TEST BANK For Foundations of Financial Management, 18th
Edition by Stanley Block, Geoffrey Hirt, Bartley Danielsen
What is interest? (5) - ANSWER:- Interest is the charge involved for the use of money
- It is expressed as a percentage of the original principle or compound value for a
given period
- Interest rates are positively associated with the rate of inflation for a given country
- The Central Bank monitors and directs the interest rates for a given country. This
occurs through monetary policy, which is implemented by the Open Market
Operations, for example, quantitative easing
- Principal + Interest = Compound Value
How would you deduce simple interest? - ANSWER:- For an interest rate of 13% over
a three year period:
- FV3 = £1,000 (1 + 0.10)^3 = £1,300
What is limited liability? - ANSWER:- Limited liability indicates how the liability of the
shareholders is limited to the amount that they have invested in the company - If the
company were to default on a loan, then their investment would be vulnerable
- However, for proprietorships and partnerships, the liability is unlimited and if the
business defaults on a loan then the business owner's home could be at risk
What is a Proprietorship? - ANSWER:- This is a company that is owned by one
individual, and they are accountable for all risks and liabilities
- It is the simplest form of organisation, and involves easy transaction details - Easy
Accounting and Finance
- Involves small/micro businesses and shops
- Unlimited liability, and challenges may arise in generating large quantities of capital
for expansion, managerial skill and time is also limited by the ability of the managers
in position
What is a partnership? - ANSWER:- This is a form of organisation developed by more
than one individual/entity
- They are held accountable for the liabilities and the risk incurred to the firm
- Simple form of business organisation
- Complex to decipher how to split the profits earned
What is a Limited Company? - ANSWER:- This is a company that is owned by the
shareholders and the manager is involved in the day to day operations on their
behalf
- It is seen as a separate legal entity and hence limited liability arises
- Can raise large sums of capital for expansion
- Can hire managers as needed - Skill can be rewarded through bonuses
- Not reliant on owners for success and continuity
,- Complexity and cost involved in committing an accountant - This arises once having
passed a certain threshold
- Communication of information from managers to shareholders - Hence a
requirement for Financial Reports
- Under control from stricter regulation and legislation
What is a Private Limited Company? - ANSWER:- These are small companies that is
not listed on the stock exchange - Hence cannot sell and buy shares in the open
market
- Small number of shareholders that are mainly composed of family and close
entities. Hence effective communication between the management and
stakeholders, and less of a reliance on Financial Accounting
- For example, Wilko and Aldi
What is a Public Limited Company? - ANSWER:- These are companies that are listed
on the stock exchange, and whose shares can be bought and sold on the open
market
- The shareholders are usually composed of a large group of small unrelated and
diverse entities - Hence there is a greater emphasis on the need for communication
and the production of Financial Reports, alongside governmental regulation
- For example, Tesco and Apple
What are Executive Directors? - ANSWER:These are directors that are sourced from
management that are responsible for the day-to-day operations of the firm
What are Non-Executive Directors? - ANSWER:These are directors that could be
sourced from outside of the firm, and are independent - Not accountable for the
day-to-day operations of the firm
What is the Chairman of the Board? - ANSWER:Heads the board of the directors, can
be a non-executive director
How is a Dominant CEO Prevented? - ANSWER:- The head of the company who acts
as the head of the company cannot be the same person as the chief executive officer
(CEO) - This is the person who is in charge of managing the day-to-day operations of
the firm
- The Board are responsible for ensuring that the CEO acts in the best interests of the
shareholders
- They have to be prepared to hold the CEO accountable, and not to be controlled by
senior management
- For example, Richard Branson is the CEO of Virgin Group
What is the Agency Theory? - ANSWER:- Formulated by Ross (1973), and states that
there is a separation between ownership and control
- Management must act as an agent for the shareholders and promote their best
interests - This is ensured through maximising shareholder value and making
,investments that generate a financial return greater than other opportunities on the
market with equivalent risk
- There are costs involved - This involves monitoring costs (including for financial
