Download Revision 1 – Financial Management, Financial Objectives and

Revision 1 – Financial Management, Financial Objectives and
Financial Environment
Topics List
1.
Financial Management
Exam Question
Reference
a. Financial management decisions – investment, financing and Jun10
Q4c
dividend decisions
b. Three decisions relationship under M&M view
Jun 10
Q4c
2.
Financial Objectives
a. Primary objective – maximize shareholders’ wealth
b.
c.
d.
e.
Maximizing and satisficing
Financial indicators for maximizing shareholders’ wealth
Non-financial indicators
External factors
Dec 10
Q4d
Dec 10
Q4d
3.
Stakeholders
a. Categories of stakeholder group
b. Stakeholders’ areas of interest
4.
Objectives in Not-for-profit Organizations
a. Value for money
b. Economy, effectiveness and efficiency
Dec 10
Dec 10
Q4d
Q4d
Agency problem
a. Meaning
b. How to reduce the agency problem?
Dec 08
Dec 08
Q1e
Q1e
5.
6.
Macroeconomic Targets
a. Economic growth and high employment
b. Low inflation
c. Balance of payments stability
d. Types of policy
1
7.
8.
Financial Institutions
a. Types of financial institutions
b. Functions of financial intermediaries
Dec 09
Financial Markets
a. Money markets
b. Capital markets
c. Euromarkets
2
Q4a
Part I Financial Management Function
Dec-11
Jun-11
Topics
I. The Nature and Purpose of Financial Management
1. Explain the nature and purpose of financial management
2. Explain the relationship betweeen financial management and
financial and management accounting
II. Financial Objectives and the Relationship with Corporate Strategy
3. Discuss the relationship between financial objectives,
corporate objectives and corporate strategy
4. Identify and describe a variety of financial objectives, including:
a. Shareholder wealth maximisation
b. Porfit maximisation
c. EPS growth
III. Stakeholders and Impact on Corporate Objectives
5. Identify the range of stakeholders and their objectives
6. Discuss the possible conflict between stakeholder objectives
7. Discuss the role of management in meeting stakeholder objectives,
including the application of agency theory
8. Describe and apply ways of measuring achievement of corporate
objectives including:
a. Ratio analysis, e.g. ROCE, ROE, EPS, DPS
b. Changes in dividends and share prices as part of total shareholder
return
9. Explain ways to encourage the achievement of stakeholder objectives,
including:
a. Managerial reward schemes such as share options and
performance-related pay
b. Regulatory requirements such as corporate governance codes of
best practice and stock exchange listing regulations
IV. Financial and Other Objectives in Not-for-profit organizations
10. Discuss the impact of non-for-profit status on financial and other
objectives
11. Discuss the nature and importance of value for money as an objective
in non-for-profit organisations
12. Discuss ways of measuring the achievement of objectives in
non-for-profit organisations
Dec-10
Jun-10
Dec-09
Jun-09
3b
4a
3b
4a
Dec-08
4c
4d
4d
4d
1e
4d
3b
1e
4d
4d
Part II Financial Management Environment
Topics
I. The Economic Environment for Business
1. Identify and explain the main macroeconomic policy targets
2. Define and discuss the role of fiscal, monetary, interest rate and
exchange rate policies in achieving macroecominc policy target
3. Explain how government economic policy interacts with planning and
decision-making in business
4. Explain the need for, and the interaction with, planning and
decision-making in business of:
a. Competition policy
b. Government assistance for business
c. Green policies
d. Corporate governance regulation
II. The Nature and Role of Financial Markets and Institutions
5. Identify the nature and rile of money and capital markets, both
nationally and internationally
6. Explain the role of financial intermediaries
7. Explain the functions of a stock market and a corporate bond market
8. Explain the nature and features of different securities in relation to the
risk/return trade-off
4a
3
Jun-08
Dec-07
Pilot
1.
Financial Management
1.1
Financial management decisions cover investment decisions, financing decisions
and dividend decisions. They are interlinked.
(June 2010)
Decision
Explanation
Investment decision



Whether to undertake new projects
Whether to invest in new plant and machinery
Whether to carry out a takeover or a merger, etc.
Financing decision


Cash available within the company
Access to new sources of finance

Cost of finance (WACC)

Pay less dividend if profits need to be retained new
for investment
Dividend decision
1.2
The three decisions relationship under Miller and Modigliani (M&M) investigation:





(June 2010)
In perfect capital market, the market value of a company and its weighted
average cost of capital (WACC) were independent of its capital structure.
Therefore, the market value depended on the business risk of the
company and not on its financial risk.
Investment decision determined the operating income of a company, so it
was important in determining the market value.
Financing decision, under M&M’s assumptions, was shown to be
irrelevant in determining the market value.
Dividend policy was also irrelevant to value of the share under the
assumption of a perfect capital market.

