BUSINESS

FINANCE FINS1613
Tutorial Week2

CONTACT DETAILS
YourTutor: PeterAndersen peter.andersen@unsw.edu.au
Besuretocheckyourstudentemailaccountlotsthroughoutthe semester,asIllbesendingyoumyslidesandlotsofothermaterials.

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CONTACTING STAFF
Guidelines: AnyemailedquestionsshouldbesenttoonlyONEstaffmember. Dontspamallofus. Wehavelivesoutsideofteaching,sodontexpectinstantreplies. Thatsprettymuchit.

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ASSESSMENTS
ASSESSMENT TutorialAttendance+ Participation Tutorial Quizzes Final Exam DATE Everyweek Weeks 4,7,10and13 Exam Period HOWMUCH 10% 40% 50%

Youmustattendatleast80%ofyourtutorialsinordertobeeligibleforspecial considerationinthefinalexam.
i.e.ifyoudontmake80%ofyourclasses,andthengetsickandcantmakethefinal,itsunlikelyyoull gettositasupplementaryexam.

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CLASS PARTICIPATION
COMPONENT HOWTOGETIT HOW MUCH

Active Participation

Answering questionsandcontributingtoclass.
(doingthehomeworkandnotsayinganythinginclass DOESNOTCOUNT asparticipation)

5%

Showingup ontime everyweek.

(ontimeisby10minutespastthehouratthelatest)

Attendance

(ifyouwalkinaftertherollhasbeencalled,donotwait untiltheendoftheclasstomakesurethetutormarksyou present)

5%

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CLASS PARTICIPATION CLARIFICATION

Classparticipationmarksaredesignedforyoutodemonstratethat youhaveprepared andthoughtabouttheassignedtutorial materialpriortoclass. Whenyouadequately attempted(notjustguessed)aquestionin class,thetutorwillrecordnexttoyournamethatyouhave participatedfortheweek. Ifyouhaveparticipatedinclassandarenotsurethatyour participationwasrecordedatthetime,theresponsibilityisyours tocheckwiththetutorthatitgetsrecordedattheendofthat tutorial(NOTattheendofsemester).

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LETS BEGIN
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TUTORIAL QUESTION 1
Q. Whichofthesecouldexplainwhysomeonewouldchoosetooperateasa soleproprietorshipratherthanasacorporation? Yourchoices: a) Soleproprietorshipshavelimitedliability b) Therearerelativelyfewrulesrelatingtotheestablishmentandrunningof asoleproprietorship c) Thefirmcanlastforever d) Itiseasytoraiselargesumofmoney e) Alloftheseanswers

A.

AnswerisB
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TUTORIAL QUESTION 2
Q. Theprimarygoalofapubliclyownedfirminterestedinservingits stockholdersshouldbeto: Yourchoices: a) Maximizeexpectedtotalcorporateprofit. b) MaximizeexpectedEPS. c) Minimizethechancesoflosses. d) Maximizethestockpricepershare. e) Maximizeexpectednetincome.

A.

AnswerisD
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TUTORIAL QUESTION 2 EXPLANATION

Answersa),b)ande)aretalkingabouttheprofitofthecompany.
EPSisEarningsPerShare(orNetIncome/#sharesoutstanding) Companiescanmaximizeprofitbycuttingexpensesorsellingproductiveassetsina particularyearandhurtthevalueofthecompanyindoingso. e.g.ApplenotreinvestinganyoftheirrevenuefromtheiPhone5into$&Dexpenses fordevelopinganiPhone6oraniPad 4.Thiswillincreasetheirprofitthisyearbut hurttheircompetitivepositionandthevalueofthecompany Ifaninvestorwantedtominimizetheriskoflosses,theywouldinvestinabank depositoragovernmentbondandgetamuchsafer(butlower)rateofreturn. Investorsputtheirmoneyatriskinthesharemarket knowingthatitisarisky investment,butexpectingtobecompensatedwithanonaveragehigherreturnthan youcangetfromasafeinvestment. Sothegoalofthecompanyshouldntbetominimizerisk.

Investorsdontinvestinsharestominimizethechancesoflosses,likeinc).

Thegoalofthecorporationistomaximizethewealthofitsstockholders, andthisisdonethroughmaximizingtheshare/stockprice.
Thesharepricerepresentsthevalueoftheownersinvestmentinthecompany. Increasesinthesharepricereflectincreasesintheownerswealth.

AnswerisD
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TUTORIAL QUESTION 3
Q. Thevaluethatthefinancialmarketsplaceonacompanysdebtandequity securitieswilldependonthe: Yourchoices: a) Standarddeviationsofthereturnsfrominvestmentsinthosesecurities. b) Riskandexpectedreturnfrominvestmentsinthosesecurities. c) Expectedreturnfrominvestmentsinthosesecurities. d) Interestrateonthedebtsecurities. Answersc)andd)refertotheratesofreturn. Standarddeviationina)referstoameasureofrisk. Howeveritistheinteractionofthetwothatdeterminesthevalueofan investment. Allelsebeingequal,returnincreasesthevalueofaninvestment,risk decreasesit.
AnswerisB
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A.

