Week 1

Question 1

What decisions are typically included in corporate finance?

Answer 1

• Investment decisions,
• Financing decisions,
• Asset management decisions.

Question 2

What does the investment decision primarily consist of?

Answer 2

The capital budgeting decision:

• Which real assets should the firm invest in? (such as machinery, building, projects or businesses)

Question 3

What does the financing decision primarily consist of?

Answer 3

Capital structure decision:

• How will the firm raise funds for the required investments?

Use of equity, debt finance or internal profits?
- Payout decision: Does the firm retain earnings for investment or pay dividends to shareholders?

Question 4

What does the asset management decision primarily consist of?

Answer 4

Day-to-day operations.

Question 5

What is the net working capital? (NWC)

Answer 5

Current assets - Current liabilities.

Question 6

Financial manager’s primary goal?

Answer 6

Increase the value of the firm by selecting good projects and making wise financing decisions.

They also aim to

• Maximizing profits,
• Minimizing costs,
• Maximizing market share and shareholders’ wealth

They act on behalf of the owners of the firm.

Question 7

What are the two governance models for a company?

Answer 7

• Shareholder governance orientation

- Stakeholder governance orientation.

Question 8

What is the primary goal of financial management in a shareholder governance orientation?

How can we measure this?

Answer 8

Maximize shareholders’ wealth.

Measured by the share price of the company * the number of shares.

Question 9

What are the main challenges with shareholder governance orientation?

Answer 9

The concerns of other stakeholders, and corporate social responsibility.

Question 10

What is the agency problem?

Answer 10

The agency problem arises when interests of the stockholders and the managers are not aligned.

Question 11

How can agency problems occur in corporations?

How do agency costs relate?

Answer 11

This occurs due to managerial goals being different from shareholders’ goals, such as growth and size of the company, which are not necessarily equivalent to increased shareholder wealth.

To limit the divergence shareholders and/or management need to incur costs, these costs are known as agency costs, and represent a loss in the wealth of shareholders.

Question 12

What are two major ways for shareholders to limit agency problems?

Answer 12

• Monitoring costs, e.g having a greater percentage of management pay linked to company performance targets.
• Use of Bonus.
• Use of External Auditors.
• Use of independent directors to the firm’s board of directors.
• Use of bonding costs for managers.

Question 13

What is the PV and FV?

Answer 13

PV = Value of an investment today, 
FV = Value of the investment at some future date.

Question 14

What is the NPV? When should we take an investment on?

Answer 14

PV of the expected cash flows - cost of the investment.

If the VPV is positive we should take on the investment.

Question 15

What is:
Perpetuity?
Growing perpetuity?
Annuity?
Growing annuity?

Answer 15

• A constant stream of cash flows that lasts forever.
• A stream of cash flows that grows at a constant rate forever.
• A stream of constant cash flows that lasts for a fixed number of periods.
• A stream of cash flows that grows at a constant rate for a fixed number of periods.

Question 16

Equation for:
The PV of a perpetuity?

The PV of a growing perpetuity?

The present value of an annuity?

The present value of a growing annuity?

Answer 16

Cash flow/discount rate.

Cash flow/(discount rate - growth rate).

PV of annuity = (C/R)x(1-(1/(1+r)^t))

PV of growing annuity = (C/(r-g))x(1-((1+g)/(1+r))^t)

Question 17

What is the effective annual rate with discrete compounding? What about continuous?

Answer 17

In discrete compounding the effective annual rate is equal to (1+ annual percentage rate/periods)^periods - 1.

In continuous compounding e^APR = (1+EAR)

Question 18

When does an annuity have it’s first payment? What about an annuity due? What is the difference between the present value and future value of the two assuming the period is the same?

Answer 18

An annuity has its first payment at the end of the year/ the start of the next year. In an annuity due the first payment is at the start of the current year.

The present value of an annuity due is equal to the present value of an annuity * 1+discount rate. The future value of an annuity due = the future value of an annuity * 1+discount rate.