Micro Asia College of Science and Technology

Poblacion South, Sta.Cruz, Zambales

Sta. Cruz Campus

Name: Date:
Grade & Section:

LEARNING MODULE
Business Finance

Grade 12 - ABM

Module 1:
Week 1 to 2
Introduction of Financial Management

Learning Competency
- The learners shall be able to explain the major role of financial management and the different
individuals involved. (ABM_BF12-IIIa-1)
- The learners shall be able to explain the major role of financial management and the different
individuals involved. (ABM_BF12-IIIa-1)
- The learners shall be able to explain the flow of fund within an organization-through and from the
enterprise-and the role of the financial manager. (ABM_BF12-IIIa-5)

Objectives
At the end of this lesson, the learners will be able to:
- Have an appreciation of what the overall objective of management should be.
- Describe the goals of the firm and explain why maximizing the value of the firm is an appropriate
goal for a business.
- Identify factors that influence the change in market price.
- Understand the key positions in a corporate organization and identify the roles of each.
- Identify the primary activities of the financial manager.

Introduction of Financial Management

Financed can be defined as the science and art of managing money. (Gitman & Zutter, 2012)

Budgeting – is the act of estimating revenue (in the form of their allowance) and expenses over a period
of time (in this case, on a daily basis). Budgeting will be further discussed in Lesson 3 – Financial
Planning Tools.

Investments – come in many forms that will generate income or appreciate in the future.
Excess money presents an opportunity for investments.
- Between hiding their cash under their bed and depositing it in the bank, it would be
better to keep their money in bank deposits because these earn interest. Investment will
be discussed further in Lesson 6 – Introduction to investments.

Sources of Funds – when faced with financial difficulties (in this case, the lack of funds to meet current
expenses) we look for people or institutions that will give us the money we need. It will be discussed on
Lesson 4 – Sources of short term and long term funding.

Finance is concerned with decisions about:

- How much is their earnings they spend?
- How much they save or how much they need
- How they invest their savings
- How they raise additional funds they need (Gitman)

We recall from ABM 1 the forms of business organizations:

- Sole Proprietorship – A business owned by one person and operated for his or her own
profit.
- Partnership – A business owned by two or more people and operated for profit.
 - Corporation – An entity created by law owned by shareholders

How they can be shareholders of a corporations? By buying stocks

- The big listed companies:
a. PLDT
b. Globe
c. JFC
d. BPI
e. Banco De Oro
f. San Miguel Corporation

How and where can they buy stocks?

- Corporations may either be privately owned or publicly owned.
- Privately owned corporations are often owned by family members whose stocks may not
be offered to outsiders unless consent by the family members is secured.
- Companies which are publicly listed are owned by unrelated investors and are traded in
organized exchanges like the Philippine Stock Exchange. While there are many
stockholders, there is generally a group of investors or a family which controls each
listed company. For example, in the case of BPI, the biggest stockholder is Ayala
Corporation and in the case of Banco De Oro, it is SM Investment Corporation. Prices of
stocks of listed corporations are driven by several factors such as the earnings of the
companies, the prospects of the industry where these companies operate, the general
market sentiment, and the economic prospects of the country, among others.

1. Measurement of the shareholder’s wealth

 How do we measure shareholder’s wealth? Simplify the example.

- Assume learner bought 10 shares of Globe Telecom at Php 2,510 each on

September 9, 2010. This brings his investments to Php 25,100. What happens to
the value of his investments if the price goes up to Php 2,600 per share or it goes
down to Php 2,300 per share?
 Shareholders’ wealth is measured based on the current market price of the corporation’s
stocks. The market price changes across different periods. Hence, the value of your
investments changes in different points on time based on the market value at that time.

2. Factors that influence Market Price

Controllable by Management Uncontrollable External Factors

 profitability  macroeconomic conditions
 having a good liquidity and reasonable  political stability
leverage position
 dividends  prospects of the industry where the company
operates
 competent management which affects the  general market sentiment
company’s operating efficiency
 coming up with corporate plans that  flow of foreign funds invested in the
improve the business prospects of the Philippine stock market
company
Factor influences market price

- Profitability
 Profit is a measure of the financial performance of a company for a period
of time.
 Although it is a major driver for increasing the value of stock, an investor
should not rely on profits alone. As discuss earlier it possible that the
company has profits but its cash flow is negative.

