BFA503 – Introduction to Financial Management Tasmanian School of Business and Economics

TUTORIAL SOLUTIONS – WEEK 1

1. Describe the cash flows between a company and its stakeholder

Cash flows are generated by a company’s productive assets that were purchased through either
issuing debt or raising equity. These assets generate revenues through the sale of goods and
services. A portion of this revenue is then used to pay wages and salaries to employees, pay
suppliers, pay taxes, and pay interest on the borrowed money. The leftover money, residual cash,
is then either reinvested back in the business or is paid out to shareholders in the form of dividends.

2. What are the three fundamental decisions the financial management team is
concerned with, and how to they affect the company’s balance sheet?
The primary financial management decisions every company faces are capital budgeting decisions,
financing decisions, and working capital management decisions. Capital budgeting addresses the
question of which productive assets to buy; thus, it affects the asset side of the balance sheet.
Financing decisions focus on raising the money the company needs to buy productive assets. This
is typically accomplished by selling long-term debt and equity. Finally, working capital decisions
involve how companies manage their current assets and liabilities. The focus here is seeing that a
company has enough money to pay its bills and that any spare money is invested to earn interest.

3. What is an agency relationship, and what is an agency conflict? How can agency
conflicts be reduced in a company?
Agency relationships develop when a principal hires an agent to perform some service or
represent the company. An agency conflict arises when the agent’s interests and behaviours are
at odds with those of the principal. Agency conflicts can be reduced through the following three
mechanisms: management compensation, control of the company, and the board of directors.

4. What is the appropriate goal of financial managers? Can managers’ decisions affect
this goal in any way? If so, how?
The appropriate goal of financial managers should be to maximise the current value of the
company’s share price. Managers’ decisions affect the share price in many ways as the value of
the share is determined by the future cash flows the company can generate. Managers can affect
the cash flows by, for example, selecting what products or services to produce, what type of assets
to purchase, or what advertising campaign to undertake.

5. Why don’t small business make greater use of the direct credit markets since these
markets enable companies to finance their activities at a very low cost?
Direct credit markets are geared toward big, established companies since they are wholesale in
nature and the minimum transaction size is far beyond the needs of a small business. Small
businesses are better off borrowing money from financial intermediaries, such as commercial
banks.

6. How do capital market instruments differ from money market instruments?

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BFA503 – Introduction to Financial Management Tasmanian School of Business and Economics

Capital market instruments are less liquid or marketable, they have longer maturities, usually
between 1 and 30 years, and they carry more financial risk.

7. Your parents have given you $1,000 a year before your graduation so that you can
take a trip when you graduate. You wisely decide to invest the money in a bank term
deposit that pays 6.75% interest. You know the trip costs $1,025 right now and that
inflation for the year is predicted to be 4%. Will you have enough money in a year to
purchase the trip?
Yes. The term deposit will be worth $1,067.50 at the end of the year ($1,000 x 6.75% + $1000),
and the price of the trip will be $1,066 ($1,025 x 4% + $1,025). The term deposit will be able to
cover the trip.

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