reporting and corporate governance), and bonding costs (bonus for performance,
share issue and dividend policy)
What is the Stakeholder Theory? - ANSWER:- Freeman (1984)
- Stipulates that company should act in the stakeholders' interests
- Including the shareholders but with fairness to other stakeholders too
- Business operates within the sanctions of society and so should be responsible to
society as well. Emergence of the concept of corporate social responsibility
- A stakeholder is any group or individual who can affect or is affected by the
pursuant of the organisational objectives
What is a Stakeholder? - ANSWER:An individual or a group that can be or has been
impacted by an organisation in the pursuit of achieving its objectives
Discuss why an Agency Problem would arise? - ANSWER:- The shareholders are
usually passive and not involved in the daily operations of the firm - They hence have
limited knowledge of the firm and fragmented interests
- The management, on the other hand, have a greater knowledge of the firm and are
aware of their personal interests
- This can lead to the management exploiting privileged information for their own
benefit to the detriment of the shareholders
Discuss examples of the Agency Problem in practice? - ANSWER:- Inflated
sales/revenue/profits to earn bonuses
- Provision of extra benefits and facilitates, such as luxury cars, holidays and private
jets
- Tesco bought a corporate jet valued at £50 million after the revelation that its
profits had been overstated by £250 million
- Valeant - Canadian pharmaceutical company accused of 'channel stuffing' - Patient
Assistance Programme - Patients are insured - Valeant sends drugs on repeat
prescriptions to patients which they may not need on specialist pharma subsidiaries
What are Not-For-Profit Organisations? - ANSWER:- These are organisations that do
not have profit as their central focus - They instead prioritise the welfare of society.
For example, Hospitals, NHS, Government, schools
- It is hence difficult to measure their output/success in objective measures
- Not captured in normal accounting terms
- Value for money - Making the most effective use of limited resources
- Economy - Spending less money to provide the same service
- Efficiency - Using the same money to provide additional service
- Effectiveness - Using the planned amount of money to deliver the planned amount
of service
, How can we overcome the Agency Problem? - ANSWER:- Corporate Governance
Regulation, Companies Act, FCA and Accounting bodies
- Linking compensation plans to shareholder wealth - Also providing stock options to
managers
- Shareholder Pressure/Dismissal
- Sell of shares to create takeover threat
- Force firms to improve information flow. For example, Rolls Royce 2018 Directors
Remuneration Report
How would financial managers enhance profit through expansion? - ANSWER:-
Financial managers can enhance profit through enhancing their activity (and the
level of sales that can be generated) - This would require an investment in
infrastructure, stocks and credit policy
- This leads to an increase in the capital that has been employed
- Unless the asset turnover is maintained, this leads to a lower return on investment
How would finance managers increase profit through looking at margins? -
ANSWER:- Finance managers can increase profit by increasing their margins - This
leads to better buying and more efficient sales
- Does not involve increasing the asset base, nor borrowing or the issuance of
greater share capital
- Return on investment will rise
Describe the interaction with the financial markets by finance managers? - ANSWER:-
Shareholders interaction
- Determination of private equity vs venture capital
- IPO vs private listing
- Determination of which exchange to be listed on and the investment bank involved
in market-making
- Share splitting, bonus issue, rights issue, reacquiring shares and dividend policy
- Debtholder interaction - Determination of short-term loans, long-term debentures,
negotiation, interest, covenants, charges
- Hence requires a knowledge of the changing markets, financial instruments and
opportunities
Discuss the investing decisions by the finance manager? - ANSWER:- Decision as to
the best use of the cash available to the finance manager to generate value for the
shareholders
- Project appraisal and capital budgeting. For example, determining whether to
invest in factory expansion to enhance production, or financing the automation of
production to increase supply
- Consideration of analytical techniques and relevant decisions - This includes
governmental restrictions, corporate strategy, skills and culture
What are Divestment Decisions? - ANSWER:- Acknowledgement of the assets and
product lines that are no longer generating shareholder value
- Reallocation of the assets and product lines to areas that are generating value
