week 1:

Question 1

What is corporate finance?

Answer 1

Corporate finance concerns the allocation of funds under conditions of risk. It involves managing a firm’s cash flows, including raising capital, investing in assets, and distributing earnings.

Question 2

What is the goal of financial management?

Answer 2

The goal of financial management is to maximise the market value of the existing owners’ equity. This means making decisions that increase the firm’s value, both today and in the future.

Question 3

Describe the role of the Chief Financial Officer (CFO).

Answer 3

• The CFO bridges a firm’s operations with the financial markets.
• They are responsible for raising capital from investors, investing that capital in the firm’s operations, and then deciding whether to reinvest the cash generated by those operations or return it to investors.

Question 4

What are the three main types of corporate finance decisions?

Answer 4

• Investment decisions: Determining which assets to invest in to generate a return greater than the minimum acceptable rate.
• Financing decisions: Choosing the optimal mix of debt and equity financing to maximise the value of investments and match the financing to the assets.
• Distribution decisions: Deciding how much of the firm’s earnings to reinvest back into the business and how much to return to the owners (e.g., through dividends or share repurchases).

Question 5

What is corporate governance?

Answer 5

Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It involves balancing the interests of the company’s stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community.

Question 6

What are some common problems that arise from the conflict of interest between managers and shareholders?

Answer 6

Effort problem: Managers may not exert the same level of effort as owners would because they don’t have the same ownership stake.

Horizon problem: Managers may prioritize short-term gains over long-term value creation, while shareholders are typically more interested in long-term growth.

Differential risk problem: Managers may be more risk-averse than shareholders, who can diversify their portfolios.

Asset use problem: Managers may misuse company assets for personal gain rather than maximizing shareholder wealth.

Question 7

What are some mechanisms used to align the interests of managers and shareholders?

Answer 7

Share ownership: Encouraging managers to own company stock aligns their financial interests with those of shareholders.

Compensation: Performance-based compensation, like stock options, can incentivize managers to make decisions that benefit shareholders.

Board of Directors: An independent board can monitor management and ensure that decisions are in the best interest of shareholders.

Large Stakeholders: Institutional investors and activist shareholders can exert pressure on management to act in the best interests of all shareholders.

Takeovers: The threat of a hostile takeover can incentivize managers to prioritize shareholder value.

Debt and dividends: Debt covenants and dividend policies can help discipline managers and prevent them from making decisions that harm shareholders.

Investors and analysts: Scrutiny from investors and analysts can hold managers accountable for their actions and decisions.