You are on page 1of 2

c1.

Compare and contrast the goals of profit maximization and maximization of shareholder
wealth.

- The major difference between the profit maximization goal and the goal of shareholder wealth
maximization is that the latter goal deals with all the complexities of the operating
environment, while the profit maximization goal does not. The major factors assumed away
by the profit maximization goal are uncertainty and the timing of the returns.

2. What is unsystematic risk and systematic risk?

- a. Unique risk is the variability in a firm's stock price that is associated with the specific
firm and not the result of some broader influence. An employee strike is an example of a
company-unique influence.

b. Systematic risk is the variability in a firm's stock price that is the result of general
influences within the industry or resulting from overall market or economic influences. A
general change in interest rates charged by banks is an example of systematic risk.

3. The common stockholders receive two types of return from their investment. What are they?

- The two types of return include dividend income and capital gains. The dividend income
for common stockholders differs from preferred stockholders, in that no specified dividend
amount is to be received. However, the common stockholders are permitted to participate in
the growth of the company. As a result of this growth, their second source of return, that of
price appreciation, results.

4. Briefly compare and contrast the NPV, PI, and IRR criteria.

- The three discounted cash flow capital, budgeting criteria are the net present value, the
profitability index, and the internal rate of return. The net present value method gives an
absolute dollar value for a project by taking the present value of the benefits and subtracting
the present value of the costs. The profitability index compares these benefits and costs
through division and comes up with a measure of the project¶s relative value²a benefit/cost
ratio. On the other hand, the internal rate of return tells us the rate of return that the project
earns. In the capital-budgeting area, these methods generally give us the same accept-reject
decision on projects but many times rank them differently. As such, they have the same
general advantages and disadvantages, although the calculations associated with the internal
rate of return method can become quite tedious.
5. What are the advantages of a stock split or dividend over a cash dividend?

- The stockholder benefits only if the price of the stock does not fall in proportion to the
number of new shares issued. An advantage to the corporation is the conservation of cash for
investment opportunities.

6. Define the hedging principle. How can this principle be used in the management of working
capital?

- The hedging principle involves matching the maturities of the sources of financing for the
firm¶s assets with the useful lives of the assets. To implement the hedging principle, the firm
must fund all its permanent assets investments not financed by spontaneous sources (payables)
with long-term sources of funds and then finance all its temporary asset investments not
funded by spontaneous sources of financing with short-term sources of funds.

7. List down major benefit of organized stock Exchange?

-(1) A continuous market. This means a series of continuous security prices is generated.
Price changes between trades are dampened, reducing price volatility, and enhancing the
liquidity of securities.

(2) Establishing and publicizing fair security prices. Prices on an organized exchange are
determined in the manner of an auction. Moreover, the prices are published in widely
available media like newspapers.
(3) An aftermarket to aid businesses in the flotation of new security issues. The
continuous pricing mechanism provided by the exchanges facilitates the determination of
offering prices in new flotations. The initial buyer of the new issue has a ready market in
which he can sell the security should he need liquidity rather than a financial asset.

8. What factor determine a bond¶s rating? Why is rating important to the firm¶s manager?

- Ratings involve a judgment about the future risk potential of the bond. Although they deal
with expectations, several historical factors seem to play a significant role in their
determination. Bond ratings are favorably affected by (1) a greater reliance on equity, and
not debt, in financing the firm, (2) profitable operations, (3) a low variability in past earnings,
(4) large firm size, and (5) little use of subordinated debt. In turn, the rating a bond receives
affects the rate of return demanded on the bond by the investors. The poorer the bond rating,
the higher the rate of return demanded in the capital markets.