- Examples: Suppose the following Income Statements and Cash Flow Statements
of companies A, B and C were presented to you. Which do you think is a more
attractive company?

Company A

Income Statement Cash Flows

Sales P 100,000 Collection from Customers P0

Less: Cost 50,000 Payment of Expenses 50,000

------------- ---------
Profits P 50,000 Net Cash Flow (P 50,000)

Company B

Income Statement Cash Flows

Sales P 100,000 Collection from Customers P 100,000

Less: Cost 150,000 Payment of Expenses 50,000

------------- --------------
Profits (P 50,000) Net Cash Flow P 50,000
 Company C

Income Statement Cash Flows

Sales P 100,000 Collection from Customers P 100,000

Less: Cost 70,000 Payment of Expenses 70,000

------------- ------------
Profits P 30,000 Net Cash Flow P 30,000

 Company A is profitable but generated negative cash flows which resulted from the uncollected
accounts receivable of Php 100,000. Without adequate cash inflows to meet its obligations, the company
will face liquidity problems, regardless of its level of profits.
 Company B on the other hand has a positive cash flow but is un profitable. This is a result of the
company’s delay in payment of its costs. Accordingly, the company will soon have to pay the remaining
Php 100,000 liability and its cash will no longer be sufficient. Again, without adequate cash inflows to
meet its obligations, the company will face liquidity problems.
 Company C is profitable and has a positive cash flow. Based on the information provided, Company C
seems to be the best.

Good liquidity and reasonable leverage position.

 Liquidity and leverage refers to the company’s management of the type and amount of assets and
liabilities that will hold in the course of its operations. This will further be discussed in Lesson 2.

Dividends.
 Holder of shares receive dividends from a corporation as returns on their investments in form of
cash or other properties. Companies which have better dividend policies are generally more
attractive than companies who do not pay out dividends.
 Note that there may be times that companies do not pay out dividends because of future expansions.
Same with the other factors affecting share price, dividend policies should go hand in hand with
other factors in determining market price.

Competent management.
 Competent managers may have any of the following attributes: 1) visionary 2) decisive 3)
people-oriented 4) inspiring 5) innovative 6) respected and 7) experienced/seasoned manager.

Corporate plans that improve the business prospects.

  Example: Company A which is in the business of selling Halo-halo in the Dapitan area (or any
other area) for 5 years. Company A is consistently earning profits and has a positive cash flow.
When asked how Company A sees itself after 5 more years, Company A answered that it would
continue to sell Halo-halo in Dapitan (orany other area).
 On the other hand, Company B sells Buko Juice in katipunan area (or any other area different
from the Company A’s area) for 5 years. Company B is consistently earning profits and has a
positive cash flow. When asked how Company B sees itself after 5 more years, Company B
answered that it has generated enough cash to expand its business to Cubao area (or any other
area) to take advantage of the growing demand of Buko Juice in Cubao.
 Between Company A and Company B, which would be a better investment? Company B. Since
it has more concrete future prospects allowing investors to hope for better revenues and net
income.

External Factors
 These factors influences the general reaction of investors in making an investment decision.
 Its affects is not only to a specific company but on all companies or a group companies under
similar circumstances.
 Such factors are a result of the environment a company operates in rather than the decisions of
the company’s management.

Role of Financial Management

 Financial management deals with decisions that are supposed to maximize the value of
shareholders’ wealth. (Cayanan)

- These decisions will ultimately affect the markets perception of the company and
influence the share price.

- The goal of financial management is to maximize the value of shares of stocks.

- Managers of a corporation are responsible for making the decisions for the
company that would lead towards shareholders’ wealth maximization.
  The Corporate Organization Structure
SHAREHOLDERS

BOARD OF DIRECTOR

PRESIDENT (CEO)

VP FOR VP FOR VP FOR VP FOR

MARKETING FINANCE PRODUCTION ADMINISTRATION

Figure 1: Illustration of the Corporate Organization Structure

 From the diagram presented, the managers of the company are making decisions for the interest
of the board of directors and the board of directors does the same for the interest of the
shareholders, it follows that the goal of each individual in a corporate organization should have
an objective of shareholders’ wealth maximization.

Roles of each position identified

 SHAREHOLDERS: The shareholders elect the Board of Directors (BOD). Each share
held is equal to one voting right. Since the BOD is elected by the shareholders, their
responsibility is to carry out the objectives of the shareholders otherwise, they would not have
been elected in that position. Ask the learners again what the objective of the shareholders is just
to refresh.