As a result, the investment decision was the most important factor for
the market value of the company and also the primary objective of
maximization of shareholders wealth.

In practice, capital markets are not perfect and a number of other factors
affect the three decision areas.

For example, pecking order theory suggests that managers do not in
practice make financing decisions with the objective of obtaining an
optimal capital structure, but on the basis of the convenience and
relative cost of different sources of finance.
4
Question 1 – Financial management decisions
Discuss the relationship between investment decisions, dividend decisions and financing
decisions in the context of financial management, illustrating your discussion with examples
where appropriate.
(8 marks)
(ACCA F9 Financial Management June 2010 Q4(c))
2.
Financial Objectives
2.1
For profit making company, the primary objective is to maximize shareholder
wealth. This could involve increasing the share price and/or dividend payout.
One problem for the financial manager is to satisfy the objectives of several
2.2
stakeholders at the same time. Therefore, in practice a distinction must be made
between maximizing and satisficing.

2.3
2.4
2.5
Maximizing – seeking the best possible outcome.

Satisficing – finding a merely adequate outcome.
Financial indicators pointing towards maximizing shareholder wealth include:

EPS

DPS

ROCE

Profit after tax

Revenue, etc.
Non-financial indicators include:

Market share

Customer satisfaction

Quality measures
External factors, for examples:

Interest rate – if falls
 Stimulate demand and revenue
 Lower the cost of debt and improve profits
 Investors switch to share market for better returns


Inflation rate – if rises
 Costs rise causing a drop in profits
 Cause interest rates to rise
 Devalues the home currency
Foreign exchange rate – if rises
 Reduce cash receipts for exporters
 Lowers the cost for importers
 Discourage exporting
5

GDP – if falls


Reduce demand and revenue
Cause interest rates to fall to stimulate demand
3.
Stakeholders
3.1
Anyone with an interest in the activities or performance of a company are stakeholders
because they have a stake or interest in what happens.
The main categories of stakeholder group in a company are usually the following:
3.2
Stakeholders
Examples of areas of interest
Internal:
(a) Directors


Reward structure
Promotion


Salary
Promotion


Wealth maximization
Profit maximization
Lenders



Interest payment
Liquidity
Solvency
Customers



Satisfaction
Quality
Delivery time
Suppliers

Prompt payment

Liquidity



Tax payments
Environmental protection
Macroeconomic influence
(b) Employees
Connected:
Shareholders
External:
Government
Society as a whole
6
Question 2 – Stakeholders’ interest
Private sector companies have multiple stakeholders who are likely to have divergent
interests.
Required:
Identify five stakeholder groups and briefly discuss their financial and other objectives.
(12 marks)
4.
Objectives in Not-for-profit Organizations
(December 2011)
4.1
They are not run to make profits but to provide benefits. Therefore, it is recognized
that these organizations should demonstrate the principles of value for money, i.e.
attempting to get the maximum benefits for the least cost.
4.2
This is usually accepted as requiring the application of economy, effectiveness and
efficiency.

Economy – attain the appropriate quantity and quality of inputs at lowest
cost to achieve a certain level of outputs.

Effectiveness – is the extent to which declared objectives/ goals are met.

Efficiency – is the relationship between inputs and outputs.
Question 3 – Not-for-profit organization
Discuss the nature of the financial objectives that may be set in a not-for-profit organisation
such as a charity or a hospital.
(8 marks)
5.
Agency Problem
(December 2008)
5.1
The agency problem occurs when there are differences in the interest of a
company’s owners and managers. For example:

Moral hazard – manager has an interest in receiving benefits from his or her
position as a mangaer.

Effort level – work less hard than they would if they were the owners of the
company.

Earnings retention – management may want to re-invest profits in order to
make the company bigger, rather than payout the profits as dividends.

Risk aversion – management might be risk-averse and so reluctant to invest in
higher-risk projects in order to protect their job.

Time horizon – management might only be interested in the short-term
7
prospects, but shareholders concern about long-term growth.
5.2
How to reduce the agency problem?

Devising a remuneration package – adequate incentive to act in the best
interests of the shareholders, such as share options scheme which is likely to
lead to share price increase.

