Topic 1 - The Role of the Financial Manager

Question 1

Name the different legal forms of business.

Answer 1

1. Sole Traders - No distinction between business and person. Easy to set up and operate; taxed as personal income. Personal liability, limited life, difficult to transfer
2. Partnerships - Two or more business owners. Each partner liable for every partner’s actions
3. Limited Partnerships - One or more general partners and many limited partners
   Limited liability of corporation, tax benefits of partnership
4. Proprietary Limited Company - Separate legal entity with all the economic rights and responsibilities of a person
   Creates roles for employees, directors and shareholders
   Regulated under the Corporations Law 2001
5. Companies - Legal entity with all the economic rights and responsibilities of a person
   Owned by shareholders
   Strengths – limited liability for investors, unlimited business life

Question 2

What are the functions of corporate finance?

Answer 2

1. Capital budgeting - investing
2. Capital structure - financing
3. Dividend - reward distribution
4. Risk management
5. Corporate governance

Question 3

What is the capital budgeting function?

Answer 3

The planning and control of cash outflows in the expectation of deriving future cash inflows from investments in non-current assets.
The investment decision. What long-term investments or projects should the business take on?
It involves evaluating the size, timing and risk of future cashflows

Question 4

What is capital structure?

Answer 4

The financing decision. How should we pay for our assets? Should we use debt or equity?

Question 5

What is the financing decision?

Answer 5

A firm’s capital structure is the specific mix of debt and equity used to finance the firms operations. Decisions need to be made on both the financing mix and how and where to raise the money. Working capital management decisions involves managing day to day activities.

Question 6

What is the dividend decision?

Answer 6

It is the return decision. Should dividends be paid and if so, how much? It involves the decision of whether to pay a dividend to the shareholders or maintain the funds within the firm for internal growth. Factors to consider are growth opportunities, taxation and shareholder preferences

Question 7

What is corporate governance?

Answer 7

A system of clearly defined responsibilities and procedures to minimise conflict of interests among stakeholders.

Question 8

What are the core attributes of corporate governance?

Answer 8

Delineation of rights of shareholders and core stakeholders; clearly defined manager and director governance responsibilities; measurable accountabilities for performance responsibilities; fair treatment in all dealings; complete transparency and accuracy in disclosure

Question 9

What is the financial managers role?

Answer 9

To maximise shareholder wealth.

In practice there is a balance made between the demands of shareholders, society, financial markets and bondholders

Question 10

What is the agency relationship?

Answer 10

Shareholders hire managers to run the company. There is a conflict of interest between the principal (shareholder) and the agent. In theory shareholders exert significant control over management via corporate congtrol, incentive compensation and monitoring of management decisions. In practice none of these mechanisms are as effective in disciplining management as theory suggests.

Question 11

What are agency costs?

Answer 11

The actions management can take can be inconsistent with or harmful to the shareholder wealth maximisation.