TUTORIAL QUESTION 4
Q. A. Shareholdersinacompanyhavelimitedliability,whichmeansthat: Yourchoices: a) Shareholderscanbecalledupontocontributeonlytheamountunpaidon sharesheldinthecompany. b) Themaximumtheshareholderscanbecalledupontocontributeisthe currentmarketpriceoftheshares. c) Shareholderscanneverbecalledupontomakeanadditionalcontribution tothecompanysassets. d) Shareholdershavelittleorlimitedinterestintheactivitiesof managementofthecompany,becausethemanagementandownership ofthefirmareseparated.

AnswerisA
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TUTORIAL QUESTION 4 EXPLANATION

a) Shareholderscanbecalledupontocontributeonlytheamountunpaid onsharesheldinthecompany.
Thecompanymayissuenewsharesonapartlypaidbasis. i.e.youagreetopay$10/share,butthecompanyonlyrequires$7/shareinitially. Ifthecompanybecomesinsolvent(assets<liabilities),theshareholdersareliablefor theremainingamountunpaidof$3/sharetothecompanyscreditors.

b) Themaximumtheshareholderscanbecalledupontocontributeisthe currentmarketpriceoftheshares.
Thecompanyscurrent(market)sharepriceisirrelevant. Onceyouhavefullypaidforyourshares,youarenotliableforanyadditional contribution.

c)

Shareholderscanneverbecalledupontomakeanadditionalcontribution tothecompanysassets.
Thisisnotstrictlytrue,ifweconsidertheamountunpaidtalkedaboutina).

d) Shareholdershavelittleorlimitedinterestintheactivitiesof managementofthecompany,becausethemanagementandownership ofthefirmareseparated.

Theshareholdersstilldocareabouttheactionsofmanagement,eventhoughthose shareholdersarenotinvolveddirectlyindecisionmaking.
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TUTORIAL QUESTION 5
Q. Whichofthefollowingdoesnotrepresentanagencycostresultingfromthe separationofownershipfromcontrolofthefirm? Yourchoices: a) Theexpenseofprovidingmanagementwithbonusesbasedon profitability. b) ThecostofacompanydirectortakingabusinesstriptoHawaiiwithno potentialbenefittothecompany. c) ThecostofastaffChristmaspartydesignedtoenhancestaffmorale. d) Thecostofmonitoringtheactivitiesofmanagementtokeeptrackofits expendituresanddecisions.

A.

AnswerisC
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TUTORIAL QUESTION 5 EXPLANATION

Broadly,anagencyproblem: Involvestwoparties:aprincipalandanagent. Theprincipalemploystheagenttoactontheirbehalf. Buttheagentisapersontoo,andmaychoosetousetheirpositionof responsibilitytoactintheirownselfinterestinsteadoftheprincipals. e.g.Theuniversity(theprincipal)hiresme(theagent)toteachyou,butI havemyownselfinterestandmaywanttoturnuplateandtomakeyou dogroupworkinsteadofteachingyouproperlyastheuniversitywants. Anagencycostbetweenshareholders(principal)andmanagers(agent): Iswealthlostbyshareholdersduetothisagencyrelationship. Canbethoughtofasthecosttothecompanyfrom:
Managementwastingcompanymoneyontheirownpersonalsatisfactioninsteadof onmaximizingshareholderwealth;OR Spendingcorporatemoneyonmonitoringmanagementcloselytomakesurethey dontwastemoney. Havingtospendmoneytoincentivizemanagementtoactintheinterestof shareholdersinsteadoftheirownselfinterest.
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TUTORIAL QUESTION 5 EXPLANATION

a) Theexpenseofprovidingmanagementwithbonusesbasedon profitability.
Exampleofhavingtospendmoneytoincentivizemanagementtoactintheinterest ofshareholdersinsteadoftheirownselfinterest.

b) ThecostofacompanydirectortakingabusinesstriptoHawaiiwithno potentialbenefittothecompany.
Exampleofmanagementwastingcompanymoneyontheirownpersonalsatisfaction insteadofonmaximizingshareholderwealth

d) Thecostofmonitoringtheactivitiesofmanagementtokeeptrackofits expendituresanddecisions.
Exampleofspendingcorporatemoneyonmonitoringmanagementcloselytomake suretheydontwastemoney.

c)

ThecostofastaffChristmaspartydesignedtoenhancestaffmorale.
Thisisalsoanagencycosttothecompany,justlikeanswersa),b)andd)above. Itismoneyspentinordertoencouragestafftodothejobthattheyarehiredto work,ratherthanactingintheirownselfinterest.Lowmorale=unproductivestaff. However,thistypeofagencycostwillbepresentregardlessofwhetherthereis separationofownershipandcontrol(i.e.inacoporation)ornot(i.e.inasole proprietoriship orpartnership)
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TUTORIAL QUESTION 6
Q. Partnershipsareacommonformofbusinessentityforsmallservice businessesbecause: Yourchoices: a) theyprovidelegalprotectionfortheproprietorfromthecreditorsofthe firm. b) theyareidealforwherethebusinessisownedbyoneperson. c) therearenolegalrequirementsthatneedtobemettoforma partnership. d) theyallowthecompanytobuy,ownandsellproperty.

