Mini Case (pg 28)

Q a.

Profit maximization refers to how much dollar profit the company makes, while Shareholder

wealth is talking about the value of the company generally expressed in the value of the stock. It

might seem like making as much profit as possible and would yield the highest value for the

stock but that is not always the case.

When investors look at a company, they not only look at dollar profit but also profit margins,

return on capital and other indicators of efficiency. Let’s say there are two companies producing

the same product. The first Company, A had sales of RM150 million and made profit of RM15

million while Company B had sales of RM220 million and profit of RM18 million. The investors

could look at Company B and say they are less valuable because they clearly do no operate as

efficiently as Company A do. So even though Company B had more profit compare to Company

A, but Company A have more shareholder value. So I would definitely will say that shareholder

value is more appropriate, based on the statement earlier.

Q b.

Risk- return trade- off means potential return which will rise with an increase in risk. Low level

risk are associated with low potential returns, whereas high levels of high risk are associated

with high potential of returns. In other words, invested money can render higher profits only if it

is subject to the possibility of being lost.

Q c.

The reason why are we interested in cash flows rather than accounting profits in determining the

value of an asset is because it is cash flows that are actually received by we can be invested

while the profit in other hand can’t do so. This is due to profits are shown when they are earned

rather than when the money is actually in hand.

Qd

An efficient market is a market in which the prices of securities at any instant in time fully reflect

all publicly available information about the securities and their actual public values. The

implications of efficient markets for us are: First the price is right. Stock prices reflect all publicly

available information regarding the value of the company. Which in here it means, we can

implement our goal of maximization of shareholder wealth by focusing on the effect each

decision should have on the stock prices and bad ones in lower stock prices. Furthermore it is

indeed reassuring that prices reflect value. It allows us to look at prices and see value reflected

in them. Thou it might make investing a little less fun but it make corporate finance much less

uncertain.

Qe

The cause of agency problem is separation of the management and ownership of the firm. We

try to solve it by Linking rewards to shareholder wealth improvements: Owners can grant

directors and other senior managers share options. These permit the managers to purchase

shares at some date in the future at a price, which is fixed in the present. If the share price rises

significantly between the dates when the option was granted and the date when the shares can

be bought the manager can make a fortune by buying at the pre-arranged price and then selling

in the market place. The managers under such a scheme have a clear interest in achieving a

rise in share price and thus congruence comes about to some extent. An alternative method is

to allot shares to managers if they achieve certain performance targets, for example, growth in

earnings per share or return on shares or by Sackings: The threat of being sacked with the
accompanying humiliation and financial loss may encourage managers not to diverge too far

from the shareholders’ wealth path. However this method is seldom used because it is often

difficult to implement due to difficulties of making a coordinated shareholder effort.

Qf

Ethics and ethical behavior have to do with finance in such way where such questions like this

arise; would you entrust your money to someone you thought was unethical? Would you risk

heavy fines and possible jail time for skimming funds from a client? Ethics and ethical behavior

also means people who work in finance are placed in a fiduciary position of trust; first, by their

employers, if they're not self-employed, but more importantly, by members of the general public,

over whose assets they are given control. Their daily business is directly working with other

people's money, or doing other things that affect the public's investment decisions, and if they

are unethical people, their clients, and the public, are at high risk for being cheated. Finance

workers are entitled to reasonable fees for their services, but they are not entitled to engage in

investment activity solely to generate more commissions for themselves, or engage in any other

self-dealing while they are doing their jobs on behalf of their clients. And they have to exercise

reasonable care when doing their jobs.

Given the many scandals of recent years, many companies have done their best to publicize

their codes of ethics, and to acknowledge their responsibility to the public. These firms know

that public confidence in their finance people matters a great deal, and unethical behavior (or

even the perception of such behavior)on the part of a firm means that people will stay away

from that firm, and they may stay away from all the others as well.

Qg

The definition on sole proprietorship is a business structure in which an individual and his/her

company are considered a single entity for tax and liability purposes. A sole proprietorship is a

company which is not registered with the state as a limited liability company or corporation. The
owner does not pay income tax separately for the company, but he/she reports business income

or losses on his/her individual income tax return. The owner is inseparable from the sole

proprietorship, so he/she is liable for any business debts. Also called proprietorship.

The definition on partnership is a type of unincorporated business organization in which multiple

individuals, called general partners, manage the business and are equally liable for its debts;

other individuals called limited partners may invest but not be directly involved in management

and are liable only to the extent of their investments. Unlike a Limited Liability Company or a

corporation, in a partnership each partner shares equal responsibility for the company's profits

and losses, and its debts and liabilities. The partnership itself does not pay income taxes, but

each partner has to report their share of business profits or losses on their individual tax return.

Estimated tax payments are also necessary for each of the partners for the year in progress.

The definition on corporation is the most common form of business organization, and one which

is chartered by a state and given many legal rights as an entity separate from its owners. This

form of business is characterized by the limited liability of its owners, the issuance of shares of

easily transferable stock, and existence as a going concern. The process of becoming a

corporation, call incorporation, gives the company separate legal standing from its owners and

protects those owners from being personally liable in the event that the company is sued (a

condition known as limited liability). Incorporation also provides companies with a more flexible

way to manage their ownership structure. In addition, there are different tax implications for

corporations, although these can be both advantageous and disadvantageous. In these

respects, corporations differ from sole proprietorships and limited partnerships.

Qh

TAXABLE INCOME
$ $
SALES 4000000
COST OF GOODS SOLDS 2400000
GROSS PROFIT 1600000
TAX-DEDUCTIBLE
EXPENSES
OPERATING EXPENSES 600000
INTEREST EXPENSES 300000 900000
700000

OTHER INCOME:
INTEREST INCOME 22000
PREFERRED INCOME
DIVIDENDS 30000
TAXABLE ORDINARY
INCOME: 752000
GAIN ON SALE
COST 100000
TAXABLE INCOME: 60000 40000
792000