Having enough independent non-executive directors inside the board – they
are able to act in the best interests of the shareholders because they are not the
employees of the company.
Question 4 – Agency problem
At a recent board meeting of Dartig Co, a non-executive director suggested that the
company’s remuneration committee should consider scrapping the company’s current share
option scheme, since executive directors could be rewarded by the scheme even when they
did not perform well. A second non-executive director disagreed, saying the problem was
that even when directors acted in ways which decreased the agency problem, they might not
be rewarded by the share option scheme if the stock market were in decline.
Required:
Explain the nature of the agency problem and discuss the use of share option schemes as a
way of reducing the agency problem in a stock-market listed company such as Dartig Co.
(8 marks)
(ACCA F9 Financial Management December 2008 Q1(e))
6.
Macroeconomic Targets
6.1
Government objectives for the economy are referred to as macroeconomic objectives
or targets. The three main targets are usually:
(a)
Economic growth and high employment
(b)
(c)
Low inflation
Balance of payments stability
8
6.2
Policies for achieving macroeconomic targets
Policy type
Definition
Fiscal policy
How much the government decides to spend, and to raise
as tax revenue
Monetary policy
Control over the money supply and of interest rates
Exchange rate policy
If the value of the local currency is forced down in value
it makes imports more expensive and exports cheaper
Competition policy
Policies to
takeovers
Green policy
Policies to encourage protection of the environment
7.
Financial Institutions
7.1
Types of financial institutions
7.2
encourage
competition,
e.g.
blocking
Types
Functions
Merchant banks
Provide large corporate loans, often syndicated. Manager
investment portfolios for corporate clients
Pension funds
Invest to meet future pension liabilities.
Insurance companies
Invest to meet future liabilities.
Financial intermediaries provide the following functions:
(December 2009)
Functions
Descriptions
Maturity
transformation
A bank can make a 10-year loan (long-term) while still
allowing its depositors to take money out whenever they
want; so short-term deposits become long-term
investments.
Aggregation of funds
A bank can aggregate lots of small amounts of money
into a large loan.
Diversification of risk
Many individuals may be scared of lending money
directly to one particular company because of that
company going bankrupt. A bank will be lending money
to many companies and will therefore be reducing the
risk to themselves and therefore to the individuals whose
money they are using.
9
Question 5 – Role of financial intermediaries
Discuss the role of financial intermediaries in providing short-term finance for use by
business organisations.
(4 marks)
(ACCA F9 Financial Management December 2009 Q4(a))
8.
Financial Markets
8.1
Money markets – if a company or a government needs to raise funds for short-term
(normally less than one year), they can access the money markets. For examples:

Treasury bills

Certificates of deposit (CD)


Commercial paper (issued by companies with high credit rating)
Bills of exchange
8.2
Capital markets – If a company needs to raise funds for the long-term, it can access
the capital markets (normally more than one year). For examples:

Bonds

Listed shares
8.3
Euromarkets – in recent years a strong market has built up which allows large
companies with excellent credit ratings to raise finance in a foreign currency. This
market is organised by international commercial banks
Question 6
List and explain the major functions performed by the capital markets.
10
(5 marks)
Additional Examination Style Questions
Question 7 – Efficient market hypothesis, effect of interest rate increase and comparison
of objectives of not-for-profit organization and private company.
Tagna is a medium-sized company that manufactures luxury goods for several well-known
chain stores. In real terms, the company has experienced only a small growth in turnover in
recent years, but it has managed to maintain a constant, if low, level of reported profits by
careful control of costs. It has paid a constant nominal (money terms) dividend for several
years and its managing director has publicly stated that the primary objective of the company
is to increase the wealth of shareholders. Tagna is financed as follows:
Overdraft
10 year fixed interest bank loan
$m
1.0
2.0
Share capital and reserves
4.5
7.5
Tagna has the agreement of its existing shareholders to make a new issue of shares on the
stock market but has been informed by its bank that current circumstances are unsuitable. The
bank has stated that if new shares were to be issued now they would be significantly
under-priced by the stock market, causing Tagna to issue many more shares than necessary in
order to raise the amount of finance it requires. The bank recommends that the company waits
for at least six months before issuing new shares, by which time it expects the stock market to
have become strong-form efficient.
The financial press has reported that it expects the Central Bank to make a substantial
increase in interest rate in the near future in response to rapidly increasing consumer demand
and a sharp rise in inflation. The financial press has also reported that the rapid increase in
consumer demand has been associated with an increase in consumer credit to record levels.
Required:
(a)
(b)
Discuss the meaning and significance of the different forms of market efficiency (weak,
semi-strong and strong) and comment on the recommendation of the bank that Tagna
waits for six months before issuing new shares on the stock market.
(9 marks)
On the assumption that the Central Bank makes a substantial interest rate increase,
discuss the possible consequences for Tagna in the following areas:
(i) sales;
11
(ii) operating costs; and,
(iii) earnings (profit after tax).
(c)
(10 marks)
Explain and compare the public sector objective of “value for money” and the private
sector objective of “maximisation of shareholder wealth”.
(6 marks)
(25 marks)
Question 8
Compare and contrast the financial objectives of a stock exchange listed company such as Bar
Co and the financial objectives of a not-for-profit organisation such as a large charity.
(11 marks)
(ACCA F9 Financial Management December 2011 Q4(d))
12