FINANCIAL MANAGEMENT

Assignment I

Lecturer:
Ika Pratiwi Simbolon

Group 4:
Eiffelyn Putri Abdikesuma (008201600007)
Giovanni (008201600064)
Jimmy Yaputra (008201600081)
Ni Putu Febby Wulan Bestari (015201400063)
Silvia Sely Grace Gea (008201600062)

President University
Jalan Ki HajarDewantara RT. 2 / RW. 4, Mekarmukti,Cikarang Utara, Bekasi, Jawa Barat 17550, No Telp: 0218910976263,
email: info@president.ac.id website: http://www.president.ac.id

2016/2017
1. What is finance? Explain how this field affect all of the activities in which businesses
engage.
Finance is a field that deals with the study of investments. It includes the dynamics of assets
and liabilities over time under conditions of different degrees of uncertainty and risk.
Finance can also be defined as the science of money management. Finance aims to price
assets based on their risk level and their expected rate of return. Not only is finance a good
indicator of the health of the company overall, but it also holds an important role in
managing business growth. Whether growth is attributable to a larger market capitalization,
and increase employee, a new location, a new product or service offering, or a new
demographic, finance is the enabler of such opportunities

2. What is the goal of the firm and, therefore, of all the managers and employees? Discuss
how one measures achievement of this goal?
The goal of the firm is to maximize the wealth of the owners for whom it is being operated.
The wealth of corporate owners is measured by the share price of the stock, which in turn is
based on the timing of returns (cash flows), their magnitude, and their risk. 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 share price.

3. What is corporate governance? Explain.

Corporate governance is the system of rules, practices and processes by which a company
is directed and controlled. Corporate governance essentially involves balancing the interests
of a company's many stakeholders, such as shareholders, management, customers, suppliers,
financiers, government and the community. Since corporate governance also provides the
framework for attaining a company's objectives, it encompasses practically every sphere of
management, from action plans and internal controls to performance measurement and
corporate disclosure.

Governance refers specifically to the set of rules, controls, policies and resolutions put in
place to dictate corporate behavior. Proxy advisors and shareholders are important
stakeholders who indirectly affect governance, but these are not examples of governance

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 itself. The board of directors is pivotal in governance, and it can have major ramifications
for equity valuation.

4. Define agency problems, and describe how they give rise to agency costs. Explain how
a firm’s corporate governance structure can help avoid agency problems.
Agency problem is a situation in which agents of an organization (e.g. the management) use
their authority for their own benefit rather than that of the principals (e.g. the shareholders).
The owner is the principal and the manager is the agent.The agency problem also refers to
simple disagreement between agents and principals.

For example, suppose you hire someone to sell your car and agree to pay that person a flat
fee when he or she sells the car. The agent's incentive in this case is to make the sale, not
necessarily to get you the best price. If you offer a commission of, say, 10 percent of the
sales price instead of a flat fee, then this problem might not exist. This example illustrates
that the way in which an agent is compensated is one factor that affects agency problems.

Relationship agency problem and company result two problems that is:
a. The occurrence of asymmetric information (information asymmetry), where
management generally has more information about the actual financial position and
position of the entity's operations. Because of that, in the context of relationships
between company owners and managers, agency problems can be the use of corporate
funds for the purchase of excessive managerial facilities, the retention of corporate
profits for unfavorable investments, and frauds that can reduce the profits or assets of a
company such as selling a company's product at a low price to the firm others who
turned out to belong to the manager.
b. The occurrence of a conflict of interest due to an inequality of purpose, in which
management does not always act in the interests of the owner.These problems give rise
to agency cost. Agency cost is costs borne by shareholders due to the presence or
avoidance of agency problems, and in either case represent a loss of shareholder wealth.

Agency problems can be addressed by a company’s corporate governance, which is

the set of rules that control the company’s behavior towards its directors, managers,
employees, shareholders, creditors, customers, competitors, and community. There are
3 how corporate governance help avoid agency problems :

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  Increasing Insider Ownership.
 The Company increases the ownership of management to align the manager's
position with the shareholders so that it acts in accordance with the wishes of the
shareholders. By increasing ownership percentages, managers become motivated to
improve performance and are responsible for improving shareholder wealth.

