group coursework- mba i

7/24/2019 Group Coursework- MBA I

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a) Managerial actions to maximize shareholders wealth.

Whereas Freeman (1984) defned shares as a unit o ownership interest in acorporationor fnancial asset, he urther defned Shareholders wealth as themarket capitaliation o the pu!lic corporation" #his market capitaliation isthe num!er o e$uit% shares outstandin& multiplied !% the share price at thetime o calculation" 'arket capitaliation is an estimate, !% capital markets,o the net worth o the frm" #he market capitaliation reects the frmstan&i!le assets plus the uture epected residual re*enue, which ma% !edistri!uted as di*idends or kept as retained earnin&s"

Shareholder wealth maimiation means maimiin& the net present *alue oa course o action to shareholders" +et present *alue or wealth o a course oaction is the dierence !etween the present *alue o its !enefts and thepresent *alue o its cost" - fnancial action that has a positi*e net present

*alue creates wealth or shareholders and thereore is desira!le" - fnancialaction resultin& in ne&ati*e +./ should !e re0ected since it would causefnancial lost to shareholders" ence aectin& Shareholder wealth" 2etweenmutuall% eclusi*e pro0ects, the one with the hi&hest +./S should !eadopted" +./S o a frms pro0ects are additi*e in nature"

+./ (-) 3+./ (2) +./ (-32)

#he shareholder wealth maimiation principle states that the immediateoperatin& &oal and the ultimate purpose o a pu!lic corporation is and should!e to maimie return on e$uit% capital" #he shareholder wealth

maimiation specifcation o what is oten termed the corporate o!0ecti*emakes operatin& &oal and ultimate purpose the same5 'ana&ers andin*estors should ocus on shareholder wealth maimiation"

Projecting earnings per share.

#he mana&ement must consider the matter o total corporate profts *ersusearnings per share (EPS). 'ana&ement should !e a!le to pro0ect the 6.Sin order to maimie shareholders wealth. For eample, suppose 7kello had million shares outstandin& and earned 1,: million, or 4 per share" ;%ou owned 1 shares o the stock, %our share o the total profts would !e4" +ow suppose 7kello sold another million shares and in*ested theunds recei*ed in assets that produced million o income" #otal incomewould rise to 1,


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its current stockholders, it should concentrate on earnin&s per share ratherthan on total corporate profts"

Timing of the earnings stream.

Aetermination o maimiation o epected earnin&s per share alwa%smaimie stockholder welare, other actors should !e considered, #hinka!out the timin& o the earnin&s" Suppose 7kello had one pro0ect that wouldcause earnin&s per share to rise !% ": per %ear or f*e %ears, or 1= intotal, while another pro0ect would ha*e no eect on earnin&s or our %ears!ut would increase earnin&s !% 1":


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the% also like the &rowth in 6.S that results rom plowin& earnin&s !ack intothe !usiness" #he fnancial mana&er must decide eactl% how much o thecurrent earnin&s to pa% out as di*idends rather than to retain and rein*est,this is called the diidend polic" decision.#he optimal di*idend polic% isthe one that maimies the frms stock price"

*orporate Social $esponsi'ilit"

-nother issue that deser*es consideration is social responsi!ilit%5 Shouldmana&ers operate strictl% in their stockholders !est interests, or are frmsalso responsi!le or the welare o their emplo%ees, customers, and thecommunities in which the% operateG Dertainl% frms ha*e an ethicalresponsi!ilit% to pro*ide a sae workin& en*ironment, to a*oid pollutin& theair or water, and to produce sae products" owe*er, sociall% responsi!leactions ha*e costs, and it is $uestiona!le whether !usinesses would incurthese costs *oluntaril%" ; some frms do act in a sociall% responsi!le manner

while others do not, then the sociall% responsi!le frms will !e at adisad*anta&e in attractin& unds"