 BOARD OF DIRECTORS: The board of directors is the highest policy making body
in a corporation. The board’s primary responsibility is to ensure that the corporation is operating
to serve the best interest of the stockholders. The following are among the responsibilities of the
board of directors:

- Setting policies on investments, capital structure and dividend policies.

- Approving company’s strategies, goals and budgets.
 - Appointing and removing members of the top management including the
president.

- Determining top management’s compensation.

- Approving the information and other disclosure reported in the financial
statements (Cayanan, 2015)

 PRESIDENT (CHIEF EXECUTIVE OFFICER): The roles of a president in

a corporation may vary from one company to another. Among the responsibilities of a president
are the following:

- Overseeing the operations of a company and ensuring that the strategies as

approved by the board are implemented as planned.

- Performing all areas of management: planning, organizing, staffing, directing and

controlling.

- Representing the company in professional, social, and civic activities.

Although the president carries out the decision making for all functions, it would be difficult for him/her to do
this alone. The president cannot manage the company on his own, especially when the corporation has become
too big. To assist him are the vice presidents of him are the vice presidents of different functional areas:
Finance, marketing, production and administration.

 VP for MARKETING: The following are among the responsibilities of VP for

Marketing

- Formulating marketing strategies and plans.

- Directing and coordinating company sales.
- Performing market and competitor analysis.
- Analyzing and evaluating the effectiveness and cost of marketing methods
applied.

- Conducting or directing research that will allow the company identify new
marketing opportunities, e.g. variants of the existing products/services already
offered in the market.

- Promoting good relationships with customers and distributors. (Cayanan, 2015)

 VP for PRODUCTION: The following are among the responsibilities of VP for
production:

- Ensuring production meets customer demands.

- Identifying production technology/process that minimizes production cost and
make the company cost competitive.

- Coming up with a production plan that maximizes the utilization of the

company’s production facilities.

- Identifying adequate and cheap raw material suppliers. (Cayanan, 2015)

 VP for ADMINISTRATION: The following are among the responsibilities of VP

for Administration:

- Coordinating the functions of administration, finance, and marketing

departments.

- Assisting other departments in hiring employees.

- Providing assistance in payroll preparation, payment of vendors, and collection
of receivables.

- Determining the location and the maximum amount of office space needed by the
company. Identifying means, processes, or systems that will minimize the
operating costs of the company. (Cayanan, 2015)

 EXERCISE NO. 1
 Identify the four (4) functions of a VP for finance (CFO) as follows:
- Financing
- Investing
- Operating
- Dividend Policies
 Financing decisions include making decisions on how to fund long term investments (such as
company expansions) and working capital which deals with the day to day operations of the
company (i.e., purchase of inventory, payment of operating expenses, etc.).
 The role of the VP for Finance of the Financial Manager is to determine the appropriate capital structure
of the company. Capital structure refers to how much of your total assets is financed by debt and how
much is financed by equity. To illustrate, show/draw the figure below:
 Equity Liabilities Assets
120%

100%

80%

60%

40%

20%

0%
Total Assets Capital Structure

Table 1: Sample Capital Structure

 Recall that Assets = Liabilities + Owner’s Equity.

- To be able to acquire assets, our funds must have come somewhere. If it was bought using cash from our
pockets, it is financed by equity.
- On the other hand, if we used money from our borrowings, the asset bought is financed by debt.
- In the figure above, the total asset is financed by 60% debt and 40% equity. Accordingly, the capital structure
is 60% debt and 40% equity.

 Do you think there is an ideal mix of debt and equity across corporations?

- Answer: No. The mix of debt and equity varies in different corporations depending on management’s strategies. It is the
responsibility of the Financial Manager to determine which type of financing (debt or equity) is best for the company.

 The advantages of debt and equity financing will be discussed in Lesson 5: Sources and Uses of Funds.
 Recall that, previously, you discussed investing as where to put your excess cash to make it more profitable. We
expand that definition by including cash held taken from funds as a result of financing decisions.

 Investments may either be short term or long term.

- Short term investment decisions are needed when the company is in an excess cash position.
 To plan for this, the Financial Manager should be able to make use of Financial Planning tools such as budgeting
and forecasting which will be discussed in Lesson 3: Financial Planning
Tools and Concepts.
• Moreover, the company should choose which type of investment it should invest in that would
provide an most optimal risk and return trade off. We will learn more about this on Lesson 6:
Introduction to investments.

