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Financial Management and Analysis

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FINANCIAL MANAGEMENT AND ANALYSIS

Tutor-marked Assignment 1

1.

(a) In your opinion who owns a public listed company? Describe the process by which the owner control the firm's management. What is the main reason that an agency relationship exist in a public listed company? Within this contest what problems could arise?

A public listed company which can usually be recognized as their official title end with the common abbreviation "Bhd". A public listed company has the permission to offer its registered securities for sales to the general public. Shareholders are the legal owners of the public listed company. The ordinary shareholders have voting rights to elect directors, while directors have the responsibility of looking after the interests of all shareholders.

The structure, functions and interrelationship of the firm's management process are shown as below:-

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A public listed company is control by the owner, the ordinary shareholders, who can vote at the Annual General Meeting to appoint or remove the Directors who manage the business. The directors are responsible for the specific functions, e.g. formulating policies, ensuring that the policies are implemented, ensuring that the enterprise has an appropriate structure and sufficient resource to achieve the objectives, and looking after the interest of the shareholders.

The chairman is the head of board of directors. He chairs the board meetings and delivers the annual company report. In some companies, the role of chairman and managing director are combined in a single person. No matter the role is combines or even separate, there has to be a good working relationship between chairman and managing director. Managing Director is a position of considerable power and responsibility. The managing director sees to it that the policies and decisions of the board are translated into actual performance. The managing director runs the company through his department managers. Each of the department managers has charge of an important area of the organization.

As what we discussed earlier, shareholders are the legal owner of a public listed company, however, the large modern corporation has a diffuse and fragmented set of shareholders and control often lies in the hands of directors. It is extremely difficult to marshal thousands of shareholders, each with a small stake in the business, to push for a change. Thus in many firms there are separation of ownership and control. Therefore, another party (the agent) will be engaged to perform some services on their behalf. The shareholders appoint the board of directors to direct the affairs of the company. The board would similarly delegate the duty to managers. In terms of this arrangement therefore, managers are the agent of the board whereas board members are also agents of the shareholders. The agency problem arises when shareholders, directors and managers have conflicting ideas on how the company should run.

If management's goals differ from those of the firm, an agency problem arises and the owners will have to incur agency costs in order to overcome this problem. It appears furthermore that shareholders at the Annual General Meeting concentrate more on statutory issues rather than the goals of management. Managers may put their interest and careers before the interests of the shareholders, and drawing high salaries and expense not fully justified by their performance. The main method employed by the firm and its shareholders to overcome the agency problem is performance driven share and bonus schemes. It is concluded that a performance measure should be used to overcome the agency problem for the benefit of both shareholder and management.

(b) List down and explain the ten major principles that form the basis for effective financial management.

i) THE RISK-RETURN TRADE-OFF - We won't take on additional risk unless we expect to be compensated with additional return

The more risk in an investment the more an investor will demand in expected return. Low levels of uncertainty (low risk) are associated with low potential returns, whereas high levels of uncertainty (high risk) are associated with high potential returns. The expected return on junk bond is greater than on a treasury because the risk is greater.

ii) THE TIME-VALUE OF MONEY - A dollar received today is worth more than a dollar received in the future

The idea that money is more valuable the sooner it is received, because the dollar received today can earn interest up until the time the future dollar is received. Time value of money is dependent not only on the time interval being considered but also the rate of discount used in calculating current or future values.

iii) CASH - NOT PROFITS - IS KING

Profit depends on allocated revenues and costs. It is calculated at the time the sale is booked, rather than when full payment is received. Cash flow is actual revenue or expenditure rates at a particular time. In measuring value we will use cash flows rather than accounting profits because it is only cash flows that the firm receives and is able to reinvest. "A sale is not a sale until it is paid for" and thus it follows that "Profit is not realized until the cash is received".

iv) INCREMENTAL CASHFLOWS - It's only what changes that counts

The relevant cash flows for a project are the incremental cash flows associated with the project. Incremental cash flows represent the difference between the cash flows with the project and the cash flows without the project. In making business decisions we will only concern ourselves with what happens as a result of that decision, whether the firm will be better off or worse off if it undertakes the project. Thus one wants to focus on the changes in cash flows affected by the project.

v) THE CURSE OF COMPETITIVE MARKETS - Why it's hard to find exceptionally profitable projects?

In competitive markets, extremely large

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