financiers, the government, and the community.

- Bad corporate governance can cast doubt on a company's operations and its
ultimate profitability.
- Corporate governance covers the areas of environmental awareness, ethical
behavior, corporate strategy, compensation, and risk management.
- The basic principles of corporate governance are accountability,
transparency, fairness, responsibility, and risk management.
Benefits of Corporate Governance
 Good corporate governance creates transparent rules and controls, provides
guidance to leadership, and aligns the interests of shareholders, directors,
management, and employees.
 It helps build trust with investors, the community, and public officials.
 Corporate governance can provide investors and stakeholders with a clear idea
of a company's direction and business integrity.
  It promotes long-term financial viability, opportunity, and returns.
 It can facilitate the raising of capital.
 Good corporate governance can translate to rising share prices.
 It can lessen the potential for financial loss, waste, risks, and corruption.
 It is a game plan for resilience and long-term success.
The Principles of Corporate Governance
While there can be as many principles as a company believes make sense, some of
the more well-known include the following:
Fairness
The board of directors must treat shareholders, employees, vendors, and communities
fairly and with equal consideration.
Transparency
The board should provide timely, accurate, and clear information about such things as
financial performance, conflicts of interest, and risks to shareholders and other
stakeholders.
Risk Management
The board and management must determine risks of all kinds and how best to control
them. They must act on those recommendations to manage them. They must inform all
relevant parties about the existence and status of risks.
Responsibility
The board is responsible for the oversight of corporate matters and management
activities. It must be aware of and support the successful, ongoing performance of the
company. Part of its responsibility is to recruit and hire a CEO. It must act in the best
interests of a company and its investors.
Accountability
The board must explain the purpose of a company's activities and the results of its
conduct. It and company leadership are accountable for the assessment of a
company's capacity, potential, and performance. It must communicate issues of
importance to shareholders.
Corporate Governance Models
- The Anglo-American Model
- The Continental Model
- The Japanese Model
The four P's of corporate governance are people, process, performance, and purpose.

Q2- Assume the following data: EBIT = 400; Tax = 100; Sales = 3000; Average total assets = 1500 and
owners' equity 1000. Calculate the ROE.

Q3- Assume a book value per share of $5 and a price per share of $12. What is the market value added of a
firm with 2,000,000 outstanding shares?