- Long term investments should be supported by a capital budgeting analysis which is among the
responsibilities of a finance manager.
• Capital budgeting analysis is a tool to assess whether the investment will be profitable in the long run and will
be further discussed in Lesson 5: Basic Long Term Financial Concepts. This is a crucial function of
management especially if this investment would be financed by debt.
• The lenders should have the confidence that the investments that management will push through with will be
profitable or else they would not lend the company any money.

• Operating decisions deal with the daily operations of the company. The role of the VP for finance is
determining how to finance working capital accounts such as accounts receivable and inventories. The company
has a choice on whether to finance working capital needs by long term or short term sources. Why does a
Financial Manager need to choose which source of financing a company should use? What do they need to
consider in making this decision?
-Short Term sources are those that will be payable in at most 12 months. This includes short-term loans
with banks and suppliers’ credit. For short-term bank loans, the interest rate is generally lower as compared to
that of long-term loans. Hence, this would lead to a lower financing cost.
- Suppliers’ credit are the amounts owed to suppliers for the inventories they delivered or services they
provided. While suppliers’ credit is generally free of interest charges, the obligations with them have to be paid
on time to maintain good supplier relationship. Such relationships should be nurtured to ensure timely delivery
of inventories.
- Short term sources pose a trade-off between profitability and liquidity risk. Because this source
matures in a short period, there is a possibility that the company may not be able to obtain enough cash to pay
their obligation (i.e. liquidity risk).
- Long term sources, on the other hand, mature in longer periods. Since this will be paid much later, the
lenders expect more risk and place a higher interest rate which makes the cost of long term sources higher than
short term sources. However, since long term sources have a longer time to mature, it gives the company more
time to accumulate cash to pay off the obligation in the future.
- Hence, the choice between short and long term sources depends on the risk and return trade off that
management is willing to take. The learners will learn more about this on Chapter 4: Sources and uses of funds.

• Dividend Policies. Recall that cash dividends are paid by corporations to existing shareholders based on their
shareholdings in the company as a return on their investment. Some investors buy stocks because of the
dividends they expect to receive from the company. Non-declaration of dividends may disappoint these
investors. Hence, it is the role of a financial manager to determine when the company should declare cash
dividends.

- Before a company may be able to declare cash dividends, two conditions must exist:
1. The company must have enough retained earnings (accumulated profits) to support cash dividend
declaration.
2. The company must have cash.

• What you think will affect the decision of management in paying dividends?
- Answer:
• Availability of financially viable long-term investment
• Access to long term sources of funds
• Management’s Target Capital structure
Reminder that dividends come from the company’s cash and availability of unrestricted retained earnings.
• Recall that one of the functions of a finance manager is investing and its available cash may be used to invest
in long term investments that would increase the profitability of the company. Some small enterprises which are
undergoing expansion may have limited access to long term financing (both long term debt and equity). This
results to these small companies reinvesting their earnings into their business rather than paying them out as
dividends.
• On the other hand, a company which has access to long term sources of funds may be able to declare
dividends even if they are faced with investment opportunities. However, these investments opportunities are
generally financed by both debt and equity.
- The management usually appropriates a portion of retained earnings for investment undertakings and this may
limit the amount of retained earnings available for dividend declaration.
- Creditors are not willing to finance entirely the cost of a company’s long term investment. Hence, the need for
equity financing (e.g. internally generated funds or issuance of new shares).
- Examples of these companies are publicly listed companies such as PLDT, Globe Telecom, and Petron. PLDT
and Globe are two of the Philippine listed companies which have generously distributed cash dividends for the
last five years (information as of 2014).
• For companies which have limited access to capital and have target capital structure, they may end up with a
residual dividend policy. This means that when companies are faced with investment opportunities, internally
generated funds will be used first to finance these investments and dividends can only be declared if there are
excess funds.

ENRICHMENT (5 MINS)
 Answer the following question:
- Explain why shareholder wealth maximization should be the overriding objective of management.
- What other positions can you think of that are related to financial management?