Edition by Stanley Block, Geoffrey Hirt, Bartley Danielsen
What is interest? (5) - ANSWER:- Interest is the charge involved for the use of money
- It is expressed as a percentage of the original principle or compound value for a
given period
- Interest rates are positively associated with the rate of inflation for a given country
- The Central Bank monitors and directs the interest rates for a given country. This
occurs through monetary policy, which is implemented by the Open Market
Operations, for example, quantitative easing
- Principal + Interest = Compound Value
How would you deduce simple interest? - ANSWER:- For an interest rate of 13% over
a three year period:
- FV3 = £1,000 (1 + 0.10)^3 = £1,300
What is limited liability? - ANSWER:- Limited liability indicates how the liability of the
shareholders is limited to the amount that they have invested in the company - If the
company were to default on a loan, then their investment would be vulnerable
- However, for proprietorships and partnerships, the liability is unlimited and if the
business defaults on a loan then the business owner's home could be at risk
What is a Proprietorship? - ANSWER:- This is a company that is owned by one
individual, and they are accountable for all risks and liabilities
- It is the simplest form of organisation, and involves easy transaction details - Easy
Accounting and Finance
- Involves small/micro businesses and shops
- Unlimited liability, and challenges may arise in generating large quantities of capital
for expansion, managerial skill and time is also limited by the ability of the managers
in position
What is a partnership? - ANSWER:- This is a form of organisation developed by more
than one individual/entity
- They are held accountable for the liabilities and the risk incurred to the firm
- Simple form of business organisation
- Complex to decipher how to split the profits earned
What is a Limited Company? - ANSWER:- This is a company that is owned by the
shareholders and the manager is involved in the day to day operations on their
behalf
- It is seen as a separate legal entity and hence limited liability arises
- Can raise large sums of capital for expansion
- Can hire managers as needed - Skill can be rewarded through bonuses
- Not reliant on owners for success and continuity
,- Complexity and cost involved in committing an accountant - This arises once having
passed a certain threshold
- Communication of information from managers to shareholders - Hence a
requirement for Financial Reports
- Under control from stricter regulation and legislation
What is a Private Limited Company? - ANSWER:- These are small companies that is
not listed on the stock exchange - Hence cannot sell and buy shares in the open
market
- Small number of shareholders that are mainly composed of family and close
entities. Hence effective communication between the management and
stakeholders, and less of a reliance on Financial Accounting
- For example, Wilko and Aldi
What is a Public Limited Company? - ANSWER:- These are companies that are listed
on the stock exchange, and whose shares can be bought and sold on the open
market
- The shareholders are usually composed of a large group of small unrelated and
diverse entities - Hence there is a greater emphasis on the need for communication
and the production of Financial Reports, alongside governmental regulation
- For example, Tesco and Apple
What are Executive Directors? - ANSWER:These are directors that are sourced from
management that are responsible for the day-to-day operations of the firm
What are Non-Executive Directors? - ANSWER:These are directors that could be
sourced from outside of the firm, and are independent - Not accountable for the
day-to-day operations of the firm
What is the Chairman of the Board? - ANSWER:Heads the board of the directors, can
be a non-executive director
How is a Dominant CEO Prevented? - ANSWER:- The head of the company who acts
as the head of the company cannot be the same person as the chief executive officer
(CEO) - This is the person who is in charge of managing the day-to-day operations of
the firm
- The Board are responsible for ensuring that the CEO acts in the best interests of the
shareholders
- They have to be prepared to hold the CEO accountable, and not to be controlled by
senior management
- For example, Richard Branson is the CEO of Virgin Group
What is the Agency Theory? - ANSWER:- Formulated by Ross (1973), and states that
there is a separation between ownership and control
- Management must act as an agent for the shareholders and promote their best
interests - This is ensured through maximising shareholder value and making
,investments that generate a financial return greater than other opportunities on the
market with equivalent risk
- There are costs involved - This involves monitoring costs (including for financial