-&enc% relationship

-n a&enc% relationship eists when one or more people (the principals) hireanother person (the a&ent) to perorm a Ser*ice and then dele&ate decisionmakin& authorit% to that a&ent" ;mportant a&enc% relationships eist (1)!etween Stockholders and mana&ers and (:) !etween stockholders andcreditors (de!t holders)"

- potential agenc" pro'lem arises whene*er the mana&er o a frm ownsless than 1 o the frms common stock" ; a frm is a proprietorshipmana&ed !% the owner, the mana&er will presuma!l% operate the !usiness ina ashion that will impro*e his or her own welare, with welare measured inthe orm o increased personal wealth, more leisure" owe*er, i themana&er incorporates and sells some o the frms stock to outsiders, apotential conict o interests immediatel% arises" For eample, the mana&ermi&ht now decide not to work as hard to maimie shareholder wealth!ecause less o this wealth will &o to him or her, or decide to take a hi&hersalar% or en0o% more !onuses !ecause part o those costs will all on theoutside stockholders" #his potential conict !etween two parties, the

principals (outside shareholders) and the a&ent (mana&er) is an a&enc%pro!lem"

;n &eneral, i a conict o interest eists, what can !e done to ensure thatmana&ement treats the outside stockholders airl%G Se*eral mechanisms areused to moti*ate mana&ers to act in the shareholders !est interests" #heseinclude (1) #he threat o frin&, (:) the threat o takeo*er and () mana&erialcompensation plans"


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1" The threat of +ring. ;t wasnt lon& a&o that the mana&ement teams olar&e frms elt secure in their positions, !ecause the chances o !ein&o*erthrown !% stockholders were so remote that mana&ers rarel% elt their0o!s were in Heopard%" #his situation eisted !ecause ownership o most frms

was so widel% distri!uted, and mana&ements control o*er the pro% (*otin&)mechanism was so stron&, that it was almost impossi!le or dissidentstockholders to &ain enou&h *otes to o*erthrow the mana&ers"

:" The threat of ta%eoer.#his is most likel% to occur when a frms stockis under*alued relati*e to its potential" ;n a hostile takeo*er, the mana&ers othe ac$uired frm &enerall% are fred, and an% who are a!le to sta% on losethe power the% had prior to the ac$uisition" #hus, mana&ers ha*e a stron&incenti*e to take actions that maimie stock prices" ;n the words o onecompan% president, B; %ou want to keep control, dont let %our compan%sstock sell at a !ar&ain price"C -ctions to increase the frms stock price and to

keep it rom !ein& a !ar&ain o!*iousl% are &ood rom the standpoint o thestockholders, !ut other tactics that mana&ers can use to ward o a hostiletakeo*er mi&ht not !e"

" Managerial compensation plans. ;ncreasin&l%, frms are !indin&mana&ers compensation to the compan%s perormance, and this moti*atesmana&ers to operate in a manner consistent with stock price maimiation";n the 19s, most perormance@!ased incenti*e plans in*ol*edexec!tie stoc% options, which allowed mana&ers to purchase stock atsome uture time at a &i*en price" 2ecause the *alue o the options was tieddirectl% to the price o the stock, it was assumed that &rantin& options would

pro*ide an incenti*e or mana&ers to take actions that would maimie thestocks price"

-olden Parach!te# Su!stantial !enefts &i*en to a top eecuti*e in thee*ent that the compan% is taken o*er !% another frm and the eecuti*e isterminated as a result o the mer&er or takeo*er" Iolden parachutes arecontracts &i*en to ke% eecuti*es and can !e used as a t%pe o antitakeo*ermeasure taken !% a frm to discoura&e an unwanted takeo*er attempt"2enefts include items such as stock options, cash !onuses, &enerousse*erance pa%or an% com!ination o these !enefts" -lso known as Jchan&e@in@control !enefts"J

golden handsha%e#is a clausein an eecuti*eemplo%ment contract thatpro*ides the eecuti*e with a si&nifcant se*erance packa&ein the case thatthe eecuti*e loses his or her 0o! throu&h frin&, restructurin&, or e*enscheduled retirement" #his can !e in the orm o cash, e$uit%, and other!enefts, and is oten accompanied !% an accelerated *estin& o stockoptions" Iolden handshake is similar to, !ut more &enerous than a &oldenparachute!ecause it not onl% pro*ides monetar% compensation and=or stock

