NATIONAL COLLEGE OF BUSINESS AND ARTS

GRADUATE STUDIES
Master in Business Administration
Cubao Campus, Quezon City

In partial fulfilment of the requirements in the subject

FINANCIAL MANAGEMENT
SY: 2022-2023

FINAL EXAMINATION

Submitted by:

Pamela Ann B. Gulfo

Submitted to:

Dr. Ma. Luisa Padlan

Date submitted:

November 8, 2022 – Tuesday

 NATIONAL COLLEGE OF BUSINESS AND ARTS
GRADUATE STUDIES
Master in Business Administration
Cubao Campus, Quezon City

SUBJECT : Financial Management (Friday, 6:00PM-9:30PM)

PROFESSOR : Dr. Ma. Luisa Padlan
STUDENT : Gulfo, Pamela Ann Britania
STUDENT NO. : 2021-30393

Explain /discuss the following:

1. Which type of financial market, dealer or auction, is best suited to expanding

internationally and why?

Answer: Dealer type of financial market is best suited to expanding internationally.

A dealer market is a financial market where dealers post prices, they would be
willing to buy and sell specific securities on their own account. Dealers act as
“market makers” by adding liquidity and are able to create a market by posting their
offer price and bid price electronically.

2. Franklin wants to start his own business and is debating between organizing the
business as a sole proprietorship or a corporation. Explain the pros and cons of
both forms of business.

Answer: If Franklin would start organizing a business, as a Financial Management

student I would suggest that he start as a Sole Proprietor. As what I’ve learned
from our previous discussions, being a sole proprietor will allow Frank to receive
all the profits from the business; decision making will be easier as he is the only
one deciding for the business; it is the easiest and least expensive form of
ownership to organize; subject to few government regulations; and subject to lower
income taxes than are corporations. However, since Frank solely owns the
business, he is also bounded to the following limitations: unlimited liability if
anything happens in the business; personal assets are at risk; decision making
may also be a disadvantage if it will be done poorly; life of the business is limited
to the life of the individual who created it; and difficulty in obtaining funds for capital
which may require securing loans from banks with high interest rates.

3. Give an example of a potential agency problem for a corporation and identify

means by which the firm can help reduce or eliminate that problem.

Answer: For a corporation, a potential agency problem that would likely to occur
is the conflict of interest between a company's management and the company's
stockholders. The clash between self-serving interests and professional duties or
 NATIONAL COLLEGE OF BUSINESS AND ARTS
GRADUATE STUDIES
Master in Business Administration
Cubao Campus, Quezon City

responsibilities. Managers’ personal goals may compete with shareholder’s wealth

maximization. Specifically, managers might be more interested in maximizing their
own wealth than their stockholders’ wealth; therefore, managers might pay
themselves excessive salaries. To curb or eliminate this problem, there are
motivational tools that may be implemented by the corporation which includes
reasonable compensation packages and semestral performance evaluation of
managers.

4. You are trying to compare the financial performance of your firm to that of similar
firms. What are some of the key problems you might encounter in doing this
comparison?

Answer: Some of the key problems that I may encounter in comparing the financial
performance of my firm between similar firms is the right financial statement
analysis to use. Since there is no underlying theory to help me identify which items
or ratios to look at and to guide me in establishing a benchmark. In addition, in
selecting a comparative data source, I should be sure that my emphasis is similar
to that of the agency whose ratios I plan to use because there are often definitional
differences in the ratios presented by different sources, so before using a source,
I should be sure to verify the exact definitions of the ratios to ensure consistency.
Another problem I might encounter in comparing financial performance is the
different accounting practices used by the firm. This can also possibly distort the
comparison of financial performance of firms. Furthermore, some companies may
also use the “Window Dressing” Technique. It is a technique employed by firms to
make their financial statements look better than they really are.

5. Since there are no perfect or ideal standard ratios for a firm, why is ratio analysis
still considered a valuable management tool?