A.

AnswerisC
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TUTORIAL QUESTION 7
Q. A. Theconceptofinvestorsbeingriskaversemeansthat: Yourchoices: a) investorswillalwayspreferaninvestmentthatcarrieslessrisk. b) investorsrequirehigherreturnstocompensateforcarryingmorerisk. c) theinvestmentsriskisthepredominantfeatureconsideredbythe investor. d) investorswillmakeallpossibleattemptstoavoidsystematicrisk. LikeinQ2,investorsdontinvesttominimizethechancesoflosses. Ariskaverseinvestorisonethatdislikesrisk.Outoftwoalternativeswith anequalreturn,ariskaverseinvestorwouldpaymorefortheinvestment oflowerrisk. However,ariskaverseinvestorwillstillinvestinariskierinvestmentifthe expectedreturnisgreatenoughtocompensatefortheadditionalrisk.
AnswerisB
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CHAPTER 1 CTCR QUESTION 1

Q. Whatarethethreetypesoffinancialmanagementdecision?Foreachtype, giveanexampleofabusinesstransactionthatwouldberelevant: Capitalbudgeting,capitalstructure,andworkingcapitalmanagement. Exampleofcapitalbudgeting(ortheinvestmentdecision): Decidingonwhethertoexpandamanufacturingplant. Decidingonwhethertoreplaceanoldpieceofmachinerywithanewone. Decidingwhetherornottodevelopanewproductline. Exampleofcapitalstructure(orthefinancingdecision): Decidingbetweenraisingmoneybyissuingequity(shares)orwithdebt. Decidingbetweenborrowingmoneythroughbondsorabankloan. Exampleofworkingcapitalmanagement: Decidingwhethertogiveyourcustomers30,60or90daystopayyou. Decidinghowmuchinventorytoholdinyourwarehouse.
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A.

CHAPTER 1 CTCR QUESTION 2

Q. Whatarethefourprimarydisadvantagestothesoleproprietorshipand partnershipformsofbusinessorganization?Whatbenefitsarethereto thesetypesofbusinessorganizationasopposedtothecorporateform? Disadvantages: Unlimitedliability
Ifthebusinesscantaffordtopayitsdebts,thebank/creditorscantakethepersonal assetsoftheowners(e.g.house/car/yacht/dog) Ifyouownawholebusinessorareapartnerinabusiness,youtypicallyhavetofind someonewithenoughmoneyANDexpertiseinthatindustrytobuythatwhole businessfromyou. Ifyouwanttoraisemoreequity,youneedtofindanewpartnerthathasenough moneytoinvesttomakeitworthwhile. Ifyourunasmallbusinessandyouunexpectedlydie,unlessyourchildrenhavethe knowledge/interesttocontinuethebusinessitislikelytoceasetoexist.
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A.

Difficulttotransferownership

Hardertoraisecapital

Limitedlife.

CHAPTER 1 CTCR QUESTION 2

Q. Whatarethefourprimarydisadvantagestothesoleproprietorshipand partnershipformsofbusinessorganization?Whatbenefitsarethereto thesetypesofbusinessorganizationasopposedtothecorporateform? Advantages: Lessregulation
BecauseyourenottakinginvestmentsfrompotentiallymillionsofMumandDad investors,thegovernmentplaceslessofaregulatoryburdenonpartnerships Thiseliminatesagencycosts.Asanowner/manager,youdonthavetoworryabout whetherthemanageryouhavehiredisrunningthecompanyintheirownself interestinsteadofinyours.

A.

Theownersarealsothemanagers

Sometimespersonaltaxratesarebetterthancorporatetaxrates

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CHAPTER 1 CTCR QUESTION 3

Q. Whatistheprimarydisadvantageofthecorporateformoforganization? Nameatleasttwoadvantagesofthecorporateform. Theprimarydisadvantageofthecorporateformisthedoubletaxationof profits(inaclassicaltaxjurisdictionliketheU.S.). First,thecompanypaystaxtothegovernmentonitsprofits. Second,whenthatmoneyispaidoutasdividendstoshareholders,the company Thesecondmaindisadvantageistheagencycostsrelatedtotheseparationof ownershipofthecompanyfromcontrolofthecompany. Advantages: Limitedliability Easeoftransferabilityofownership Abilitytoraisecapital Unlimitedlife.
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A.

THINGS TO DO FOR NEXT WEEK

I. II. III. IV. BuytheRTBWJtextbook! ReadChapters4and5ofRTBWJ! Dotheassignedtutorialmaterials Doallofthebackofchapterquestionstoo.
Advice: UnderstandtheTimeValueofMoneywellassoonaspossible. Itwillhelpyounotonlyinthiscourse(itsprobablythemostimportant concept),butalsoinanyfuturefinancecoursesyouaresillyenoughto take. PutextraeffortintonextweeksmaterialandIpromisethatitwillpay dividends.

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THE END
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