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http://www.investopedia.com/terms/m/merger.asphttp://www.investopedia.com/terms/t/takeover.asphttp://www.investopedia.com/terms/s/severancepay.asphttps://en.wikipedia.org/wiki/Clausehttps://en.wikipedia.org/wiki/Corporate_officerhttps://en.wikipedia.org/wiki/Severance_packagehttps://en.wikipedia.org/wiki/Firinghttps://en.wikipedia.org/wiki/Restructuringhttps://en.wikipedia.org/wiki/Retirementhttps://en.wikipedia.org/wiki/Cashhttps://en.wikipedia.org/wiki/Share_(finance)https://en.wikipedia.org/wiki/Vestinghttps://en.wikipedia.org/wiki/Stock_optionshttps://en.wikipedia.org/wiki/Stock_optionshttps://en.wikipedia.org/wiki/Golden_parachutehttps://en.wikipedia.org/wiki/Golden_parachutehttp://www.investopedia.com/terms/m/merger.asphttp://www.investopedia.com/terms/t/takeover.asphttp://www.investopedia.com/terms/s/severancepay.asphttps://en.wikipedia.org/wiki/Clausehttps://en.wikipedia.org/wiki/Corporate_officerhttps://en.wikipedia.org/wiki/Severance_packagehttps://en.wikipedia.org/wiki/Firinghttps://en.wikipedia.org/wiki/Restructuringhttps://en.wikipedia.org/wiki/Retirementhttps://en.wikipedia.org/wiki/Cashhttps://en.wikipedia.org/wiki/Share_(finance)https://en.wikipedia.org/wiki/Vestinghttps://en.wikipedia.org/wiki/Stock_optionshttps://en.wikipedia.org/wiki/Stock_optionshttps://en.wikipedia.org/wiki/Golden_parachutehttps://en.wikipedia.org/wiki/Golden_parachute


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options at the termination o emplo%ment, it includes the same se*erancepacka&es eecuti*es would &et at retirement"

Stoc%holders ers!s *reditors- second a&enc% pro!lem in*ol*es conicts !etween stockholders and

creditors (de!t holders)" Dreditors lend unds to the frm at rates that are!ased on (1) the riskiness o the frms eistin& assets, (:) epectationsconcernin& the riskiness o uture asset additions, () the frms eistin&capital structure (that is, the amount o de!t fnancin& it uses), and (4)epectations concernin& uture capital structure chan&es" #hese are theactors that determine the riskiness o the frms de!t, so creditors !ase theinterest rate the% char&e on epectations re&ardin& these actors"

The External Enironment-lthou&h mana&erial actions aect the *alue o a frms stock, eternalactors also inuence stock prices" ;ncluded amon& these actors are le&al

constraints, the &eneral le*el o economic acti*it%, the ta laws, andconditions in the stock market" Workin& within the set o eternal constraints,mana&ement makes a set o lon&@run strate&ic polic% decisions that plan auture course or the frm" #hese polic% decisions, alon& with the &eneralle*el o economic acti*it% and the le*el o corporate income taes, inuencethe frms epected profta!ilit%, the timin& o its cash ows, and theire*entual transer to stockholders"

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#he *iew that the corporate o!0ecti*e is and should !e shareholder wealth

maimiation (SW') is a prescripti*e, standard assumption in the economicsand fnance literature" #here are oundations or the principle in utilitarianismand propert% ri&hts" #he stron& orm o the principle is ar&ua!l% notdescripti*el% or instrumentall% deensi!le" #here is reason to think thatmarkets in which stock prices are set are seriousl% imperect"#he principle does not correspond with the actual le&al duties o oKcers anddirectors" #here are o!0ections to strict Shareholder Wealth 'aimiationrom !usiness ethics and corporation law, corporate social responsi!ilit%" #hecorporate o!0ecti*e is !etter understood as constrained maimiation inprinciple, relaed to constrained wealth seekin& in practice (Hensen :1)"