 Increase Funding Sources Through Debt.

 The addition of debt in the capital structure can reduce the use of stocks so as to
minimize the cost of equity agency. However, the company has an obligation to
repay the loan and pay the interest expense periodically. In addition, the use of debt
that is too large will also lead to agency conflicts between shareholders with
debtholders resulting in the cost of agency debt.

 Institutional Investors (Include Owner).

 A form of outside stock (outside of shareholders) is institutional investors and
shareholders may result in an increase in the cost of agency equity (agency costs).
This is because it is a resource that can be used to support or challenge the proximity
of management, then the concentration or dissemination of power into something
relevant in the company.

5. How can the firm structure management compensation to minimize agency problems?
What is the current view with regard to the execution of many compensation plans?
The firm structure management can compensate through incentive plans (owned stock rises
in price) or performance plans (stock or cash).
 Incentive plans : Incentive plans tie management compensation to share price. Under this
plan, if the firm’s stock price rises over time, the managers will be rewarded by being
able to purchase stock at market price effective at the time of grant of shares and then to
sell the shares at the prevailing higher prices.
 Performance plans : Compensation under this plan is often in the firm of performance
shares or cash bonuses. Performance shares are shares of stock given to management as
a result of meeting the stated performance goals and the cash bonuses are incentives to
the managers for the achievement of certain goals.

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 Current view is that studies have failed to find a strong relationship between the
performance that companies achieve and the compensation that CEOs receive.

6. How do market forces—both shareholder activism and the threat of takeover—act to

prevent or minimize the agency problem? What role do institutional investors play in
shareholder activism?
The threat of takeover when a firm’s internal corporate governance structure is unable to
keep agency problems in check, it is likely that rival managers will try to gain control of the
firm. Because agency problems represent a misuse of the firm’s resources and impose
agency costs on the firm’s shareholders, the firm’s stock is generally depressed, making the
firm an attractive takeover target. The threat of takeover by another firm that believes it can
enhance the troubled firm’s value by restructuring its management, operations, and
financing can provide a strong source of external corporate governance. The constant threat
of a takeover tends to motivate management to act in the best interests of the firm’s owners.

Institutional investors as monitoring agents. A form of outside stock (outside of

shareholders) is institutional investors and shareholders may result in an increase in the cost
of agency equity (agency costs). This is because the ownership is the source of authority
that can be used to support or challenge the proximity of management, then the
concentration or dissemination of power into something relevant in the company.

7. What is the financial services area of finance? Describe the field of managerial finance.
- Financial Services
 Financial services is the area of finance concerned with the design and delivery of
advice and financial products to individuals, businesses, and governments. It
involves a variety of interesting career opportunities within the areas of banking,
personal financial planning, investments, real estate, and insurance.
- Managerial Finance
 Managerial finance is concerned with the duties of the financial manager working in
a business. Financial managers administer the financial affairs of all types of
businesses—private and public, large and small, profit seeking and not for profit.
They perform such varied tasks as developing a financial plan or budget, extending

Financial Management – Assignment I |4

 credit to customers, evaluating proposed large expenditures, and raising money to
fund the firm’s operations

8. Why is the study of managerial finance important to your professional life regardless
of the specific area of responsibility you may have within the business firm? Why is it
important to your personal life?
Because the consequences of most business decisions are measured in financial terms, the
financial manager plays a key operational role. People in all areas of responsibility—
accounting, information systems, management, marketing, operations, and so forth—need
a basic awareness of finance so they will understand how to quantify the consequences of
their actions.

Study of Managerial Finance is really important in our professional life because managers
in the firm, regardless of their job descriptions, usually have to provide financial justification
for the resources they need to do their job. Whether you are hiring new workers, negotiating
an advertising budget, or upgrading the technology used in a manufacturing process,
understanding the financial aspects of your actions will help you gain the resources you need
to be successful.