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Introduction to Financial Management

Learning Competencies
The learners shall be able to:
• Distinguish a financial institution from financial instrument and financial market. (ABM_BF12-IIIa-2)
• Enumerate the varied financial institutions and their corresponding services. (ABM_BF12-IIIa-3)
• Compare and contrast the varied financial instruments. (ABM_BF12-IIIa-4)
• Explain the flow of funds within an organization – through and from the enterprise—and the role of the
financial manager. (ABM_BF12-IIIa-5)

Specific Learning Outcomes

The learners will be able to:

• Prepare a diagram illustrating how the Financial System works.
• Define Financial Markets, Financial Institutions and Financial Instruments.
• Identify the types of Financial Markets, Financial Institutions and Financial Instruments.

-If A knows that B is in need of funds, or if B knows that A is willing to invest funds, A and B may agree to
make a Private Placement. (Draw the box for Private Placement between A and B and link the boxes as shown
in Figure 1.)

- However, if these facts are unknown to them, A and B can go to a Financial Market which is an organized
forum that lets A, along with other suppliers of funds, and B, along with other users of funds, meet and make
transactions. Once A and B have met in the Financial Market, they can now agree to make a private placement.
(Draw the box for Financial Markets and link this to A and B as shown in Figure 1.)

- If A and B do not want to make an effort to find a counterparty in the Financial Markets, A and B may go to a
Financial Institution. A Financial Institution will receive A’s supply of funds and match it with B’s demand of
funds. Unlike the Financial Markets were A and B knows to whom the fund went and from whom the funds
came, Financial Institutions serve as an intermediary to the suppliers and users of funds. (Draw the box for
Financial Institutions and link this to A and B as shown in Figure 1.)

- Moreover, Financial institutions actively participate in the financial markets as both suppliers and users of
funds. (Draw the link between Financial Institutions and Financial Markets as shown in Figure 1.)

• Mention that the resulting diagram illustrates the Financial System.

Financial System

Financial Institutions

(Learner A) (Learner B)
Savers/Suppliers Private Placement Users/Demanders
Of Funds of Funds

Financial Markets

Flow of funds Flow of securities/notes/bonds/debt instruments

Figure 1: The Financial System

• How transactions between suppliers and users of funds take place. How would they prove that there was a
transaction so that the demander will be able to repay the supplier on time and at the right amount?
- Answers:
- Verbal agreement
- Written agreement

• Due to the increased need for security for the performance of obligations arising from these transactions and
due to the growing size of the financial system, the transfers of funds from one party to another are made
through Financial Instruments.
• Note that on the diagram presented, the solid lines represent the flow of cash/funds, while the broken lines
represent the flow of financial
instruments which represent obligations to transfer cash or other assets in the future.

I will further discuss the composition of the Financial System and that you will identify the types of
Financial Markets, Financial Institutions and Financial Instruments.
1. Financial Instruments
• When a financial instrument is issued, it gives rise to a financial asset on one hand and a financial liability or
equity instrument on the other.
• Recall the following definitions:
- A Financial Asset is any asset that is:
• Cash
• An equity instrument of another entity
• A contractual right to receive cash or another financial asset from another entity.
• A contractual right to exchange instruments with another entity under conditions that are potentially
favorable. (IAS 32.11)
• Examples: Notes Receivable, Loans Receivable, Investment in Stocks, Investment in Bonds
- A Financial Liability is any liability that is a contractual obligation:
• To deliver cash or other financial instrument to another entity.
• To exchange financial instruments with another entity under conditions that are potentially
unfavorable. (IAS 32)
• Examples: Notes Payable, Loans Payable, Bonds Payable
- An Equity Instrument is any contract that evidences a residual interest in the assets of an entity after
deducting all liabilities. (IAS 32)
• Examples: Ordinary Share Capital, Preference Share Capital

• Who are the holders of Financial Assets?

- Answer: Suppliers of Funds

• Who the makers of Financial Liabilities and Equity instruments are?

- Answer: Users of Funds

• Continue discussing that when companies are in need of funding, they either sell debt securities (or
bonds) or issue equity instruments. The proceeds from the sale of the debt securities and issuance of bonds will
be used to finance the company’s plans. On the other hand, investors buy debt securities of equity instruments
in hopes of receiving returns through interest, dividend income or appreciation in the financial asset’s price.

• Identify common examples of Debt and Equity Instruments.

