Chp 2: Strategic Financial Policy Decisions

Question 1

What are the three decisions associated with maximising shareholder wealth?

Answer 1

1. Investment Decision - identifying and evaluating invesment opportunities
2. Financing Decision - how much debt a company should have and aim to minimise the cost of capital.
3. Dividend Decision - how much surplus cash to pay out to shareholders.

Question 2

What are the three additional risks associated with international investment decisions?

Answer 2

1. Political Risk - adverse effect from government action or changing political relationships
2. Translation Risk - overseas assets reducing in value due to changing currency values
3. Economic Risk - company’s economic vlaue falling due to a drop in competitive strength caused by exchange rate movements

Question 3

What are the three types of financing options for international investments?

Answer 3

1. Loan from a local bank - reduces an entities net assets in a foreign currency and reduces net foreign currency inflows.
2. Overseas Government Loan - may be offered at a cheaper rate to encourage foreign investment.
3. Currency Swap - underwritten by a merchant bank. Involves borrowing in home currency and then swapping with a foreign company.

Question 4

What is the interrelationship between the three decisions for a high growth company?

Answer 4

1. Investment Decision - high levels of capital investment
2. Financing Decision - low levels of debt finance
3. Dividend Decision - low or zero dividend

Question 5

What is the interrelationship between the three decisions for a mature company?

Answer 5

1. Investment Decision - moderate to low levels of capital investment.
2. Financing Decision - high levels of debt finance.
3. Dividend Decision - high dividend payouts

Question 6

Return on Capital Employed

Ratio / formula

Answer 6

(PBIT) /
(Capital Employed)

Capital Employed = Shareholders funds’ + Long-term debt finance

Question 7

Current Ratio

Answer 7

Current Assets /
Current Liabilities

Question 8

Dividend Yield

Formula

Answer 8

((Dividend per share) /
(Market Price per share)) * 100

Question 9

Price/Earnings Ratio (P/E Ratio)

Formula

Answer 9

(Market price per share) /
(EPS)

EPS = Earnings per share

Question 10

What are the four areas that lenders use to assess an entiites credit worthiness?

Answer 10

1. Business Plan - PARTS
2. Financial Ratios - Gearing etc.
3. Cash Flow Forecasts
4. Credit Agencies - lower interest rates given to higher rated companies

Question 11

How is the Business Plan used to assess credit worthiness?

PARTS

Answer 11

1. Purpose - lender assesses if the project is risky
2. Amount - relative to the financial resources of the company
3. Repayment - at the end of the loan or in installments
4. Time Period - longer loans are considered more risky
5. Security - securing asets against the loan makes the loan appear less risky

Question 12

How do regulatory requirements affect financial strategic policy?

Answer 12

1. Price Control - regulator agrees the output price with the industry
2. Profit Control - regulator agrees the maximum profit the industry can make
3. The regulator will also want to promote competition and address any quality and safety concerns

Question 13

What is Thin Capitalisation?

Answer 13

A company with significantly more debt than equity, far above what they could acheive on their own is considered thinly capitalised.

This is ususally a subsidiary and can achieve excessive tax relief on interest payments.