Answer: Ratio analysis is a type of comparing approach designed to decipher data

and information from financial reports and thereby aid in evaluating the financial
health and performance of firms. This method is employed by both internal users
like management and external users like investors and financial experts. The five
most common categories of ratio analysis used by financial professionals are
profitability, liquidity, leverage, solvency, and activity ratio. Due to a variety of
factors, ratio analysis is still regarded as an effective management technique
today. In general, it supports organizations in making smart and correct decisions
by assisting with suitable analysis and management control decision-making.
Businesses check the relationship between the financial statement and the
 NATIONAL COLLEGE OF BUSINESS AND ARTS
GRADUATE STUDIES
Master in Business Administration
Cubao Campus, Quezon City

balance sheet by doing ratio analysis. This gives organizations the ability to assess
their financial strengths and shortcomings. This will be a great help to them as they
move forward and take the appropriate steps to promote their growth, particularly
as they compete with other companies in the same sector. The firm’s ratios are
compared with averages for its industry and with the leading firms in the industry
(benchmarking), and these comparisons are used to help formulate policies that
will lead to improved future performance. Similarly, the firm’s own ratios can be
analyzed over time to see if its financial situation is getting better or worse. Thus,
ratio analysis conducted in a mechanical, unthinking manner is dangerous, but
used intelligently and with good judgment, it can provide useful insights into firms’
operations.

6. How is the stated value of a preferred stock utilized?

Answer: Preferred stock is a hybrid—it is similar to bonds in some respects and

to common stock in other ways. Accountants classify preferred stock as equity;
hence, they show it on the balance sheet as an equity account. However, from a
finance perspective, preferred stock lies somewhere between debt and common
equity. It imposes a fixed charge, so it increases the firm’s financial leverage.
However, omitting the preferred dividend does not force a company into
bankruptcy.

This value is used to calculate future dividend payments and is unrelated to the
market price of the security. Then, companies may issue dividends similar to how
bonds issue coupon payments. Though the mechanism is different, the end result
is ongoing payments derived from an investment.

7. How are preferred stock dividends treated for tax purposes by the issuer, an
individual shareholder, and a corporate shareholder?

Answer: For issuers, preferred stock has a tax disadvantage relative to debt—
interest expense is deductible, but preferred dividends are not. Still, firms with low
tax rates may have an incentive to issue preferred stock that can be bought by
corporate investors with high tax rates, who can take advantage of the 70%
dividend exclusion. If a firm has a lower tax rate than potential corporate buyers,
the firm might be better off issuing preferred stock than debt. The key here is that
the tax advantage to a high-tax-rate corporation is greater than the tax
disadvantage to a low-tax-rate issuer.
 NATIONAL COLLEGE OF BUSINESS AND ARTS
GRADUATE STUDIES
Master in Business Administration
Cubao Campus, Quezon City

The firm’s after-tax earnings belong to its stockholders. Bondholders are

compensated by interest payments; preferred stockholders, by preferred
dividends. But the net earnings remaining after paying interest and preferred
dividends belong to the common stockholders, and these earnings serve to
compensate them for the use of their capital. The managers, who work for the
stockholders, can either pay out earnings in the form of dividends or retain
earnings for reinvestment in the business.

Although nonpayment of preferred dividends will not bankrupt a company,

corporations issue preferred with every intention of paying the dividend. Even if
passing the dividend does not give the preferred stockholders control of the
company, failure to pay a preferred dividend precludes payment of common
dividends. In addition, passing the dividend makes it difficult to raise capital by
selling bonds and virtually impossible to sell more preferred or common stock.

Thus, from the viewpoint of the corporation, preferred stock is less risky than
bonds. However, for investors, preferred stock is riskier than bonds: (1) Preferred
stockholders’ claims are subordinated to those of bondholders in the event of
liquidation and (2) bondholders are more likely to continue receiving income during
hard times than are preferred stockholders. Accordingly, investors require a higher
after-tax rate of return on a given firm’s preferred stock than on its bonds. However,
because 70% of preferred dividends is exempt from corporate taxes, preferred
stock is attractive to corporate investors. In recent years, high-grade preferred
stock, on average, has sold on a lower pretax yield basis than high-grade bonds.
The tax treatment accounted for this differential. Traditionally, a large portion of the
outstanding nonconvertible preferred stock has been owned by corporations (and
other institutions), which can take advantage of the 70% dividend exclusion to
obtain a higher after-tax yield on preferred stock than on bonds.

8. Identify three managerial options that relate to project analysis and explain how
those options affect the net present value of a project.