- Debt Instruments generally have fixed returns due to fixed interest rates. Examples of debt instruments
are as follows:
• Treasury Bonds and Treasury Bills are issued by the Philippine government. These bonds and bills have
usually low interest rates and have very low risk of default since the government assures that these will be paid.
• Corporate Bonds are issued by publicly listed companies. These bonds usually have higher interest rates than
Treasury bonds. However, these bonds are not risk free. If the company which issued the bonds goes bankrupt,
the holder of the bonds will no longer receive any return from their investment and even their principal
investment can be wiped out.
- Equity Instruments generally have varied returns based on the performance of the issuing company.
Returns from equity instruments come from either dividends or stock price appreciation. The following are
types of equity instruments:
• Preferred Stock has priority over a common stock in terms of claims over the assets of a company. This
means that if a company were to be liquidated and its assets have to be distributed, no asset will be distributed
to common stockholders unless all the claims of the preferred stockholders have been given. Moreover,
preferred stockholders have also priority over common stockholders in cash dividend declaration. Dividends to
preferred stockholders are usually in a fixed rate. No cash dividends will be given to common stockholders
unless all the dividends due to preferred stockholders are paid first. (Cayanan, 2015)
• Holders of Common Stock on the other hand are the real owners of the company. If the company’s growth is
spurring, the common stockholders will benefit on the growth. Moreover, during a profitable period for which a
company may decide to declare higher dividends, preferred stock will receive a fixed dividend rate while
common stockholders receive all the excess.
• Which of the financial instruments presented they find most appealing?
• Inform them that they will learn more about the advantages and disadvantages of debt and equity instruments
in Lesson 4: Sources and Uses of Funds and Lesson 5: Introduction to Investments.

2.Financial Markets
• Recall the definition of financial markets from earlier discussion.
• Classify Financial Markets into comparative groups:
- Primary vs. Secondary Markets
• To raise money, users of funds will go to a primary market to issue new securities (either debt or equity)
through a public offering or a private placement.
• The sale of new securities to the general public is referred to as a public offering and the first offering of
stock is called an initial public offering. The sale of new securities to one investor or a group of investors
(institutional investors) is referred to as a private placement.
• However, suppliers of funds or the holders of the securities may decide to sell the securities that have
previously been purchased. The sale of previously owned securities takes place in secondary markets.
• The Philippine Stock Exchange (PSE) is both a primary and secondary market.
- Money Markets vs. Capital Markets
• Money markets are a venue wherein securities with short-term maturities (1 year or less) are sold. They are
created because some individuals, businesses, governments, and financial institutions have temporarily idle
funds that they wish to invest in a relatively safe, interest-bearing asset. At the same time, other individuals,
businesses, governments, and financial institutions find themselves in need of seasonal or temporary financing.
• On the other hand, securities with longer-term maturities are sold in Capital markets. The key capital market
securities are bonds (long-term debt) and both common stock and preferred stock (equity, or ownership).

3. Financial Institutions
• Recall the definition of Financial institutions from the earlier discussion.
• Identify examples of financial institutions:
- Commercial Banks - Individuals deposit funds at commercial banks, which use the deposited funds to
provide commercial loans to firms and personal loans to individuals, and purchase debt securities issued by
firms or government agencies.
- Insurance Companies - Individuals purchase insurance (life, property and casualty, and health) protection
with insurance premiums. The insurance companies pool these payments and invest the proceeds in various
securities until the funds are needed to pay off claims by policyholders. Because they often own large blocks of
a firm’s stocks or bonds, they frequently attempt to influence the management of the firm to improve the firm’s
performance, and ultimately, the performance of the securities they own.
- Mutual Funds - Mutual funds are owned by investment companies which enable small investors to enjoy the
benefits of investing in a diversified portfolio of securities purchased on their behalf by professional investment
managers. When mutual funds use money from investors to invest in newly issued debt or equity securities,
they finance new investment by firms. Conversely, when they invest in debt or equity securities already held by
investors, they are transferring ownership of the securities among investors.
- Pension Funds - Financial institutions that receive payments from employees and invest the proceeds on their
behalf.
- Other financial institutions include pension funds like Government Service Insurance System (GSIS) and
Social Security System (SSS), unit investment trust fund (UITF), investment banks, and credit unions, among
others.
 Figure 2: How Financial Institutions Provide Financing for Firms (Gitman & Zutter, 2012)
• The figure above illustrates how the key financial institutions serve as intermediaries for suppliers and users of funds.

 EXERCISES NO. 1

True/False
Direction: Write “T” if the statement is true and “F” if the statement is false on the space provided.

