Sources of finance and financial markets Flashcards
what is the primary role of a manager?
use a blend of quantitative tools and analyses to make financial decisions that create value for owners of the firm.
what is managerial finance all about
maximizing value for owners of the firm or maximizing value
how does the firm generate inflow
selling goods and services produced by human capital and productive assets
what is residual cash flow
remaining cash - usually paid to shareholders or reinvested in business
failure to generate sufficient cash flow may result in
bankruptcy
rescue plan
insolvent
name the three fundamental decisions (financial)
capital investment/budgeting
financing/capital structure plan
Working capital management
What is the capital budgeting/investment decision?
aka CAPEX decision
involves deciding what productive assets to buy
the rule of this decision: Accept an investment project if the value of future cash inflows exceeds the cost of the project (thus creating firm value)
what does CAPEX stand for
capital expenditure decision
why is CAPEX decision considered to be the most important?
- productive assets that generate most of the firm’s cacsh inflows
- long term
- involve huge cash outlays
what is the financing/capital structure decision?
- determines how the productive assets are financed
- involves selecting the optimal capital structure - good mix of debt and equity
- Firm value comes mainly from the investment rather than the financing decision. However, a bad financing decision can destroy value.
what are some advantages and disadvantages of debt
+ interest is tax deductible - reduces the amount of tax that is paid
- more debt is more risk to share holder
what is the working capital management decision
determines how current assets and current liabilites are managed
maximize value create and minimize or avoid destroying value
examples of WCM decisions
how much inventory to buy or maintain
where to invest idle cash
whether or not to sell goods on credit or whether or not to offer settlement discounts
effects of debt on the capital structure
–When profits are high or are increasing, the ROE is greater for firms with debt than those without debt, thus benefiting shareholders.•Shareholders benefit due to the tax benefit of interest –less tax paid.
–When profits are low or are decreasing, the ROE is worse for firms with debt than those without debt, thus disadvantaging shareholders (or destroying shareholder value).•Shareholders are disadvantaged because (unlike dividends), interest on debt is paid whether or not the firm is making a profit.
Companies with highly uncertain and variable operating income should make minimum use of debt.
trade off between risk and return
higher risk higher return
what are the two main categories of long term finance?
Equity or share capital
Long term debt (liabilities)
what is equity/share capital?
normally comprising of ordinary shares (class A shares), preference shares (class B shares) and retained income (undistributed profits). The two primary ways of raising equity finance are: new issue of shares (ordinary or preference shares) and retained income (or profits).
forms of long term debt
loans, debentures, bonds
what does the convention say about financing long term assets?
they should be financed with long term debt
This ensures that the costs of borrowing are matched with the benefits arising from the use of the assets.
From the point of view of the investor, investing in long-term debt (bonds/debentures) is much safer than investing in ordinary shares – why?
This is because (a) both the periodic interest payments and repayment of the capital sum on maturity are guaranteed; and (b) the debt can be secured against assets of the firm.
disadvantages of long term borrowing
higher interest rates - due to greater uncrtainty
impose conditions - managers decisions are less
Failure to pay periodic interest and/or to repay the capital sum could result in liquidation or bankruptcy.
what are ordinary shares(class A shares)
- ordinary shareholders are the effective owners of a company
- Ordinary shares confer rights to ordinary shareholders to: attend and vote at the company’s AGM, elect directors of the board, share in the company’s profits through dividends, and to share in any surplus assets on liquidation of the company
- are not tax deductible
what are the benefits of listing shares on a stock exchange include
- easier for shareholders to sell their shares - the price is readily available
- increased ability to raise large new capital
- enhanced public image and greater exposure in the media
- enables a company to facilitate BEE or BBBEE deal
what is IPO
initial public offering - when company offers shares to public for the first time
from the point of the investors which carry the greatest risk
ordinary shares
preference shares
debt
preference shareholders have preferential rights over ordinary shares with respects to
payment of dividends - their dividends are fixed and must be paid before that of ordinary shareholders’
repayments of capital sum investment if the company is liquidated