1)

TheFirmsObjective
Thegoaloffinancialmanagementistomaximiseshareholderswealth.
Shareholderswealthcanbemeasuredasthecurrentvaluepershareofexistingshares.
TheAgencyProblem
ManagerialGoals>ManagerialgoalsmaybedifferentfromshareholdergoalsExpensiveperquisites
SurvivalIndependence>Increasedgrowthandsizearenotnecessarilyequivalenttoincreased
shareholderwealth
InternalRateofReturn(IRR)
>Disadvantages:DoesnotdistinguishbetweeninvestingandborrowingIRRmaynotexist,there
maybemultipleIRRsProblemswithmutuallyexclusiveinvestments
>Advantages:Easytounderstandandcommunicate
TheProfitabilityIndex(PI)>MinimumAcceptanceCriteria:AcceptifPI>1>RankingCriteria:
SelectalternativewithhighestPI
SummaryDiscountedCashFlow
>NetpresentvalueDifferencebetweenmarketvalueandcostAccepttheprojectiftheNPVis
positiveHasnoseriousproblemsPreferreddecisioncriterion
>InternalrateofreturnDiscountratethatmakesNPV=0TaketheprojectiftheIRRisgreater
thantherequiredreturnSamedecisionasNPVwithconventionalcashflowsIRRisunreliablewith
nonconventionalcashflowsormutuallyexclusiveprojects
>ProfitabilityIndexBenefitcostratioTakeinvestmentifPI>1Cannotbeusedtorankmutually
exclusiveprojectsMaybeusedtorankprojectsinthepresenceofcapitalrationing
SummaryPaybackCriteria
>PaybackperiodLengthoftimeuntilinitialinvestmentisrecoveredTaketheprojectifitpays
backinsomespecifiedperiodDoesnotaccountfortimevalueofmoney,andthereisanarbitrary
cutoffperiod
>DiscountedpaybackperiodLengthoftimeuntilinitialinvestmentisrecoveredonadiscounted
basisTaketheprojectifitpaysbackinsomespecifiedperiodThereisanarbitrarycutoffperiod

2)
FinancingCostsInterestcostsshouldnot
beincludedasanexplicitcashflow,
because:interestcostsareincludedinthe
requiredrateofreturn(discountrate,
companycostofcapital)usedtoevaluatethe
projectiftheprojectsNPVispositive,the
cashflowsfromtheinvestmentwillcover
interestcosts