TOPIC: Introduction to Financial Management

1. Which of the following can be accepted as main points to note when it comes to a company's financial objective?

O It is generally accepted that the main financial objective of a company should be to maximise (or at least increase) shareholder wealth.

O There are practical difficulties in selecting a suitable measurement for growth in shareholder wealth. Financial targets such as profit maximization and growth in EPS might be used, but no financial target on its own is ideal.

O Financial performance is therefore assessed in a variety of ways: by the actual or expected increase in the share price, growth in profits, growth in EPS, and so on.

2. Which of the following statement/s depicts agency relationships and conflicts?

I. The owners expect the agents to act in the best interests of the owners. Ideally, the 'contract' between the owners and the managers should ensure that the managers always act in the best interests of the shareholders. However, it is impossible to arrange the 'perfect contract', because decisions by the managers (agents) affect their own personal interests as well as the interests of the owners. Managers will give priority to their personal interests over those of the shareholders.

II. If a company needs to raise more long-term finance, its directors and shareholders might wish to do so by raising more debt capital, because debt capital is usually cheaper than equity finance. (The reason why this is so will be explained in a later chapter.) However, existing lenders might believe that the company should not borrow any more without first increasing its equity capital - by issuing more shares or retaining more profits. The terms of loan agreements (the lending 'covenants') might therefore include a specification that the company must not allow its debt level (gearing level) to exceed a specified maximum amount.

III. Executive directors and senior managers usually earn most of their income from the company they work for. They are therefore interested in the stability of the company, because this will protect their job and their future income. This means that management might be risk-averse, and reluctant to invest in higher-risk projects. In contrast, shareholders might want a company to take bigger risks, if the expected returns are sufficiently high.

3. Which of the following is/are considered as the main function/s of a stock exchange?

O system in which shares can be traded in a regulated manner

O financial markets for primary issues and secondary market trading in long such as debt and equity securities

O there is an efficient system for providing new financial information about companies to investors in the market

4. Management is a user of financial analysis. Which of the following comments does not represent a fair statement as to the management perspective?

I. Management is always interested in maximum profitability.

II. Management is interested in the view of investors.

III. Management is interested in the financial structure of the entity.

IV. Management is interested in the asset structure of the entity.

5. Financial management is about planning and controlling the financial affairs of an organization, to ensure that the organization achieves its objectives, particularly its financial objectives.

This involves decisions about:

O how much finance the business needs for its operations, both its day-to-day operations and for longer-term investment projects

O where the finance should be obtained from: long-term finance is raised as equity capital(share capital and profits) or as debt capital, and short-term finance is obtained mainly from trade suppliers and bank overdrafts what should be the balance between long-term and short-term finance, and what should be the balance between equity capital and debt capital

O providing compensation and bonuses ensuring that the providers of finance are suitably rewarded: the organization must make sure that it can meet the interest payments on its borrowing, and companies must ensure that shareholders receive an appropriate dividend out of profits where appropriate, protecting the organization against financial risks