The Financial Manager and the Firm (Read Moles et al Chapter 1)

1. Describe the cash flows between a firm and its stakeholders. What are the three
fundamental decisions financial management team is concerned with and how do they affect
the firm’s balance sheet?

2. Explain what should be the goal of the firm.

3. Explain why maximising the current value of the firm’s share price is the appropriate goal
for management.

4. Why is value maximisation superior to profit maximisation as a goal for the firm?

5 In determining the price of a firm’s shares, what are some of the external and internal
factors that affect tthe price? What is the difference between these two types of variables?

6. Identify the causes of agency costs. What are some ways a company can control these
factors?
7.. Discuss how agency conflicts affect the goal of maximising shareholder wealth.

8. Explain how agency costs might be found within a firm whose CEO owns no shares in the
firm and whose compensation package is unaffected by the profits (cash or accounting
profits) of the firm.

9.
(a) “The goal of the firm and its financial managers should be the maximisation of
shareholder wealth, by which we mean maximisation of the price of the existing common
stock". When stating the goal of the firm, why does finance theory give greater importance to
the firm’s shareholders than to its other stakeholders?

(b) What are some of the problems involved in the use of profit maximisation as the goal of
the firm? How does the goal of maximisation of shareholder wealth deal with those
problems?

10. Susan George has £100 to invest. She could put it in her bank account, which would pay
her interest at the rate of 6% per year. But Susan wants to invest the amount so as to get the
maximum profit possible. She has found an investment that would give her back a total
amount of £108 after one year, i.e. a profit of £8. But, since she wants to maximise the profit,
she is attracted by another equally safe investment that would give her back a bigger sum of
£132 at the end of five years – i.e. 4 times the profit that the one-year investment would give.

Evaluate whether the one-year investment or the five-year investment would be more
worthwhile for Susan, given the fact that, by making the investment, she is losing the
opportunity of placing the sum in her bank account at an annual interest rate of 6%. What do
your calculations tell you about the limitations of ‘profit maximisation’ as an objective?

11. Explain what is meant by the "agency problem" between the shareholders of a firm and
its managers, giving examples of how such problems could arise, and suggesting ways in
which these problems could be minimised.