FIN2603 lEARNING UNITS & ANSWERS.

LEARNING UNIT 1 The financial goal of the firm Instructions: Study in the prescribed book Study chapter 1 entitled “The financial goal of a firm” in your prescribed book. Overview This study unit introduces you to the field of finance and explores career opportunities in both financial services and managerial finances. The forms of business organisation, the financial goal of the firm and the role of management in achieving the goal will be explained. The study unit concludes by looking at the agency problem, and the conflict that exists between managers and owners in a large company. Learning outcomes Once you have worked through this study unit, you should be able to • define profitability in a company • distinguish between liquidity and solvency • distinguish between profit maximisation and wealth maximisation • know why companies prefer wealth maximisation to profit maximisation • know what is the difference between financial management and accounting • know what are the functions of the financial manager • know what are the fundamental principles of financial management • describe the agency problem 1.1 THE FINANCIAL GOAL OF A FIRM Read section 1.3 of the prescribed book. The goal of the firm is to maximise shareholders’ wealth and not maximise profit. Profit maximisation is not consistent with wealth maximisation, because of • the timing of earnings per share • earnings that do not represent cash flows available to shareholders • a failure to consider risk 1.2 FINANCIAL MANAGEMENT AND ACCOUNTING Many people regard financial management and accounting in the business environment as the same thing; however, there is a difference. Handling of funds and decision making are the two reasons why financial management and accounting are considered different fields. 1.2.1 Handling of funds The primary functions of an accountant are to develop and provide data for measuring the performance of the firm, to assess its financial position and to see to the payment of taxes. The financial manager’s role differs in the way in which he/she views the funds of the firm. 1.2.2 Decision making The accountant devotes the majority of his/her attention to the collection and presenta- tion of historical financial data, whereas the financial manager evaluates the accountant’s financial statements, processes and additional data, and makes decisions based on subsequent analyses. 1.3 THE FUNDAMENTAL PRINCIPLES OF FINANCIAL MANAGEMENT Financial management is based on the following principles: • the cost-benefit principle • the risk-return principle • the time value of money LEARNING UNIT 1 Self assessment questions Instructions: Answer the multiple choice questions (1) The financial goal of the firm is to … 1 maximise return. 2 optimise solvency. 3 increase the value of the firm. 4 optimise liquidity. (2) Financial management is based on the following principles, except for … 1 the time value of money. 2 risk-returns. 3 annuities. 4 cost benefit. (3) The primary goal of a public company interested in serving its shareholders should be to … 1 minimise the debt use by the firm. 2 maximise expected earnings per share. 3 minimise the chance of losses. 4 maximise the share price. (4) The goal of profit maximisation would result in a priority for … 1 cash flows available to stockholders. 2 risk of the investment. 3 earnings per share. 4 timing of the return