(2012-S2) - FINS1613 - Tutorial Slides - Week 02

BUSINESSFINANCEFINS1613

TutorialWeek 2

1

CONTACTDETAILSYour Tutor:Peter [email protected]

Be sure to check your student email account lots throughout the semester, as I’ll be sending you my slides and lots of other materials.

3FINS1613 — Peter Kjeld Andersen (2012‐S2)

Guidelines:Any emailed questions should be sent to only ONE staff member. Don’t spam all of us.

We have lives outside of teaching, so don’t expect instant replies.

That’s pretty much it.

CONTACTINGSTAFF


ASSESSMENT DATE HOW MUCH

Tutorial Attendance + Participation Every week 10%

Tutorial Quizzes Weeks 4, 7, 10 and 13 40%

Final Exam Exam Period 50%

ASSESSMENTS

5

You must attend at least 80% of your tutorials in order to be eligible for special consideration in the final exam.

i.e. if you don’t make 80% of your classes, and then get sick and can’t make the final, it’s unlikely you’ll get to sit a supplementary exam.

FINS1613 — Peter Kjeld Andersen (2012‐S2)

CLASSPARTICIPATION

6

COMPONENT HOW TO GET IT HOWMUCH

ActiveParticipation

Answering questions and contributing to class.(doing the homework and not saying anything in class

DOES NOT COUNT as participation)5%

Attendance

Showing up on time every week.(“on time” is by 10 minutes past the hour at the latest)

(if you walk in after the roll has been called, do not wait until the end of the class to make sure the tutor marks you

present)

5%


• Class participation marks are designed for you to demonstrate that you have prepared and thought about the assigned tutorial material prior to class.

• When you adequately attempted (not just guessed) a question in class, the tutor will record next to your name that you have participated for the week.

• If you have participated in class and are not sure that your participation was recorded at the time, the responsibility is yours to check with the tutor that it gets recorded at the end of that tutorial (NOT at the end of semester).

CLASSPARTICIPATIONCLARIFICATION


LET’S BEGIN


TUTORIALQUESTION1Q. Which of these could explain why someone would choose to operate as a

sole proprietorship rather than as a corporation?

A. Your choices:a) Sole proprietorships have limited liabilityb) There are relatively few rules relating to the establishment and running of

a sole proprietorshipc) The firm can last foreverd) It is easy to raise large sum of moneye) All of these answers

Answer is B


TUTORIALQUESTION2Q. The primary goal of a publicly‐owned firm interested in serving its

stockholders should be to:

A. Your choices:a) Maximize expected total corporate profit.b) Maximize expected EPS.c) Minimize the chances of losses.d) Maximize the stock price per share.e) Maximize expected net income.

Answer is D


TUTORIALQUESTION2— EXPLANATION• Answers a), b) and e) are talking about the profit of the company.

– EPS is Earnings Per Share (or Net Income / # shares outstanding)– Companies can maximize profit by cutting expenses or selling productive assets in a

particular year and hurt the value of the company in doing so.– e.g. Apple not reinvesting any of their revenue from the iPhone 5 into $&D expenses

for developing an iPhone 6 or an iPad 4. This will increase their profit this year but hurt their competitive position and the value of the company

• Investors don’t invest in shares to minimize the chances of losses, like in c).– If an investor wanted to minimize the risk of losses, they would invest in a bank

deposit or a government bond and get a much safer (but lower) rate of return.– Investors put their money at risk in the sharemarket knowing that it is a risky

investment, but expecting to be compensated with an on‐average higher return than you can get from a safe investment.

– So the goal of the company shouldn’t be to minimize risk.

• The goal of the corporation is to maximize the wealth of its stockholders, and this is done through maximizing the share/stock price.

– The share price represents the value of the owner’s investment in the company.– Increases in the share price reflect increases in the owner’s wealth.

Answer is D


TUTORIALQUESTION3Q. The value that the financial markets place on a company’s debt and equity

securities will depend on the:

A. Your choices:a) Standard deviations of the returns from investments in those securities.b) Risk and expected return from investments in those securities.c) Expected return from investments in those securities.d) Interest rate on the debt securities.

