Lecture 9: Corporate Finance

Question 1

What are different components of corporate finance?

Answer 1

• Business forms and structure of companies
• The financial manager
• Investment decisions
• Equipment decisions

Question 2

What are the 3 main forms of businesses in NZ?

Answer 2

• Sole traders
• Partnerships and joint ventures
• Companies

Question 3

Explain what sole traders are.

Answer 3

A type of business form that own all the assets of a business and are responsible for all the risks, obligations and debts.

Question 4

Explain what partnerships and joint ventures are.

Answer 4

A type of business form that can combine overseas capital or expertise with business networks and ownership of resources in NZ.

Partnership Act 1908

Question 5

Explain companies as a business form.

Answer 5

Anybody can apply to register a company, either alone or with someone else.

A company must have a registered name, one or more shares, one or more shareholders, and one or more directors.

Companies Act 1993

Question 6

What are key components of the structure of companies?

Answer 6

• Shareholders
• Board of directors
• Advisory Board
• Top management
• Staff

Question 7

What is an agency problem?

Answer 7

A manager who is principally an agent for stockholders and acts in his own interest instead of maximising market value.
(E.g. claiming high expenses, and avert riskto secure own position)

Question 8

How are agency problems combated?

Answer 8

• Compensation plans
• Board of directors
• Takeovers
• Monitoring

Question 9

What is accounting?

Answer 9

Accounting relates to preperation of accounting records, preperation, analysing and interpretation of financial statements.

Question 10

What is economics?

Answer 10

Economics is a study of choices made by people who are face with scarcity.

Question 11

What is finance?

Answer 11

Finance consists of investments, the decisions of institutions as they choose to invest, and managerial finance (business finance) which involves the actual management of the firm.

Question 12

What are some important decisions financial managment must make?

Answer 12

• Expand your business?
• How to finance the expansion?
• Invest in new equipment?

Question 13

Explain the flow of cash between a firm and the market.

Answer 13

• Cash generated by firm (to financial manager)
• Cash returned to investors, dividend etc. (to market)
• Cash raised, selling securities, loans etc. (to financial manger)
• Cash invested into firm

Question 14

Explain the role of the financial manager.

Answer 14

• Make project decisions
• Invest in research and development
• Invest in marketing
• Issure shares
• Borrow (terms and conditions)
• Certainty against market fluctuations (hedging and futures)
• Short term decisions (ability to pay bills, stay solvent)

Question 15

What are some important investment decisions?

Answer 15

• Whether to do a project
• Which project to do if projects are mutually exclusive
• Payback / ROI / NPV / PI

Question 16

What is the payback period?

Answer 16

• Time until cash flows recover the intial investment of the project.

Question 17

Explain the payback rule.

Answer 17

• The payback rule specifies that a project be accepted if its payback period is less than the specified cutoff period.
• No account of time value for money
• No value given to cash flows after the cut-off
• Cut off is arbitrary
• Emphasis is on liquidity

Question 18

Explain return on investment (ROI).

Answer 18

The ratio of cashflows (gained) and initial investment

• No account of time value of money
• No acount of the size of a project

Question 19

Explain time value of money.

Answer 19

The concept that a dollar today is worth more than a dollar tomorrow.

• investment and interest

Future value = $100*(1+r)^t
r= interest rate
t= time

Question 20

What is present value?

Answer 20

• The investment i have to do now to get a certain value in the future

Question 21

Explain the net present value rule.

Answer 21

The net present value rule states that managers increase shareholders value by accepting all projects that are worth more than they cost. Therefore they should accept all projects with a positive net present value.

Question 22

What is net present value?

Answer 22

Net present value is the present value of cash flows minus investment.

NPV = sum of [ (benefits-costs)/(1+r)^t]

Question 23

What are some important decisions related to equipment investments?

Answer 23

• Choice between equipment
  (compare products on cost versus expected cash flows, buy long lived (expensive) or short lived (cheap) equipment?)
• Investment timing decision
  (Buy now or next year?)
• Replacement decision
  (When do we replace equipment?)

Question 24

What is equivalent annual cost?

Answer 24

• The cost per period with the same present value as the cost of buying and operating a machine

Equivalent annual cost= present value of costs/ EAA factor

EAA Factor = 1/r - 1/r(1+r)^t

Question 25

Who are shareholders?

Answer 25

The owners of the company

Question 26

What are the duties of the board of directors?

Answer 26

The business and affairs of a company must be managed by, or under the direction of or supervision of, the board of the company.

Question 27

Who elects the board of directors?

Answer 27

The shareholders (owners of the company)

Question 28

What are the duties of the advisory board?

Answer 28

Provide advice and information to the board and management. The advisory board “advises” only and has no power of decision making.

Question 29

Explain internal rate of return (IRR).

Answer 29

The discount rate at which NPV equals 0.

Question 30

What is good governance?

Answer 30

The effective seperation, management and execution of the relationships, duties, obligations and accountabilities of an entity such that the entity is best able to fulfill its purpose.