FOUNDATIONS OF FINANCIAL MANAGEMENT
UPDATED SCRIPT WITH COMPLETE ANSWERS
◉ Objective of financial management.
Answer: Maximise shareholder wealth through optimal choices in
the three major financial decisions.
◉ Shareholder wealth.
Answer: Present value of expected future returns to the owners of
the firm; represented by the market value of the firm's common
stock when markets are in equilibrium.
◉ Shareholder wealth formula.
Answer: Number of shares outstanding × market price per share.
◉ Three determinants of value.
Answer: Amount (magnitude), timing, and risk of expected cash
flows.
◉ Why shareholder wealth maximisation is preferred to profit
maximisation.
Answer: It explicitly considers the timing and risk of expected
benefits and provides an objective basis for evaluating decisions.
,◉ Sole proprietorship.
Answer: A business with a single owner who has unlimited personal
liability.
◉ Partnership.
Answer: A business with two or more co-owners who are generally
jointly and severally liable, although agreements may limit some
partners' liability.
◉ Corporation.
Answer: A business organisation treated as a legal person, with
ownership divided into shares held by shareholders.
◉ Agency relationship.
Answer: Shareholders are principals and managers are agents;
agency problems arise when their objectives diverge.
◉ Agency costs.
Answer: Costs incurred by shareholders to minimise agency
problems, including monitoring costs and bonding costs.
◉ Methods for reducing agency problems.
,Answer: Corporate governance, managerial compensation linked to
firm value, and the threat of takeovers.
◉ Net Present Value concept.
Answer: NPV = PV(benefits) − PV(costs); NPV represents the change
in shareholder wealth from a decision.
◉ Financial system purpose.
Answer: Transfers funds through the savings-investment cycle
toward the most efficient users of funds, with competitive markets
determining rates of return.
◉ Market efficiency.
Answer: Security prices fully and rapidly reflect economically
relevant information about expected returns and risk; under no-
arbitrage, price is an unbiased estimate of intrinsic value.
◉ Weak-form efficiency.
Answer: Prices reflect historical price and return information.
◉ Semi-strong-form efficiency.
Answer: Prices reflect all publicly available information.
, ◉ Strong-form efficiency.
Answer: Prices reflect all public and private information.
◉ Holding Period Return (HPR).
Answer: HPR = [(P1 − P0 + D1) / P0] × 100%, where P1 is ending
price, P0 beginning price, and D1 distributions received.
◉ Time value of money principle.
Answer: Cash flows can only be directly compared when valued at
the same point in time using an appropriate opportunity cost of
capital.
◉ Interest.
Answer: Compensation for forgoing current consumption or
alternative investment opportunities; effectively the rent paid for
borrowing money.
◉ Nominal vs real interest rate.
Answer: The difference is inflation; the real interest rate is the
inflation-adjusted return.
◉ Fisher equation.
Answer: (1 + nominal rate) = (1 + real rate)(1 + inflation rate).
UPDATED SCRIPT WITH COMPLETE ANSWERS
◉ Objective of financial management.
Answer: Maximise shareholder wealth through optimal choices in
the three major financial decisions.
◉ Shareholder wealth.
Answer: Present value of expected future returns to the owners of
the firm; represented by the market value of the firm's common
stock when markets are in equilibrium.
◉ Shareholder wealth formula.
Answer: Number of shares outstanding × market price per share.
◉ Three determinants of value.
Answer: Amount (magnitude), timing, and risk of expected cash
flows.
◉ Why shareholder wealth maximisation is preferred to profit
maximisation.
Answer: It explicitly considers the timing and risk of expected
benefits and provides an objective basis for evaluating decisions.
,◉ Sole proprietorship.
Answer: A business with a single owner who has unlimited personal
liability.
◉ Partnership.
Answer: A business with two or more co-owners who are generally
jointly and severally liable, although agreements may limit some
partners' liability.
◉ Corporation.
Answer: A business organisation treated as a legal person, with
ownership divided into shares held by shareholders.
◉ Agency relationship.
Answer: Shareholders are principals and managers are agents;
agency problems arise when their objectives diverge.
◉ Agency costs.
Answer: Costs incurred by shareholders to minimise agency
problems, including monitoring costs and bonding costs.
◉ Methods for reducing agency problems.
,Answer: Corporate governance, managerial compensation linked to
firm value, and the threat of takeovers.
◉ Net Present Value concept.
Answer: NPV = PV(benefits) − PV(costs); NPV represents the change
in shareholder wealth from a decision.
◉ Financial system purpose.
Answer: Transfers funds through the savings-investment cycle
toward the most efficient users of funds, with competitive markets
determining rates of return.
◉ Market efficiency.
Answer: Security prices fully and rapidly reflect economically
relevant information about expected returns and risk; under no-
arbitrage, price is an unbiased estimate of intrinsic value.
◉ Weak-form efficiency.
Answer: Prices reflect historical price and return information.
◉ Semi-strong-form efficiency.
Answer: Prices reflect all publicly available information.
, ◉ Strong-form efficiency.
Answer: Prices reflect all public and private information.
◉ Holding Period Return (HPR).
Answer: HPR = [(P1 − P0 + D1) / P0] × 100%, where P1 is ending
price, P0 beginning price, and D1 distributions received.
◉ Time value of money principle.
Answer: Cash flows can only be directly compared when valued at
the same point in time using an appropriate opportunity cost of
capital.
◉ Interest.
Answer: Compensation for forgoing current consumption or
alternative investment opportunities; effectively the rent paid for
borrowing money.
◉ Nominal vs real interest rate.
Answer: The difference is inflation; the real interest rate is the
inflation-adjusted return.
◉ Fisher equation.
Answer: (1 + nominal rate) = (1 + real rate)(1 + inflation rate).