• Answers c) and d) refer to the rates of return.• Standard deviation in a) refers to a measure of risk.• However it is the interaction of the two that determines the value of an

investment.• All else being equal, return increases the value of an investment, risk

decreases it.Answer is B


TUTORIALQUESTION4Q. Shareholders in a company have limited liability, which means that:

A. Your choices:a) Shareholders can be called upon to contribute only the amount unpaid on

shares held in the company.b) The maximum the shareholders can be called upon to contribute is the

current market price of the shares.c) Shareholders can never be called upon to make an additional contribution

to the company’s assets.d) Shareholders have little or limited interest in the activities of

management of the company, because the management and ownership of the firm are separated.

Answer is A


TUTORIALQUESTION4— EXPLANATIONa) Shareholders can be called upon to contribute only the amount unpaid

on shares held in the company.– The company may issue new shares on a partly‐paid basis.– i.e. you agree to pay $10/share, but the company only requires $7/share initially.– If the company becomes insolvent (assets < liabilities), the shareholders are liable for

the remaining “amount unpaid” of $3/share to the company’s creditors.

b) The maximum the shareholders can be called upon to contribute is the current market price of the shares.

– The company’s current (market) share price is irrelevant.– Once you have fully paid for your shares, you are not liable for any additional

contribution.

c) Shareholders can never be called upon to make an additional contribution to the company’s assets.

– This is not strictly true, if we consider the “amount unpaid” talked about in a).

d) Shareholders have little or limited interest in the activities of management of the company, because the management and ownership of the firm are separated.

– The shareholders still do care about the actions of management, even though those shareholders are not involved directly in decision making.


TUTORIALQUESTION5Q. Which of the following does not represent an agency cost resulting from the

separation of ownership from control of the firm?

A. Your choices:a) The expense of providing management with bonuses based on

profitability.b) The cost of a company director taking a business trip to Hawaii with no

potential benefit to the company.c) The cost of a staff Christmas party designed to enhance staff morale.d) The cost of monitoring the activities of management to keep track of its

expenditures and decisions.

Answer is C


TUTORIALQUESTION5– EXPLANATIONBroadly, an agency problem:• Involves two parties: a “principal” and an “agent”.• The principal employs the agent to act on their behalf.• But the agent is a person too, and may choose to use their position of

responsibility to act in their own self interest instead of the principal’s.• e.g. The university (the principal) hires me (the agent) to teach you, but I

have my own self‐interest and may want to turn up late and to make you do group work instead of teaching you properly as the university wants.

An agency cost between shareholders (principal) and managers (agent):• Is wealth lost by shareholders due to this agency relationship.• Can be thought of as the cost to the company from:

– Management wasting company money on their own personal satisfaction instead of on maximizing shareholder wealth; OR

– Spending corporate money on monitoring management closely to make sure they don’t waste money.

– Having to spend money to incentivize management to act in the interest of shareholders instead of their own self interest.


TUTORIALQUESTION5– EXPLANATIONa) The expense of providing management with bonuses based on

profitability.– Example of having to spend money to incentivize management to act in the interest

of shareholders instead of their own self interest.

b) The cost of a company director taking a business trip to Hawaii with no potential benefit to the company.

– Example of management wasting company money on their own personal satisfaction instead of on maximizing shareholder wealth

d) The cost of monitoring the activities of management to keep track of its expenditures and decisions.

– Example of spending corporate money on monitoring management closely to make sure they don’t waste money.

c) The cost of a staff Christmas party designed to enhance staff morale.– This is also an agency cost to the company, just like answers a), b) and d) above.– It is money spent in order to encourage staff to do the job that they are hired to

work, rather than acting in their own self interest. Low morale = unproductive staff.– However, this type of agency cost will be present regardless of whether there is

separation of ownership and control (i.e. in a coporation) or not (i.e. in a sole proprietoriship or partnership)


TUTORIALQUESTION6Q. Partnerships are a common form of business entity for small service

businesses because:

A. Your choices:a) they provide legal protection for the proprietor from the creditors of the

firm.b) they are ideal for where the business is owned by one person.c) there are no legal requirements that need to be met to form a

partnership.d) they allow the company to buy, own and sell property.