It is important in our personal life because many of the principles in managerial finance
apply there. Learning a few simple financial principles can help us manage our own money
more effectively. It also can help us in facing our economy problem and we can also adjust
our expense with our revenue.

9. Describe the roles and the basic relationships among the major parties in a
corporation—stockholders, board of directors, and managers. How are corporate
owners rewarded for the risks they take?
- Stockholders
 The owners of a corporation, whose ownership, or equity, takes the form of either
common stock or preferred stock. They are rewarded through dividends or residual
claimants.
- Board of Directors

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  Voted individuals who are typically responsible for approving strategic goals and
plans, setting general policy, guiding corporate affairs, and approving major
expenditures.
- Managers
 Managing day-to-day operations and carrying out the policies established by the
board of directors.

Shareholder-director relationships

 Under current company law, the shareholder-director relationship is seen as the

archetypal problem of who should bear responsibility where a principal employs an
agent. Directors are accountable to shareholders, but shareholders are not
responsible for decisions of directors. Directors are only obliged to provide limited
information on company performance to shareholders, in the form of accounts and
associated information at the AGM.

Shareholder-Managers relationships

 Generally few shareholders have direct contact with employees. Employees have
rights enshrined in legislation, and excellent employment conditions in many
companies are a result not just of enlightened self-interest by the directors but of a
wider humanitarian concern, with implicit endorsement from shareholders.

Corporate owners are rewarded for the risks they take by given some incentives. Because
the decision and the risk that had been taken gave much advantages to the company.

10. Define each of the following terms:

a. Proprietorship; Partnership; Corporation
- Sole Proprietorship
 A sole proprietorship is business owned by a single individual who collects all the
profit from it, and maintains all liability for its debt.
Advantages
 It is easily and inexpensively formed; It is subject to few government
regulations, and all of the income and expenses go straight to the owner, who
can report them on their personal income tax forms.
Disadvantages

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  It may be difficult for a proprietorship to obtain the capital needed for growth;
The proprietor has unlimited personal liability for the business’s debts, which
can result in losses that exceed the money invested in the company (creditors
may even be able to seize a proprietor’s house or other personal property)
- Partnership
 A partnership is business wherein two or more individuals share the management,
profit and liability for the company’s debts.
Advantages
 Like a sole proprietorship, a partnership is very simple to setup and run.
Disadvantages
 Regarding liability, the partners can potentially lose all of their personal assets,
even assets not invested in the business, because under partnership law, each
partner is liable for the business’s debts.
- Corporation
 A corporation is a legal entity created under state laws, and it is separate and distinct
from its owners and managers.
Advantages
 Unlimited life—a corporation can continue after its original owners and
managers are deceased; easy transferability of ownership interest—ownership
interests are divided into shares of stock, which can be transferred far more
easily than can proprietorship or partnership interests; and limited liability—
losses are limited to the actual funds invested.
Disadvantages
 Corporate earnings may be subject to double taxation—the earnings of the
corporation are taxed at the corporate level, and then earnings paid out as
dividends are taxed again as income to the stockholders; Setting up a corporation
involves preparing a charter, writing a set of bylaws, and filing the many
required state and federal reports, which is more complex and time-consuming
than creating a proprietorship or a partnership.
b. Limited partnership; Limited Liability Partnership; Professional Corporation
- Limited Partnership
 In a limited partnership, the limited partners can lose only the amount of their
investment in the partnership, while the general partners have unlimited liability.
However, the limited partners typically have no control—it rests solely with the

