Afm-Unit 1

Which ratio is best used for measuring
how well management did in managing

the funds provided by shareholders?
a. Profit Margin
b. Debt to Equity
c. Return on Equity
d. Inventory Turnover
If Operating
63,000 and Income (Earnings Before Interest Taxes) is $
Net Sales are $ 900,000, then Operating Income to Sales is:
a. 18%
b. 12%
c. 7%
d. 4%
In order for budgeting to really work, we must link the budgeting
process with:
a. Financial Statements
b. Accounting Transactions
c. Strategic Planning
d. Operating Reports
Which of the following is relevant in determining the cash flows of a
project?
a. Sunk costs
b. Depreciation
c. Payback period
d. Net Present Value
You are considering investing in a new cotton-bailing machine. The
purchase price of
new bailer is $ 10,000. It will cost $ 750 to transport the bailer to your
location. The
old bailer will be sold for $ 2,000 and your tax rate is 40%. The net
investment for this
project is:
a. $ 11,950
b. $ 10,750
c. $ 9,550
d. $ 8,950
In addition to using Net Present Value to evaluate a project, another good
economic criteria that can be used is:
a. Accounting Rate of Return
b. Modified Internal Rate of Return
c. Simple Payback
d. Return on Investment
Which budget is prepared for determining how much external
financing
we will need to support estimated sales?
a. Cash Budget
b. Budgeted Income Statement
c. Budgeted Balance Sheet
d. Sales Forecast
If the price of the stock is $ 45.00 and the Earnings per Share is $ 9.00,
then the P
/ E Ratio is:
a. 2
b. 5
c. 9
d. 15
Delphi Corporation has common stock with a listed beta coefficient of
1.40.
U.S. Treasury Bonds are paying 6.2% and the overall market rate
according
to Standard and Poor's is 13.5%. Using the Capital Asset Pricing Model
(CAPM),
the cost of common stock is:
a. 10.22%
b. 13.50%
c. 16.44%
d. 18.33%
Fleming Corporation has plans to raise $ 2 million in capital by issuing
50,000 shares of $ 20.00 common stock and by issuing $ 1 million in bonds @
12% interest. Fleming's tax rate is 40%. Fleming expects EBIT (Earnings
Before Interest Taxes) of $ 4.5 million and its current capital structure
consists only of common stock - 250,000 shares outstanding. What will
EPS (Earnings per Share) be after the financing plan?
a) $ 6.67
b) $ 7.97
c) $ 8.76
d) $ 9.00
Role of senior finance advisor
 Financial impact of a finance managers decision

 Strategic impact of a finance managers decision
i. The chances of the investment enhancing the firm’s competitive
advantage?
ii. Does it FIT the environment?
iii. Do we have the resources for the investment?
iv. Stakeholders expectation
v. Risk in the project
Financial Strategy formulation
Entity 1
this is a listed entity in the electronics industry. its stated financial objectives are:
1. to increase earnings per share year on year by 10% per annum; and
2. to achieve a 25% per annum return on capital employed.
this entity has an equity market capitalisation of £600 m. it also has a variety of debt instruments
trading at a total value of £150 m.
Entity 2
This entity is a newly established purchaser and provider of healthcare services in the public sector.
The entitie’s legal status is a trust. Its total income for the current year will be almost £100 m. It is
considering funding the building of a new healthcare centre via the Private Finance Initiative (PFI). The
total debt will be £15 m. Capital and interest will be repaid over 15 years at a variable rate of interest,
currently 9% each year. The trust’s sole financial objective states simply ‘to achieve financial balance
during the year’. Its other objectives are concerned with qualitative factors such as ‘providing high
quality healthcare’.
 Requirements (a) Discuss
 (i) the reasons for the differences in the financial objectives of the two
types of entity given above; and
 (ii) the main differences in the business risks involved in the
achievement of their financial objectives and how these risks might
be managed
Answer to Q1
 The financial objectives remain the key areas for the private sector,
whose primary responsibility is to their shareholders, and
 the public sector’s primary objectives are the provision of a quality
service
 The private sector will generally set their objectives, by reference to

the needs of their stakeholders, while the public sector organisation
will have many of its objectives imposed by the government
Answer to Q2
 EPS
Earnings per share are used by shareholders to judge the growth achieved. While
it can be misleading, it gives an idea of the profits generated in the year. The
public sector generally does not have such a financial measure but concentrates
more on the service provided.
ROCE
The private sector company has to give a sufficient return to its investors for the
risk they perceive in the investment.
This can be approximated by tracking the return on capital employed. In the public
sector, to convince the ‘investors’, usually the government, to release funds and
not withdraw resources, the organisation must persuade them that the activities
represent value for money.
This is often politically driven rather than being based on long-term financial
analysis.
 Cash limits
The public sector has a major objective to achieve financial balance
during the year, as it is unable to raise more during the year. The private
sector charges customers and can raise more revenue by selling more
 Business risk
 For private sector: its customers and profit
 For public sector: It’s the quality of services provided
The following issues thus need to be
considered when setting criteria for future
finance and deciding policies:
 Is the firm at its optimal gearing level with associated minimum cost
of capital?
 What gearing level is required?
 What sources of finance are available?
 Tax implications.
 The risk profile of investors and management.
 Restrictions such as debt covenants.
 Implications for key ratios.
The ethical impact of the financial
manager's decisions
 Ethics, and the company’s ethical framework, should provide a basis
for all policy and decision making.
 The financial manager must consider whether an action is ethical at
a:
• society level
• corporate level
• individual level
Management of international trade and
finance
Dividend Policy
• stable dividend
policy
• constant payout
ratio
• zero dividend policy
• residual approach to
dividends.
Stable dividend policy
 Paying a constant or constantly growing dividend each year:
• offers investors a predictable cash flow
• reduces management opportunities to divert funds to non-profitable
activities
• works well for mature firms with stable cash flows.
Disadvantages
 There is a risk that reduced earnings would force a dividend cut
with all the associated difficulties.
Constant payout ratio
 Paying out a constant proportion of equity earnings:
• maintains a link between earnings, reinvestment rate and dividend
flow but
• cash flow is unpredictable for the investor
• gives no indication of management intention or expectation.
Zero dividend policy
 All surplus earnings are invested back into the business. Such a
policy:
• is common during the growth phase
• should be reflected in increased share price.
Residual dividend policy
 A dividend is paid only if no further positive NPV projects available. This
may be popular for firms:
• in the growth phase
• without easy access to alternative sources of funds.
However:
• cash flow is unpredictable for the investor
• gives constantly changing signals regarding management expectations.
 https://www.moneycontrol.com/stocks/marketinfo/dividends_declared/
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Which ratio is best used for measuring

how well management did in managing

 Financial impact of a finance managers decision

 The private sector will generally set their objectives, by reference to

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