Ii*en compliance with these antecedent conditions, then mana&ementshould attempt to maimie the sustaina!le economic *alue o shareholdersin*estments o*er time" #ime horion is a matter o strate&ic 0ud&ment" #heshareholders must !e concerned to minimie misappropriation o thiseconomic *alue !% mana&ement actin& as sel@interested (i"e", opportunistic)a&ents" -nd such a&ents ma% undermine eorts at meetin& the protot%peconditions"


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') 3inancing *!rrent ssets

Aurin& the normal course o !usiness operations, a compan% will usuall%ha*e read% access to certain sources or fnancin& its current assets to some

etent" -s these sources emer&e in the normal course o !usiness these are

reerred to as LspontaneousL sources" #hese include accrued epenses,

pro*isions and trade credit" -s trade credit is one o the *er% important

sources o fnance, it merits a detailed discussion in its own ri&ht" ;t is taken

up in the ollowin& section while the other two sources are considered !elow"

ccr!ed Expenses

#hese are !asicall% lia!ilities co*erin& epenses incurred on and prior to a

specifed date, pa%a!le at some uture date" #%pical eamples o accrued

epenses are accrued wa&es and salaries" ;n case, a compan% decides to

make pa%ment o wa&es on a monthl% !asis instead o weekl% !asis

(assumin& trade unions accept the polic% chan&e without demur) the amount

o accrued wa&es will increase and the drain on cash resources is deerred !%

three weeks" ;t should !e noted that Laccrued epensesL constitute a small

raction o current lia!ilities and its useulness as a source o fnancin&

current assets is *er% much limited"

Proisions

#hese are !asicall% char&es or an estimated epense" #%pical eamples are

pro*ision or di*idends, pro*ision or taes and pro*ision or pa%ment o

!onus" .ro*isions also do not call or immediate cash drain" #he drain on

cash resources occurs when the actual amount o lia!ilit% is known and paid

or" #he useulness o Lpro*isionsL as a source o fnancin& current assets is

*er% much limited"

Trade *redit

#rade credit or accounts pa%a!les or sundr% creditors are a *er% important

spontaneous source or fnancin& current assets" 7n an a*era&e, trade credit

accounts or a!out 4 percent o current lia!ilities"

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#rade credit has two important acets" #he frst one is to instill confdence in

suppliers !% maintainin& &ood relations supported !% prompt pa%ment" #his

will ena!le a compan% to o!tain trade credit" ;t ma% not !e out o place here

to mention that some o the reputed companies tend to stretch pa%ment to

their suppliers" ;n one instance in*ol*in& an automo!ile manuacturin&

compan%, one o the suppl%in& companies stopped supplies !ecause o

undul% dela%ed pa%ments" #his aspect needs a little ela!oration" #he second

acet o trade credit relates to the cost o trade credit when suppliers pro*ide

an incenti*e in the orm o cash discount or prompt pa%ment" #hese two

aspects are !rie% discussed !elow"

Short4Term 5an% 3inance

#raditionall%, !ank fnance is an important source or fnancin& the current

assets o a compan%" 2ank fnance is a*aila!le in dierent orms" 2ankers are&uided !% the credit worthiness o the customer, the orm o securit% oered

and the mar&in re$uirement on the assets pro*ided as securit%" #hese

aspects will !e discussed !elow"

2ank fnance ma% !e either direct or indirect" Mnder direct fnancin& the !ank

not onl% pro*ides the fnance !ut also !ears the risk" Dash credit, o*erdrat,

note lendin&, purchase=discountin& o !ills !elon& to the cate&or% o direct

fnancin&" When the !ank opens a Netter o Dredit in a*our o a customer,

the !ank assumes onl% the risk o deault !% the customer and the fnance is

pro*ided !% a third part%" 2oth direct and indirect orms o fnance are !rie%

outlined !elow"