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 general partners—and their returns are likewise limited. Limited partnerships are
common in real estate, oil, equipment leasing ventures, and venture capital.
- Limited Liability Partnership
 All partners enjoy limited liability with regard to the business’s liabilities, and their
potential losses are limited to their investment in the LLP. Of course, this
arrangement increases the risk faced by an LLP’s lenders, customers, and suppliers.
- Professional Corporation
 These types of corporations do not relieve the participants of professional
(malpractice) liability. Indeed, the primary motivation behind the professional
corporation was to provide a way for groups of professionals to incorporate and
thus avoid certain types of unlimited liability yet still be held responsible for
professional liability. Professionals such as doctors, lawyers, and accountants often
form as this type of corporation.
c. Stockholder Wealth Maximization
Shareholders are the owners of a corporation, and they purchase stocks because they want
to earn a good return on their investment without undue risk exposure. In most cases,
shareholders elect directors, who then hire managers to run the corporation on a day-to-
day basis. Because managers are supposed to be working on behalf of shareholders, they
should pursue policies that enhance shareholder value. Consequently, we operate on the
assumption that management’s primary objective is stockholder wealth maximization.
Therefore, when we say management’s objective should be to maximize stockholder
wealth, we really mean it is to maximize the fundamental price of the firm’s common
stock, not just the current market price.
d. Money Market; Capital Market; Primary Market; Secondary Market
- Money Market
 The money market is where financial instruments with high liquidity and very
short maturities are traded. It is used by participants as a means for borrowing and
lending in the short term, with maturities that usually range from overnight to just
under a year. Among the most common money market instruments are euro dollar
deposits, negotiable certificates of deposit (CDs), bankers acceptances,
U.S. Treasury bills, commercial paper, municipal notes, federal
funds and repurchase agreements (repos).

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 - Capital Market
 The markets for corporate stocks and debt maturing more than a year in the future.
Capital markets channel savings and investment between suppliers of capital such
as retail investors and institutional investors, and users of capital like businesses,
government and individuals.
- Primary Market
 Where securities are created. It's in this market that firms sell (float) new stocks and
bonds to the public for the first time. For our purposes, you can think of the primary
market as the market where an initial public offering (IPO) takes place. Simply put,
an IPO occurs when a private company sells stocks to the public for the first time.
The primary market is also the market where governments or public sector
institutions raise money through bond offerings. The important thing to understand
about the primary market is that securities are purchased directly from an issuing
company.
- Secondary Market
 Markets in which existing, already outstanding securities are traded among
investors. The national exchanges, such as the New York Stock Exchange (NYSE)
and the NASDAQ, are secondary markets. Secondary markets also exist for bonds,
mortgages, and other financial assets. The corporation whose securities are being
traded is not involved in a secondary market transaction and, thus, does not receive
any funds from such a sale.

e. Private Markets; Public Markets; Derivatives

- Private Markets
 Markets in which transactions are worked out directly between two parties and
structured in any manner that appeals to them. Bank loans and private placements
of debt with insurance companies are examples of private market transactions.
- Public Market
 Markets in which standardized contracts are traded on organized exchanges.
Securities that are issued in public markets, such as common stock and corporate
bonds, are ultimately held by a large number of individuals.

Financial Management – Assignment I |9

 - Derivatives
 A security with a price that is dependent upon or derived from one or more
underlying assets. The derivative itself is a contract between two or more parties
based upon the asset or assets. Its value is determined by fluctuations in the
underlying asset. The most common underlying assets
include stocks, bonds, commodities, currencies, interest rates and market indexes.
f. Investment Banker; Financial Services Corporation; Financial Intermediary
- Investment Banker
 An individual who works in a financial institution that is in the business primarily
of raising capital for companies, governments and other entities, or who works in a
large bank's division that is involved with these activities, often called
an investment bank. Investment bankers may also provide other services to their
clients such as mergers and acquisition advice, or advice on specific transactions,
such as a spin-off or reorganization.
- Financial Services Corporation
 A corporation that offers a wide range of financial services such as brokerage
operations, insurance, and commercial banking.
- Financial Intermediary
 Intermediary that buys securities with funds that it obtains by issuing its own
securities. An example is a common stock mutual fund that buys common stocks
with funds obtained by issuing shares in the mutual fund.
g. Mutual Fund; Money Market Fund
- Mutual Fund
 Corporations that accept money from savers and then use these funds to buy
financial instruments. These organizations pool funds, which allows them to reduce
risks by diversification and achieve economies of scale in analysing securities,
managing portfolios, and buying/selling securities.
- Money Market Fund
 A mutual fund that invests in short-term debt instruments and offers investors
check-writing privileges; thus, it amounts to an interest-bearing checking account.

