Textbook Exercise Solutions Part 1

Textbook Exercise Solutions Part 1 - SOLUTIONS TO EXERCISES...

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SOLUTIONS TO EXERCISES TOPIC 1 1-1 OBJECTIVE OF FINANCIAL MANAGER The financial manager is constantly engaged in decision-making. Decisions regarding investment projects to be undertaken and decisions regarding sources of finance are the major focus of financial management. The criteria to be used to measure the effectiveness of decision-making, is the extent to which wealth has been created by increasing the value of the firm. If the financial manager is efficient in the task of resource allocation and is making effective decisions, the present value of the expected future returns generated by the investment will increase. In the case of the shareholders of a listed company, value is added by investing in projects with returns on capital that exceed the cost of financing those projects (cost of capital). The returns can be realised in two ways; firstly by a return in the form of dividends which is cash paid to shareholders from the earnings of the company. Secondly by market forces which drive the share price of a successful company upward, thus creating the opportunity for the shareholder to sell the shares, recovering the capital invested plus a capital profit. Dividends and capital gains thus constitute the return to shareholders. This may be expressed as a return on funds invested. The financial manager’s fundamental objective is to ensure that the return to shareholders is maximized by making decisions which will result in returns that exceed the cost of capital. There are numerous subsidiary objectives that the financial manager may have. In most instances they are designed to ensure that the fundamental objective is achieved. Some of the more commonly cited objectives would be: To ensure that the market price of the shares remains as high as possible. To set and pursue targets for expansion and growth of the company. To reduce the risk of the company through appropriate diversification. To ensure that financial gearing is used effectively. To attract providers of loan capital and ensure that their investment is protected and that interest commitments are paid on time. To increase revenues and reduce costs To adopt a socially responsible attitude in financial decisions which will ensure the long-term future of the company. 1
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1-4 GOALS OF THE FIRM AND THE FINANCIAL MANAGER If a business enterprise is managed by the owner or owners, it is apparent that the goals of the firm will be congruent with those of the owner. So for example in the case of a sole proprietor, the owner will have the objective of supplying goods or services in the most efficient manner and to ensure that the business is profitable. The profits which accrue to the business also accrue to the owner. With the separation of ownership and management in the case of companies, it is not intuitive that managers will always act in the interests of the firm or the shareholders. There may be times when the goals of management are not congruent with those of the firm. For example,
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This note was uploaded on 04/24/2011 for the course BAFI 1012 taught by Professor Michaelgangemi during the Three '10 term at Royal Melbourne Institute of Technology.

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Textbook Exercise Solutions Part 1 - SOLUTIONS TO EXERCISES...

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