*ash *redit

Mnder the cash credit arran&ement, the customer is permitted to !orrow up

to a pre@fed limit called the cash credit limit" #he customer is char&ed

interest onl% on the amount actuall% utilied, su!0ect to some minimum

ser*ice char&e or maintainin& some minimum !alance also known as

compensator% !alance in the cash credit account" -s per the !ankin&re&ulations, the mar&ins are specifed on dierent t%pes o assets pro*ided

as securit%" From the operational *iew point, the amount that can !e

!orrowed at an% time is the minimum o the sanctioned limit and the

*alue=asset as reduced !% the re$uired mar&in" - simple illustration is &i*en

!elow or !etter understandin&"

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/erdraft

7*erdrat arran&ement is similar to the cash credit arran&ement descri!ed

a!o*e" Mnder the o*erdrat arran&ement, the customer is permitted to

o*erdraw upto a pre@fed limit" ;nterest is char&ed on the amount(s)

o*erdrawn su!0ect to some minimum char&e as in the case o cash credit

arran&ement" #he drawin& power is also determined as in the case o cash

credit arran&ement" Aierence !etween cash credit and 7A is that cash

credit account operates a&ainst securit% o in*entor% and accounts

recei*a!les in the orm o h%pothecation=pled&e whereas o*erdrat account

operates a&ainst securit% in the orm o pled&e o shares and securities,

assi&nment o lie insurance policies and sometimes e*en mort&a&e o fed

assets"

0ote 1ending

Mnlike cash credit=o*erdrat accounts which are runnin& accounts, note

lendin& is or a specifed period ran&in& rom two to three months" #he

customer takes a loan a&ainst a promissor% note" ;nterest is char&ed on the

entire amount sanctioned as loan unlike cash credit=o*erdrat arran&ement

where interest is not char&ed on the undrawn portion within the sanctioned

limit" #his is not *er% much in *o&ue like cash credit = o*erdrat arran&ement

which is $uite popular as the lia!ilit% o the loanee is unlimited"

P!rchasing 6 isco!nting of 5ills

Mnder this arran&ement, the !ank pro*ides fnance to the customer either !%

outri&ht purchasin& or discountin& the !ills arisin& out o sale o fnished

&oods" 7!*iousl%, the !ank will not pa% the ull amount !ut pro*ides credit

ater deductin& its char&es" #o !e on the sae side the !anker will scrutinie

the authenticit% o the !ill and the credit worthiness o the concerned

or&aniation !esides co*erin& the amount under the cash credit=o*erdrat

limit"

Mnlike open credit sale o &oods which &i*es rise to accounts recei*a!les, the

!ill s%stem specifes the date !% which the purchaser o &oods has to make

pa%ment" #hus, the !u%er is time@!ound in his pa%ment under this s%stem

which did not fnd much a*our with man% !u%ers" #his is the real reason

!esides stamp duties etc", or the limited success o the !ill market scheme"

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1etter of *redit

Netter o credit is opened !% a !ank in a*or o its customer undertakin& the

responsi!ilit% to pa% the supplier (or the supplierLs !ank) in case its customer

ails to make pa%ment or the &oods purchased rom the supplier within the

stipulated time" Netter o credit arran&ement is !ecomin& more and more

popular !oth in the domestic and orei&n markets" Mnlike in other t%pes o

fnance where the arran&ement is !etween the customer and !ank and the

!ank assumes the risk o non@pa%ment and also pro*ides fnance, under the

letter o credit arran&ement the !ank assumes the risk while the supplier

pro*ides the credit"

Sec!rit"

-s mentioned earlier, !eore takin& a decision to pro*ide fnancial assistanceto a compan% the !ank will consider the credit worthiness o the compan%

and the nature o securit% oered" For pro*idin& accommodation towards

fnancin& the current assets o a compan%, the !ank will ask or securit% in

the orm o h%pothecation and=or pled&e"