Answer: Procedures must be established for screening projects and the Net
Present Value is the best method, primarily because it addresses directly the
central goal of financial management—maximizing shareholder wealth; the larger
the NPV, the more value the project adds—and added value means a higher stock
price. One of the three managerial options that may be related to project analysis
is Independent Projects it is the projects with cash flows that are not affected by
the acceptance or nonacceptance of other projects. Another managerial option is
 NATIONAL COLLEGE OF BUSINESS AND ARTS
GRADUATE STUDIES
Master in Business Administration
Cubao Campus, Quezon City

the Mutually Exclusive Projects it is a set of projects where only one can be
accepted. Third managerial option is the Projects S and L. The S stands for short;
the L, for long. Project S is a short-term project in the sense that more of its cash
inflows come early, while L has more total cash inflows but they come in later in its
life. The projects are equally risky, and they both have a 10% cost of capital.
Furthermore, the cash flows have been adjusted to reflect depreciation, taxes, and
salvage values. The investment outlays include fixed assets and any necessary
investments in working capital, and cash flows come in at the end of the year.

Net present value, commonly seen in capital budgeting projects, accounts for the
time value of money (TVM). Time value of money is the idea that future money has
less value than presently available capital, due to the earnings potential of the
present money. A business will use a discounted cash flow (DCF) calculation,
which will reflect the potential change in wealth from a particular project. The
computation will factor in the time value of money by discounting the projected
cash flows back to the present, using a company's weighted average cost of capital
(WACC). A project or investment's NPV equals the present value of net cash
inflows the project is expected to generate, minus the initial capital required for the
project.

During the company's decision-making process, it will use the net present value
rule to decide whether to pursue a project, such as an acquisition. If the calculated
NPV of a project is negative (< 0), the project is expected to result in a net loss for
the company. As a result, and according to the rule, the company should not
pursue the project. If a project's NPV is positive (> 0), the company can expect a
profit and should consider moving forward with the investment. If a project's NPV
is neutral (= 0), the project is not expected to result in any significant gain or loss
for the company. With a neutral NPV, management uses non-monetary factors,
such as intangible benefits created, to decide on the investment.

9. A firm is considering two different capital structures. The first option is an all-equity
firm with 32,000 shares of stock. The second option is 20,000 shares of stock plus
some debt. Ignoring taxes, the break-even level of earnings before interest and
taxes between these two options is $48,000. How much money is the firm
considering borrowing if the interest rate is 8 percent?

Answer: Capital structure is a corporate finance term that describes the funds
companies use to pay for their operations and assets. These funds appear on the
company’s balance sheet and consist of equity capital, amount of debt, and
 NATIONAL COLLEGE OF BUSINESS AND ARTS
GRADUATE STUDIES
Master in Business Administration
Cubao Campus, Quezon City

preferred stock. If you’re a business owner, your goal is to achieve optimal capital
structure, defined in financial management as the proportion of debt and equity
that results in the lowest weighted average cost of capital (WACC) for your
company. Given this, the firm may consider borrowing $225,000.

10. Karl Lean Louise is a successful manufacturer of both consumer and industrial
hand tools and is publicly owned. The firm has several positive net present value
projects that it would like to pursue and thus decided to issue additional shares of
common stock. As a result of this stock issue, the firm's stock price declined.
Explain why this occurred when the proceeds of the issue are being used to fund
positive net present value projects.

Answer: When the company is already listed into the stock market and it has
issued additional number of common stocks it will mean that the company is trying
to dissolve the additional equity. Additional equity financing increases the number
of outstanding shares for a company. The result can dilute the value of the stock
for existing shareholders. Issuing new shares can lead to a stock selloff,
particularly if the company is struggling financially. However, there are cases when
equity financing can be seen as favorable, such as when the funds are used to pay
off debt or improve the company.

When companies issue additional shares, it increases the number of common

stocks being traded in the stock market. For existing investors, too many shares
being issued can lead to share dilution. Share dilution occurs because the
additional shares reduce the value of the existing shares for investors.

For example, let's say a company has 100 shares outstanding, and an investor
owns ten shares or 10% of the company's stock. If the company issues 100
additional new shares, the investor now has 5% ownership of the company's stock
since the investor owns 10 shares out of 200. In other words, the investor's
holdings have been diluted by the newly issued shares.