Examination in Finance, Essay Example

What is the difference between earnings and cash flow?

Earnings differ from cash flow mainly because of the way in which accrual accounting treats timing differences involving different cash movements and business actions. The main reason for this is that short-term timing different exist with regard to when sales and expenses of firms are recorded versus the time when cash is received or paid out.

Why is shareholder wealth maximization a better objective than maximizing earnings per share?

Maximization of earning per stock is not an objective approach since it does not give accurate information on the duration and timing of the expected returns. The time value of the money invested is difficult to determine. With the wealth maximization approach, there is no need for the time value of money to be calculated. Moreover, very few stockholders would be wiling to buy into a project that promises to pay its first returns within 100 years, no matter the high value attached to the earning per share.

What options does debt give stockholders?

Shareholder debts can be settled through the use of equity that the shareholder holds in a company. Some companies oppose this approach, whereby they prefer to request their shareholders to look for other sources of financing for their debt. A shareholder’s option are determined by the amount of the debt, prospects for a lucrative dividend payout in the near future and whether or not he is on the blink of bankruptcy.

How would the agency problems in a corporation differ from those in a sole proprietorship and a partnership?

Agency problems in corporations differ remarkably from those that are experienced in partnerships as well as sole proprietorships. In corporations, these problems are of a higher magnitude compared to sole proprietorships and in partnerships. This is because more stakeholders’ are involved. Moreover, the government exerts a stronger influence on the way corporations are run, compared to partnerships and sole proprietorships.

In a sole proprietorship, agency problems can be solved with ease because the decision-making process is not long. The same case applies to partnerships. Moreover, in these types of businesses, the amount of money that is at risk is much lesser compared to the amount of money that is at stake in corporations. It is not surprising, therefore, that it is much more expensive to solve corporation agency problems compared to those involving the sole proprietorship or partnership business.

Why are dividends so important in determining the value of a corporation?

Dividends are crucial determinants of a corporation’s value since they are an indicator of the corporation’s ability to pay its main debtors. Dividends are also useful in determining a corporation’s market capitalization. Market capitalization is derived by multiplying the number of stocks that is outstanding and multiplying it with the current price of every share.

Dividends have a direct link with the number and value of preferred stocks. This is beneficial for a corporation since preferred stock may take the form of either debt or equity. The choice of one or the other of these options depends on the nature of every individual issue.

What would a high debt-equity ratio signify?

The high debt/equity ratio means signifies that the financial leverage of a company is high. It indicates that the proportion of equity and debt being used by a company to finance its assets is equally high.

Why are corporations so reluctant to lower dividends?

This is because dividends may act as a public signal relating to how the management of a company anticipates to make future policies relating to the firm’s prospects. Low dividends are regarded as bad news to the public. Rather than giving out this bad news, the corporations would rather wait until the dividend payout improves.

What is the importance of an acid-test ratio?

The ratio is a key indicator of a corporation’s financial integrity. It indicates whether a firm is in possession of enough assets that can cover for all immediate liabilities without having to sell inventory. The ratio is more strenuous to calculate than a working capital ratio, mainly because in the working capital ratio, an allowance for inclusion of inventory assets is given.

Companies that have a ratio that is below 1 cannot afford to pay all their current liabilities. Therefore, they need to be look at with utmost caution. If the acid-test ratio is lower than a company’s working ratio, this indicates that all the current assets are largely dependent on the existing inventory.

Briefly explain the variables that financial managers focus on

Financial managers focus on economic and political environments in areas where their businesses operate or where they plan to extend their businesses. They carry out comparative assessments of these variables in order to determine the areas where business investments carry the lowest risks and the highest returns.

Additionally, financial managers use sales and purchases forecasts when they are developing budgets. They also factor in the influence of various costs, changes in the market trends, and consistency in production when they are assessing future revenues.

Please explain why financial instruments are so specialized

Financial instruments are highly specialized mainly because many different variables have to be put into consideration simultaneously. Since it is impossible for one financial analyst to consider many variables at the same time, specialization becomes a necessary undertaking.

Moreover, there is always a need to monitor the behavioral characteristics of different structured credit instruments in order to account for different write-downs and losses that may be incurred in the course of doing business. Monitoring is necessary for purposes of preventing major shocks arising from major economic crises in different economies.