reporting and corporate governance), and bonding costs (bonus for performance,
share issue and dividend policy)
What is the Stakeholder Theory? - ANSWER:- Freeman (1984)
- Stipulates that company should act in the stakeholders' interests
- Including the shareholders but with fairness to other stakeholders too
- Business operates within the sanctions of society and so should be responsible to
society as well. Emergence of the concept of corporate social responsibility
- A stakeholder is any group or individual who can affect or is affected by the
pursuant of the organisational objectives
What is a Stakeholder? - ANSWER:An individual or a group that can be or has been
impacted by an organisation in the pursuit of achieving its objectives
Discuss why an Agency Problem would arise? - ANSWER:- The shareholders are
usually passive and not involved in the daily operations of the firm - They hence have
limited knowledge of the firm and fragmented interests
- The management, on the other hand, have a greater knowledge of the firm and are
aware of their personal interests
- This can lead to the management exploiting privileged information for their own
benefit to the detriment of the shareholders
Discuss examples of the Agency Problem in practice? - ANSWER:- Inflated
sales/revenue/profits to earn bonuses
- Provision of extra benefits and facilitates, such as luxury cars, holidays and private
jets
- Tesco bought a corporate jet valued at £50 million after the revelation that its
profits had been overstated by £250 million
- Valeant - Canadian pharmaceutical company accused of 'channel stuffing' - Patient
Assistance Programme - Patients are insured - Valeant sends drugs on repeat
prescriptions to patients which they may not need on specialist pharma subsidiaries
What are Not-For-Profit Organisations? - ANSWER:- These are organisations that do
not have profit as their central focus - They instead prioritise the welfare of society.
For example, Hospitals, NHS, Government, schools
- It is hence difficult to measure their output/success in objective measures
- Not captured in normal accounting terms
- Value for money - Making the most effective use of limited resources
- Economy - Spending less money to provide the same service
- Efficiency - Using the same money to provide additional service
- Effectiveness - Using the planned amount of money to deliver the planned amount
of service
, How can we overcome the Agency Problem? - ANSWER:- Corporate Governance
Regulation, Companies Act, FCA and Accounting bodies
- Linking compensation plans to shareholder wealth - Also providing stock options to
managers
- Shareholder Pressure/Dismissal
- Sell of shares to create takeover threat
- Force firms to improve information flow. For example, Rolls Royce 2018 Directors
Remuneration Report
How would financial managers enhance profit through expansion? - ANSWER:-
Financial managers can enhance profit through enhancing their activity (and the
level of sales that can be generated) - This would require an investment in
infrastructure, stocks and credit policy
- This leads to an increase in the capital that has been employed
- Unless the asset turnover is maintained, this leads to a lower return on investment
How would finance managers increase profit through looking at margins? -
ANSWER:- Finance managers can increase profit by increasing their margins - This
leads to better buying and more efficient sales
- Does not involve increasing the asset base, nor borrowing or the issuance of
greater share capital
- Return on investment will rise
Describe the interaction with the financial markets by finance managers? - ANSWER:-
Shareholders interaction
- Determination of private equity vs venture capital
- IPO vs private listing
- Determination of which exchange to be listed on and the investment bank involved
in market-making
- Share splitting, bonus issue, rights issue, reacquiring shares and dividend policy
- Debtholder interaction - Determination of short-term loans, long-term debentures,
negotiation, interest, covenants, charges
- Hence requires a knowledge of the changing markets, financial instruments and
opportunities
Discuss the investing decisions by the finance manager? - ANSWER:- Decision as to
the best use of the cash available to the finance manager to generate value for the
shareholders
- Project appraisal and capital budgeting. For example, determining whether to
invest in factory expansion to enhance production, or financing the automation of
production to increase supply
- Consideration of analytical techniques and relevant decisions - This includes
governmental restrictions, corporate strategy, skills and culture
What are Divestment Decisions? - ANSWER:- Acknowledgement of the assets and
product lines that are no longer generating shareholder value
- Reallocation of the assets and product lines to areas that are generating value