Answer is C


TUTORIALQUESTION7Q. The concept of investors being risk averse means that:

A. Your choices:a) investors will always prefer an investment that carries less risk.b) investors require higher returns to compensate for carrying more risk.c) the investment’s risk is the predominant feature considered by the

investor.d) investors will make all possible attempts to avoid systematic risk.

• Like in Q2, investors don’t invest to minimize the chances of losses.• A risk averse investor is one that dislikes risk. Out of two alternatives with

an equal return, a risk averse investor would pay more for the investment of lower risk.

• However, a risk averse investor will still invest in a riskier investment if the expected return is great enough to compensate for the additional risk.

Answer is B


CHAPTER1— CTCRQUESTION1Q. What are the three types of financial management decision? For each type,

give an example of a business transaction that would be relevant:

A. Capital budgeting, capital structure, and working capital management.

Example of capital budgeting (or the investment decision):• Deciding on whether to expand a manufacturing plant.• Deciding on whether to replace an old piece of machinery with a new one.• Deciding whether or not to develop a new product line.

Example of capital structure (or the financing decision):• Deciding between raising money by issuing equity (shares) or with debt.• Deciding between borrowing money through bonds or a bank loan.

Example of working capital management:• Deciding whether to give your customers 30, 60 or 90 days to pay you.• Deciding how much inventory to hold in your warehouse.


CHAPTER1— CTCRQUESTION2Q. What are the four primary disadvantages to the sole proprietorship and

partnership forms of business organization? What benefits are there to these types of business organization as opposed to the corporate form?

A. Disadvantages:• Unlimited liability

– If the business can’t afford to pay it’s debts, the bank/creditors can take the personal assets of the owners (e.g. house/car/yacht/dog)

• Difficult to transfer ownership– If you own a whole business or are a partner in a business, you typically have to find

someone with enough money AND expertise in that industry to buy that whole business from you.

• Harder to raise capital– If you want to raise more equity, you need to find a new partner that has enough

money to invest to make it worthwhile.

• Limited life.– If you run a small business and you unexpectedly die, unless your children have the

knowledge/interest to continue the business it is likely to cease to exist.


CHAPTER1— CTCRQUESTION2Q. What are the four primary disadvantages to the sole proprietorship and

partnership forms of business organization? What benefits are there to these types of business organization as opposed to the corporate form?

A. Advantages:• Less regulation

– Because you’re not taking investments from potentially millions of Mum and Dad investors, the government places less of a regulatory burden on partnerships

• The owners are also the managers– This eliminates agency costs. As an owner/manager, you don’t have to worry about

whether the manager you have hired is running the company in their own self‐interest instead of in yours.

• Sometimes personal tax rates are better than corporate tax rates


CHAPTER1— CTCRQUESTION3Q. What is the primary disadvantage of the corporate form of organization?

Name at least two advantages of the corporate form.

A. The primary disadvantage of the corporate form is the double taxation of profits (in a classical tax jurisdiction like the U.S.).• First, the company pays tax to the government on its profits.• Second, when that money is paid out as dividends to shareholders, the

company The second main disadvantage is the agency costs related to the separation of ownership of the company from control of the company.

Advantages:• Limited liability• Ease of transferability of ownership• Ability to raise capital• Unlimited life.


I. Buy the RTBWJ textbook!II. Read Chapters 4 and 5 of RTBWJ!III. Do the assigned tutorial materialsIV. Do all of the back of chapter questions too.

Advice:• Understand the “Time Value of Money” well as soon as possible.• It will help you not only in this course (it’s probably the most important

concept), but also in any future finance courses you are silly enough to take.

• Put extra effort into next week’s material and I promise that it will pay dividends.

THINGSTODOFORNEXTWEEK


THE END


Documents

(2012-S2) - FINS1613 - Tutorial Slides - Week 02