Ch 6 - Theory of Finance Flashcards
Types of Mergers
Horizontal
Vertical
Conglomerate
The financial manager will need to consider two basic issues
Capital budgeting decision
Financing decision
Capital budgeting decision
Considers the choice of projects, and hence real assets, in which the firm should invest
Mainly the remit of the controller/CFO
Complicated in practice because:
May be more than one apparently profitable project
Very difficult to estimate the future profitability of a project
Financing decision
How to best raise the required finance
Mainly the responsibility of the treasurer who:
Looks after the company’s cash
Raises new capital
Maintains relationships with banks, shareholders and other investors
Investment in fixed capital, however, often involves complex decisions between
Alternative capital assets
Dates of commencement
Methods of financing
Financial manager
responsible for the financial operations of the firm. Is the link between the firm’s operations and the financial markets
Real assets
asset used by the company in its normal line of business to generate profits – can be either tangible or intangible
Financial analysis
In capital budgeting involves bringing together estimates and ideas from a variety of disciplines in order to reveal their financial implications
Basically analyse the financial implications of different possible courses of action
It can help with the decision making progress with respect to the following:
Delineate the risks involved in the project
Highlight the salient factors
Suggest risk mitigation for the various risks
Two methods in which to do a financial analysis
Leave the investment appraisal to the people who are most concerned to see the project accepted - May need input from the experts listed above
Likely not to be objective
Use a specialist finance function in an attempt to enforce impartiality and realism
But may lack specialist knowledge of the particular project under consideration
Agency theory
Is a principle that is used to explain and resolve issues in the relationship between business principals and their agents.
Relationship between two parties in which one, the agent, represents the other, the principal, in day-to-day transactions. The principal or principals have hired the agent to perform a service on their behalf. Most commonly, that relationship is the one between shareholders, as principals, and company executives/managers, as agents. Agency theory assumes that the interests of a principal and an agent are not always in alignment.
Considers issues such as the nature of the agency costs, conflicts of interest and how to avoid them, and how agents may be motivated and incentivised
Separation of ownership and management can lead to principal-agent problems, which is
Where the interests of owners and managers diverge
This gives rise to agency costs
Agency costs examples
The costs associated with monitoring the action of others
and seeking to influence their actions
and the lower returns to the principles than would be the case if the company was run in line with the principles best interests
Horizontal merger
Involves two firms engaged in similar activities
Horizontal merger motives
I ECO
Inefficient resources eliminated
Economies of scale
Complementary resources (have access to)
Opportunities that would otherwise be unavailable can be accessed - only available for larger organisations
Vertical merger
Involve companies engaged in different stages of a production process