Chapter 1: Financial management function

Question 1

Identify and describe a variety of financial objectives

Answer 1

1. Shareholder wealth maximisation
2. Profit maximisation
3. Earnings per share growth

Question 2

Shareholder wealth maximisation

Answer 2

This is the prime financial objective of profit making businesses. Wealth is delivered to shareholders through the payment of dividends and the
increase in share price. So this combination needs to be maximised.

Question 3

Profit maximisation

Answer 3

Applying shareholder wealth maximisation to internal decisions can be difficult and consequently it is not uncommon for organisations to follow an objective of profit maximisation.

As long as this is long term profit maximisation, it should be consistent with shareholder wealth maximisation.

Question 4

Earnings per share growth

Answer 4

It can be very difficult to judge whether a company has maximised its shareholders’ wealth or maximised its long-term profitability, so the word ‘maximised’ will often be replaced with the word
‘increased’.

One way of judging whether there has been an increase is to see if earnings per share have grown. These earnings can either be used to pay a dividend or to reinvest to create capital growth.

Question 5

Calculation of earnings per share

Answer 5

Earnings = PAT - preference dividends

/

number of shares

Question 6

What is the agency theory?

What is the agency problem?

Answer 6

Agency theory says the directors will always put the shareholders objectives first. This doesn’t mean that the directors will ignore all other stakeholders objectives.

Agency problem refers to the situation where the directors may be tempted to act in their own best interest rather than the shareholders. - Directors may have bonuses based on short term goals for ex)

Question 7

How to encourage the achievement of stakeholder objectives

2 ways

Answer 7

Managerial reward schemes such as share options and performance related pay (long term objectives)

Regulatory requirements such as corporate governance codes of best practice and stock exchange listing requirements

Question 8

Importance of value for money in not-for-profit organisations - 3 criteria

Answer 8

Economy - cost of resources
Efficiency - outputs vs inputs
Effectiveness - achieving targets

Question 9

Measuring achievement of objectives in not-for-profit organisations

Answer 9

Comparing actual performance to non-financial targets
Questioning users
Appointing regulators/experts to monitor performance
Comparing actual performance to appropriate financial targets