__________1. High cash flow is generally associated with a higher share price whereas higher risk tends to
result in a lower share price.

__________2. When considering each financial decision alternative or possible action in terms of its impact on
the
share price of the firm's stock, financial managers should accept only those actions that are expected to increase
the firm's profitability.

__________3. To achieve the goal of profit maximization for each alternative being considered, the financial
manager would select the one that is expected to result in the highest monetary return.

__________4. Dividend payments change directly with changes in earnings per share.

__________5. The wealth of corporate owners is measured by the share price of the stock.

__________6. Risk and the magnitude and timing of cash flows are the key determinants of share price, which
represents the wealth of the owners in the firm.

__________7. When considering each financial decision alternative or possible action in terms of its impact on
the share price of the firm's stock, financial managers should accept only those actions that are expected to
maximize shareholder value.
__________8. An increase in firm risk tends to result in a higher share price since the stockholder must be
compensated for the greater risk.

__________9. Stockholders expect to earn higher rates of return on investments of lower risk and lower rates of
return on investments of higher risk.

Multiple Choice

_______1. The primary goal of the financial manager is

A. minimizing risk.
B. maximizing profit.
C. maximizing wealth.
D. minimizing return.
_______2. Corporate owners receive realizable return through
A. earnings per share and cash dividends.
B. increase in share price and cash dividends.
C. increase in share price and earnings per share.
D. profit and earnings per share.

_______3. The wealth of the owners of a corporation is represented by

A. profits.
B. earnings per share.
C. share value.
D. cash flow.
_______4. Wealth maximization as the goal of the firm implies enhancing the wealth of
A. the Board of Directors.
B. the firm's employees.
C. the federal government.
D. the firm's stockholders.
________5. The goal of profit maximization would result in priority for
A. cash flows available to stockholders.
B. risk of the investment.
C. earnings per share.
D. timing of the returns.
________6. Profit maximization as a goal is not ideal because it does NOT directly consider
A. risk and cash flow.
B. cash flow and stock price.
C. risk and EPS.
D. EPS and stock price.
________7. Profit maximization as the goal of the firm is not ideal because
A. profits are only accounting measures.
B. cash flows are more representative of financial strength.
C. profit maximization does not consider risk.
D. profits today are less desirable than profits earned in future years.
_________8. Profit maximization fails because it ignores all EXCEPT
A. the timing of returns.
 B. earnings per share.
C. cash flows available to stockholders.
D. risk.
__________9. The key variables in the owner wealth maximization process are
A. earnings per share and risk.
B. cash flows and risk.
C. earnings per share and share price.
D. profits and risk.
________10. Cash flow and risk are the key determinants in share price. Increased cash flow results in
________, other things remaining the same.
A. a lower share price B. a higher share price
C. an unchanged share price D. an undetermined share price
________11. Cash flow and risk are the key determinants in share price. Increased risk, other things remaining
the same, results in
A. a lower share price. B. a higher share price.
C. an unchanged share price. D. an undetermined share price.

________12. Financial managers evaluating decision alternatives or potential actions must consider
A. only risk. B. only return. C. both risk and return.
D. risk, return, and the impact on share price.

________13. A financial manager must choose between four alternative Assets: 1, 2, 3, and 4. Each asset costs
$35,000 and is expected to provide earnings over a three-year period as described below.

Asset Year 1 Year 2 Year 3

Based on the profit maximization goal,
1 $ 21,000 $ 15,000 $ 6,000
the financial manager would choose
2 $ 9,000 $ 15,000 $ 21,000
3 $ 3,000 $ 20,000 $ 19,000
4 $ 6,000 $ 12,000 $ 12,000

A. Asset 1.
B. Asset 2.
C. Asset 3.
D. Asset 4.
_______14. A financial manager must choose between three alternative investments. Each asset is expected to
provide earnings over a three-year period as described below. Based on the wealth maximization goal, the
Asset Year 1 Year 2 Year 3 financial manager would
1 $ 21,000 $ 9,000 $ 15,000
2 $ 15,000 $ 15,000 $ 15,000
3 $ 9,000 $ 21,000 $ 15,000
$ 45,000 $ 45,000 $ 45,000
A. choose Asset 1. B. choose Asset 2.
C. choose Asset 3. D. be indifferent between Asset 1 and Asset 2.

Prepared by:

Mr. Jayson F. Moralejo

Instructor