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11. What is a firm’s fundamental, or intrinsic, value? What might cause a firm’s intrinsic
value to be different than its actual market value?
Firm’s fundamental and intrinsic value could be defined as firm’s real or actual value
(worth) based on an underlying perception of its true value including all aspect of business
(investopedia, 2010). Fundamental analysis helps to determine firm’s fundamental value.
To identify firms fundamental value, fundamental analysis analyze the firm’s financial
information such as income statement, balance sheet, and cash flow statement and other
factors such as firm’s competitive advantage, earning growth, sales revenue growth, market
share, financial reserve, and quality of management. There is a significant difference
between intrinsic value and market value. Intrinsic value is an estimate of the actual true
value of a company. Market value is the value of a company as reflected by the company's
stock price. Therefore, market value may be significantly higher or lower than the intrinsic
value. The market value is usually higher than the intrinsic value if there is strong investment
demand, leading to possible overvaluation. The opposite is true if there is weak investment
demand, which can result in undervaluation of the company.

12. Edmund Enterprises recently made a large investment to upgrade its technology.
Although these improvements won’t have much of an impact on performance in the
short run, they are expected to reduce future costs significantly. What impact will this
investment have on Edmund Enterprises’ earnings per share this year? What impact
might this investment have on the company’s intrinsic value and stock price?
Since firm has recently invested large capital to upgrade their technology, earning per share
of the firm will go down. The reason why firms earning per share go down is that the firm has
less money (as expenses goes up, profit decreases due to capital investment) to distribute
dividends to the shareholders. The intrinsic value of firm may increase due to positive future
perception of investor towards firm that firms future cash flow will increase due to the change
in technology. Since investors have positive perception towards firm, the demand of stock
goes up as a result intrinsic value and stock price go up.

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13. Describe the different ways in which capital can be transferred from suppliers of
capital to those who are demanding capital.
Capital
Capital refers to financial assets or the financial value of assets, such as funds held in deposit
accounts, as well as the tangible machinery and production equipment used in environments
such as factories and other manufacturing facilities.

Capital includes:
- Facilities (the buildings used for the production & storage of the manufactured goods).
- Materials (used and consumed as part of the manufacturing process do not qualify).

In a well-functioning economy, capital will flow efficiently from those who supply capital
to those who demand it. This transfer of capital can take place in three different ways:
1) Direct transfers of money and securities occur when a business sells its stocks or bonds
directly to savers, without going through any type of financial institution. The business
delivers its securities to savers, who in turn give the firm the money it needs.
2) Transfers may also go through an investment banking house which underwrites the issue.
An underwriter serves as a middleman and facilitates the issuance of securities. The
company sells its stocks or bonds to the investment bank, which in turn sells these same
securities to savers. The businesses' securities and the savers' money merely "pass
through" the investment banking house.
3) Transfers can also be made through a financial intermediary. Here the intermediary
obtains funds from savers in exchange for its own securities. The intermediary uses this
money to buy and hold businesses' securities. Intermediaries literally create new forms
of capital. The existence of intermediaries greatly increases the efficiency of money and
capital markets.

14. What are financial intermediaries, and what economic functions do they perform?
Financial Intermediary
Financial intermediary is an entity that helps to ensure that the funds supplied by the sources
of capital are made available to those who need them (the users of capital). Financial
intermediaries offer a number of benefits to the average consumer, including safety,
liquidity, and economies of scale involved in commercial banking, investment banking and
asset management.

F i n a n c i a l M a n a g e m e n t – A s s i g n m e n t I | 12
 Financial intermediaries are financial institution like banks, insurance company, investment
banks or pension funds. A financial intermediary offers individuals or firms to save or
borrow money. For example, if you need to borrow money you can do it by your own and
try to find somebody who will give you a lone. This will be time consuming much easier is
it then to go to a bank or a institutions to get a loan or to invest money.

