Microeconomic and Organisational Context I

Question 1

Organisation Definition

Answer 1

It is a social arrangement for controlled performance of collective goals.

It is a group or institution arranged for efficient work.

Is is a process of structured activities to achieve objective

Question 2

Why do we need organisations?

Answer 2

To share skills &knowledge, specialise and pool resources.

Synergy of a group allows to achieve more than individuals could on their own.

Question 3

Profit-seeking organisations - goal and objectives

Answer 3

Profit-seeking
Goal: maximize the wealth of their owners
Objectives: 
to make a profit, 
to maintain growth and development, 
to continue existence (survival)

Question 4

Not-for profit (NFP) / Non-profit organisations (NPO)

Answer 4

• don’t have financial objectives as primary one
• to satisfy need of their members or of particular sector of society
• museums, schools, councils, gov
• they still need to maintain their budget

Question 5

Financial objective of NFP

Answer 5

For NFP financial matters are contraints under which they need to operate rather than they are their main objective

Question 6

Mutual organisation definition

Answer 6

It is voluntary NFP, to raise funds by subscriptions/deposits of their members.

(building societies, co-operatives, trade unions)

it does not have shareholders

Question 7

Public sector organisation definition

Answer 7

Part of the economy to provide basic government services, controlled by government

(police, military, public roads, healthcare)

Question 8

Private sector organisation definition

Answer 8

• part of economy that is not controlled by government
• it may be profit-seeking or not-for-profit org
• businesses, charities, clubs

Question 9

How to measure shareholder wealth?

Answer 9

By share prices
By dividends

*Managers make decisions to&raquo_space; increase company value&raquo_space; shareholder wealth

Question 10

Define three main focus points to measure and increase shareholder value.

Answer 10

1. Cash flows correlate more to shareholder value than making profit. (Cash is prefrable)
2. Exceeding cost of capital - earings made above cost of capital leads to growth of business value.
3. Short & long-term financial perspective- investors are more interested in long-term perspective

Question 11

Why cash is more important to investors than making profit?

Answer 11

Profit = sales - expenses
Net cash flow = cash receipts - cash payments

If sales is made on credit than cash received is smaller than sales.

Dividends for investors are calculated based on cash received.

Profit and cash belongs to the shareholders whether or not thay are paid out as dividends.

Question 12

Example - calculation of shareholder value

Answer 12

Debt $100 milion, interest rate 6% -> $6m
Equity $200 milion, return expected 15% -> $30m
Taxes 30%
Profit $36m

Income statement

1. Profit made (before interest & tax) $36m
2. -interest gives profit before tax $30m
3. -tax 30% *30 =9m gives profit after tax $21m

Profit after interest and after tax is a profit available to investors.

Minimum profit required by investors is $30m, so company has made a profit but it is not enough to cover cost of capital and by this we can say that it have decreased shareholder value.

Question 13

Identify two SHORT-TERM measures of financial performance

Answer 13

1. Earnings per share

2. Return on capital employed (ROCE)

Question 14

Define ROCE

Answer 14

1. Short-term measure of financial performance
2. Return on capital employed
3. ROCE = (profit before interest & tax)/(average capital employed)*100%

Operating profit = profit before interest and before tax***

> how well business uses its capital to generate profit
it is easy to compare different companies using this measure

Weakness: it does not correlate with the goal of maximizing shareholder wealth.

Question 15

Define RONA

Answer 15

1. Short-term measure of financial performance
2. Return on net assets
3. RONA= (operating profit before interest and tax) / (total assets minus current liabilities) *100%

Question 16

Define EPS

Answer 16

1. Short-term financial measure
2. Earnings per share
3. EPS = (profits after interest, tax, preference share dividends) / number of ordinary shares issued
4. It is monetary value

> gives earnings per share that each owner of ordinary share may expect to receive
it is up to directors how much to pay out as dividend

Weakness: it does not correlate with the goal of maximizing shareholder wealth.

Question 17

Rate of return to shareholder

Answer 17

To calculate rate of return to shareholder we need to take into account the price shareholder had to pay to acquire share.

Question 18

Long-term measure of financial performance

Answer 18

It is important in realtion to investment done.

It is not easy to calculate it long term because you need to:

• establish cost of capital of investment project
• estimate income flows for the whole time of the investment
• value income flows

To estimate it we calculate PRESENT VALUE OF FUTURE CASH FLOW. (*discounted cash flow)

Question 19

Share value -variables

Answer 19

It can be impacted by market rumors and press releases.

The rule is : if project will result in higher cash flows (positive Net Present Value NVP) it will rise share value. Oposite will result in fall in share price.

Share value may be impacted by EXTERNAL factore (eg. recession) or INTERNAL factors (fail on new product, raise in costs, an expected decline in sales)