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Bbmf2093 Corporate Finance

The document discusses several key concepts in corporate finance including agency relationships, reducing agency problems, factors that affect stock price, the effects of stock price maximization on society, the social responsibilities of corporations, and the goal of financial management. Agency relationships exist whenever a principal hires an agent to act on their behalf, such as shareholders and managers. Shareholders can reduce agency problems through incentives for managers and independent auditing. The three main factors that affect stock price are projected cash flows, the timing of cash flows, and the riskiness of cash flows. Maximizing stock prices benefits society through efficiency and meeting consumer needs. The three social responsibilities of corporations are ethical business decisions, employee safety, and environmental protection. The overall goal of financial

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50 views

Bbmf2093 Corporate Finance

The document discusses several key concepts in corporate finance including agency relationships, reducing agency problems, factors that affect stock price, the effects of stock price maximization on society, the social responsibilities of corporations, and the goal of financial management. Agency relationships exist whenever a principal hires an agent to act on their behalf, such as shareholders and managers. Shareholders can reduce agency problems through incentives for managers and independent auditing. The three main factors that affect stock price are projected cash flows, the timing of cash flows, and the riskiness of cash flows. Maximizing stock prices benefits society through efficiency and meeting consumer needs. The three social responsibilities of corporations are ethical business decisions, employee safety, and environmental protection. The overall goal of financial

Uploaded by

XUE WEI KONG
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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BBMF2093 CORPORATE FINANCE

TUTORIAL 1 NATURE AND SCOPE OF FINANCIAL PLANNING.

1. Briefly discuss “Agency relationship”.

An agency relationship exists whenever a principal hires an agent to act on their


behalf. Within a corporation, agency relationships exist between shareholders and
managers and shareholders and creditors. For example, Maybank’s shareholders are
regarded as principals, and Maybank’s directors are regarded as agents appointed by
the shareholders to manage the daily operations of the bank.

Possibility of conflicts:- example

Stockholders and manager: Managers may grow their firms to prevent a takeover
attempt to increase their own job security. However, a takeover may be in the best
interest of the shareholders.

Stockholders and creditors: Manager could borrow $ to repurchase shares to lower the
corporation's share base to increase the shareholders return. Creditors will be
concerned given the increase in debt that would affect the future cash flow.
50 million (debt) + xx million

Conflict of interest
Total outstanding shares increase, share price increase, return of shareholder increase
2. Explain how shareholders can reduce agency problems.

Agency problems arise between shareholders and managers, because some managers
make business decisions based on their interests rather than the interests of the
company.

The most common way of reducing agency problems is to implement an incentives


scheme. There are two types of incentives which are financial and non-financial.

Financial incentives are the most common incentive schemes. Financial incentives
based on performance help motivate agents to act in the best interest of the company.
For examples of financial incentives such as stock options. profit-sharing and
managerial performance shares.

Non-financial incentives are less commonly used. For examples of non-financial


incentives are new office or workspace, training opportunities, recognition from co-
workers and corporate car.

Another method: Independent auditing to monitor the actions of management


(Auditor will be biased if he or she has a relationship with the company management./
threat of firing (You will be fired and replaced by other people) / threat of takeover

increase

Worker will be loyalty and word


hard to company since they are
holding the co’s shares.
Threat of take over & threat of firing

3. Describe the three factors that affect stock price.

● Projected cash flows to shareholders


By generally accepted accounting principles, the sale is recorded even though
the customer has yet to pay. Midland seems to be profitable. The perspective
of corporate finance is different. It is interested in whether cash flows are
being created by the operation of Midland. The higher the cash flow, the
higher the stock price.

● Timing of the cash flow stream


The value of an investment made by the firm depends on the timing of cash
flows. "A dollar received today is worth more than a dollar received a year
from now". It can earn interest on money received today.The faster the cash
flow, the higher the stock price.

● Riskiness of the cash flows


Concept of finance is “higher risk, higher return”. For an asset with uncertain
cash flows (risky), a rational investor will demand for a higher return than a
risk-less asset. The lower the riskiness of cash flow, market confidence toward
the company will increase, the demand for the stock will increase and it will
cause the price of stock to increase.

4. Discuss the effects of stock price maximization to society.

The action of maximizing stock prices can benefit society. This is because stock price
maximization requires:
– efficient, low-cost operations that produce high-quality goods and services at
the lowest possible cost.

– the development of products and services that consumers want and need, so
the profit motive leads to new technology, to new products, and to new jobs.

– efficient and courteous service, adequate stocks of merchandise, and well-


located business establishments--factors that are all necessary to make sales,
which are necessary for profits.

5. Describe the three social responsibilities of corporation.

The company should make ethical business decisions. This is because there is a
positive correlation between ethics and long run profitability and there is no room for
unethical business decisions in the business world. Many consumers prefer to buy
from socially responsible companies rather than from those that shun social
responsibility.

The company should provide a safe working environment to their employees. Because
employees are an important asset of the company, if the company does not have
employees, it cannot provide valuable services to the public. Therefore, the company
must ensure that the employees' working environment is safe.

The company should avoid polluting the air or water. To become a socially
responsible company, the company should also make sure that the waste of
production they dispose of will not pollute or harm the environment.

The company should produce safe products. The company provides safe products to
the public that not only can make profits, but also can enhance the company's
reputation to attract more consumers. Providing safe products to consumers is the
company's responsibility and the company's way to avoid product liability lawsuits.

6. What is the goal of Financial Management

The goal of financial management is shareholder wealth maximization, which


translates to maximizing stock price. The company will try to expand their business
by acquisition, financing and management of assets as well as making any valuable
investment. For example, maximize sales and minimize cost. This can increase the
earning ability and the business size of the company. As a result, the share price of the
company will increase and the company can provide more dividend to their
shareholders so all the shareholders can enjoy capital appreciation and dividend at the
same time.
7. Maximizing share prices does not make sense because investors focus on short-term
results, and not on the long-term consequences. Comment.
Ans: The statement is not practicable in the market. Financial managers concentrate
more on investing in the long term compared with short term investors. Because the
company needs to go through business development to grow and earn more money in
the future. Once the company’s project is successful, the profit will be sustained for
the company in the long run and it will affect the price of company stock. For
example, company Financing: Debt - loans and bonds, Equity - shares.

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