FINC2011 Tutorial 1

BMA Ch.1 Problems 1, 2, 3, 4, 5, 7, 8, 10, 11

1.

Read the following passage: Companies usually buy real assets. These
include both tangible assets such as executive airplanes and intangible assets
such as brand names. To pay for these assets, they sell financial assets such as
bonds. The decision about which assets to buy is usually termed the
investment or capital budgeting decision. The decision about how to raise the
money is usually termed the financing decision. Now fit each of the
following terms into the most appropriate space: financing, real, bonds,
investment, executive airplanes, financial, capital budgeting, brand names.

2.

Which of the following are real assets, and which are financial?
a.

A share of stock. Financial

b.
A personal IOU. Financial
c.
A trademark. Real
d.
A factory. Real
e.
Undeveloped land. Real
f.
The balance in the firm's checking account. Financial
g.
An experienced and hardworking sales force. Real
h.
A corporate bond. Financial

3.

Vocabulary test. Explain the differences between:

a.
Real and financial assets.
Financial assets are cash and securities, whereas real assets represent
tangible possessions
b.
Capital budgeting and financing decisions.
Capital budgeting decisions involve the purchase of real assets, while
financing decisions involve the same of financial assets.
c.
Closely held and public corporations.
Closely held corporations has its shares privately held and are not
publicly traded. Public corporations has its shares traded in public
markets.
d.
Limited and unlimited liability.
The liabilities of the business are automatically those of the owners in
unlimited liability, while in a limited liability, the liability is limited to
the corporation

Which of the following statements always apply to corporations?

a. Unlimited liability.
b. Limited life.
c. Ownership can be transferred without affecting operations.
d. Managers can be fired with no effect on ownership.

In most large corporations, ownership and management are separated. What are
the main implications of this separation?

It allows stockholders to sell their shares to new investors without disrupting

the operations of the business. However it allows managers and directors to act
in their own interests rather than in the stockholders interest.

7. We can imagine the financial manager doing several things on behalf of the firm's
stockholders. For example, the manager might:
a. Make shareholders as wealthy as possible by investing in real assets.
b. Modify the firm's investment plan to help shareholders achieve a particular
time pattern of consumption.
c. Choose high- or low-risk assets to match shareholders' risk preferences.
d. Help balance shareholders' check books.
But in well-functioning capital markets, shareholders will vote for only one of
these goals. Which one? Why?

8. Ms. Espinoza is retired and depends on her investments for her income. Mr. Liu is
a young executive who wants to save for the future. Both are stockholders in
Scaled Composites, LLC, which is building SpaceShipOne to take commercial
passengers into space. This investment's payoff is many years away. Assume it
has a positive NPV for Mr. Liu. Explain why this investment also makes sense for
Ms. Espinoza.
Because the investment has a positive NPV, Ms. Espinoza will have a profit when
the SpaceShipOne has been built.

10. Why might one expect managers to act in shareholders' interests? Give some
reasons.
Managers should make decisions to increase the current value of the companys

shares, this is in itself the shareholders interests.

11. Many firms have devised defences that make it more difficult or costly for other
firms to take them over. How might such defences affect the firm's agency
problems? Are managers of firms with formidable takeover defences more or less
likely to act in the shareholders' interests rather than their own? What would you
expect to happen to the share price when management proposes to institute such
defences?
The first line of defence for a corporation would be to establish stock securities
that have differential voting rights, to provide fewer voting rights to shareholders.
While this is beneficial for the company when a potential acquirer announces its
intentions, other well intentioned shareholders can purchase additional company
stock at a discounted price, which will make it harder for a corporate raider to
take control. In this sense, managers are not acting in the shareholders interests.