15. What is a firm’s intrinsic value? Its current stock price? Is the stock’s “true long-run
value” more closely related to its intrinsic value or its current price. Is it better for a
firm’s actual stock price in the market to be under, over, or equal to its intrinsic value?
Intrinsic Value
The intrinsic value is the actual value of a company or an asset based on an underlying
perception of its true value including all aspects of the business, in terms of both tangible
and intangible factors. This value may or may not be the same as the current market value.
Additionally, intrinsic value is primarily used in options pricing to indicate the amount an
option is in the money.

A firm’s intrinsic value is an estimate of a stock’s “true” value based on accurate risk and
return data. It can be estimated but not measured precisely. A stock’s current price is its
market price-the value based on perceived but possibly incorrect information as seen by the
marginal investor. From these definitions, you can see that a stock’s “true” long-run value
is more closely related to its intrinsic value rather than its current price (market price).

It is better that the actual stock price and intrinsic value to be equal, however intrinsic value
is a long run concept. If a stock's market price and intrinsic value are equal, then the stock
is in equilibrium, and there is no pressure (for buying/selling) to change the stock's price.
Therefore maximizing the intrinsic value will maximize the average price over the long
term, but not necessarily the current price at each specific point in time.

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 REFERENCES
Books
C.E, Michael & F.B, Eugene (2014) Financial Management: Theory and Practice, 13th edition,
USA

Internet Source
Finance
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https://en.wikipedia.org/wiki/Finance

The Impact of Finance on Business Growth

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http://smallbusiness.chron.com/impact-finance-business-growth-4506.html

Introduction to Managerial Finance

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Corporate Governance
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http://www.investopedia.com/terms/c/corporategovernance.asp

Governance and Agency

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https://quizlet.com/11235252/14-governance-and-agency-flash-cards/

Teori Keagenan (Agency Theory)

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https://bungrandhy.wordpress.com/2013/01/12/teori-keagenan-agency-theory/

The threat of takeover when a firms internal

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https://www.coursehero.com/file/p6jtksm/The-Threat-of-Takeover-When-a-firms-
internal-corporate-governance-structure-is/

Introduction to Managerial Finance

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Assignment%20I/Part_Introduction_to_Managerial_Finance.pdf

Finance and Business

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Risk, Reward and Responsibility: Limited liability and company reform by Michael Schluter
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 http://www.jubilee-centre.org/risk-reward-and-responsibility-limited-liability-and-
company-reform-by-michael-schluter/

Sole Proprietorship vs. Partnership vs. Corporation

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http://www.business-opportunities.biz/2014/11/06/sole-proprietorship-vs-partnership-vs-
corporation/

Money Market
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http://www.investopedia.com/terms/m/moneymarket.asp

Capital Market
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http://www.investopedia.com/terms/c/capitalmarkets.asp

A Look At Primary And Secondary Markets

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Secondary Market
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http://www.investopedia.com/terms/s/secondarymarket.asp

Derivative
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http://www.investopedia.com/terms/d/derivative.asp

Investment Banker
Retrieved from
http://www.investopedia.com/terms/i/investmentbanker.asp

What is the difference between intrinsic value and current market value?
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http://www.investopedia.com/ask/answers/011215/what-difference-between-intrinsic-
value-and-current-market-value.asp

Financial Intermediary
Retrieved from
http://www.investopedia.com/terms/f/financialintermediary.asp

Capital
Retrieved from
http://www.investopedia.com/terms/c/capital.asp

F i n a n c i a l M a n a g e m e n t – A s s i g n m e n t I | 15
Explain it is better for a firms stock price to be
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https://www.coursehero.com/file/p71jo4/Explain-It-is-better-for-a-firms-stock-price-to-
be-equal-to-its-intrinsic-value/

What are financial intermediaries and what

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https://www.coursehero.com/file/p5ar3br/1-6-What-are-financial-intermediaries-and-
what-economic-functions-do-they/

What are the economic functions financial intermediaries perform?

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https://www.reference.com/world-view/economic-functions-financial-intermediaries-
perform-cbf1c9023aca97de

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