Hypothecation: 2% and lar&e, securit% in the orm o h%pothecation is

limited to mo*a!le propert% like in*entories" Mnder h%pothecation

a&reement, the &oods h%pothecated will !e in the possession o the

!orrower" #he !orrower is under o!li&ation to prominentl% displa% that the

items are h%pothecated to such and such a !ank" ;n the case o limited

companies, the h%pothecation char&e is re$uired to !e re&istered with the

Oe&istrar o Dompanies o the state where the re&istered oKce o the

compan% is located"

Pledge: Mnlike in the case o h%pothecation, in a pled&e, the

&oods=documents in the orm o share certifcates, !ook de!ts, insurance

policies, etc", which are pro*ided as securit% will !e in the possession o the

!ank lendin& unds !ut not with the !orrowin& compan%" #hus possession o

items o securit%, distin&uishes pled&e rom h%pothecation" ;n the e*ent odeault !% the !orrowin& compan% either under h%pothecation or pled&e, the

lender can sue the compan% that has !orrowed unds and sell the items o

securit% to realie the amount due"

P!'lic eposits for 3inancing *!rrent ssets

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Oe&ulations imposed on the a*aila!ilit% o !ank fnance ha*e induced man%

companies to eplore alternati*e sources or fnancin& their current assets"

'o!iliation o unds rom &eneral pu!lic, especiall% rom the middle and

upper middle class people, !% oerin& reasona!l% attracti*e rates o interest

has !ecome an important source" #he deposits thus mo!ilied rom pu!lic !%

non@fnancial manuacturin& companies are popularl% known as L.u!lic

AepositsL or LFied depositsL" #hese are &o*erned !% the re&ulations o pu!lic

deposits under the Dompanies (-cceptance o Aeposits) -mendment Oules,

19E8"

*ommercial Paper

Dommercial .apers (D.s) are short@term usance promissor% notes with a

fed maturit% period, issued mostl% !% leadin&, reputed, well@esta!lished,

lar&e corporations who ha*e a *er% hi&h credit ratin&" ;t can !e issued !%!od% corporates whether fnancial companies or non@fnancial companies"

ence, it is also reerred to as Dorporate .aper"

D.s are mostl% used to fnance current transactions o a compan% and to

meet its seasonal need or unds" #he% are rarel% used to fnance the fed

assets or the permanent portion o workin& capital"

3actoring

Factorin& is a Jcontinuin&J arran&ement !etween a fnancial intermediar%

called a JFactorJ and a JSellerJ (also called a client) o &oods or ser*ices"

2ased on the t%pe o actorin&, the actor perorms the ollowin& ser*ices in

respect o the -ccounts Oecei*a!les arisin& rom the sale o such &oods or

ser*ices"

P .urchases all accounts recei*a!les o the seller or immediate cash"

P -dministers the sales led&er o the seller"

P Dollects the accounts recei*a!le"

P -ssumes the losses which ma% arise rom !ad de!ts"

P .ro*ides rele*ant ad*isor% ser*ices to the seller"Factors are usuall% su!sidiaries o !anks or pri*ate fnancial companies" ;t is

to !e noted that actorin& is a continuous arran&ement and not related to a

specifc transaction" #his means that the actor handles all the recei*a!les

arisin& out o the credit sales o the seller compan% and not 0ust some

specifc !ills or in*oices as is done in a !ills discountin& a&reement"

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$E3E$E0*ES

7. 2M P0E8# Financial 'ana&ement 1th

6dition :1 p&4:" 'asem!e Qa!ali5 Financial 'ana&ement R .olic% rd6dition :1" -llen, F" 6" Darletti, and O" 'ar$ue" :E" Stakeholder capitalism,corporate &o*ernance and frm *alue"4" -llen, W" #" 199:" 7ur schiophrenic conception o the !usinesscorporation"

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group coursework- mba i

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