Advanced Financial Management

Section A-Question 1

a) The rationale for selecting maximization of shareholder wealth being the only true objective of a company and consideration of profit maximization as an alternative goal

A shareholder is identified as a key stakeholder of the company that has a legal claim on the profit and assets of the company. Limited liability is managed by the shareholder in relation to his ownership in the company. Therefore, companies have considered wealth maximization as the primary objective because shareholders are the ultimate risk-taker in an organization because they could lose everything in the situation of bankruptcy. It influences the management to protect the interest of shareholders in which companies pay extra attention to the dividend flow. In the context of the contemporary business environment, shareholder wealth can be evaluated with reference to the stock price of an organization. Moreover, the management of an organization is directly responsible for attaining the interest of shareholders. This is because the approach of wealth maximization is usually linked with the short and long term strategic plans of the company and the board of directors have to consider those projects and investment plan that could maximize the company’s value along with the business profitability. In this process, management has to consider the interest of shareholders because investors invest lots of funds in the hiring of top executives and board members. The wealth maximization could be termed as a primary task or social responsibility of the company that ensures shareholders about the increase in corporate profit. This is because consideration of high returns for shareholders as the primary goal influences the management to identify the best goals or locations for capital investment. Moreover, it also assures the optimum utilization of resources and the selection of an appropriate mix of goods and services.

Therefore, companies consider profit maximization as an alternative goal because the profitability of an organization is linked with the selection of investment projects and the development of the business strategy. For boosting the company’s profit, the business entity has to pay significant attention to the product quality, needs of consumers, selection of target buyers, production cost, the market position of the company, level of competition, business expansion, selection of marketing strategy and many more. For the attainment of the corporate goals of shareholder's wealth maximization, the business entity has to pay significant attention to enhance overall business efficiency and strategic planning so as an organization can also properly attain the profit maximisation goals along with wealth maximization.

b) Advantages and disadvantages of MD’s suggestions about the alternative goals

The managing director of the multination company has provided four different suggestions about the alternative business goals such as cash flow generation, profitability, risk-adjusted returns to shareholders, and performance improvement like environment, employee remuneration, working conditions, and customer satisfaction. The objective of cash flow generation helps a business entity to enhance the corporate liquidity so as a business entity can easily attain short term liabilities. The cash flow generation is linked with the sales volume, purchase, and liquidation of assets, capital gains from the investment, financing, and investment. The cash flow generation is being addressed as the most critical task for the business entity through which a company can enhance its liquidity. It also encourages the management of the liquidation of unused assets. It also supports business entity in the long term of financial planning. On the other hand, there are some drawbacks identified of the motive of cash flow generation such as increased in level of debt financing for assessing more liquid funds, early liquidation of fixed assets of the company and short term assets, and increment in operating expenditure to enhance the sales volume that could enhance the corporate liabilities.

The second suggestion of MD is aimed to consider profitability as an important indicator of earnings of the company after-tax along with the return on investment. In the context of the contemporary business environment, profit after tax determines the efficiency of business operations because a higher profit margin shows the increment in sales and reduction in business expenditures. Therefore, companies can enhance the efficiency of the business operation by evaluating the change in its profitability within a certain period. It also assists a business entity in determining the returns on investment in which an organization can determine the proportion of net earnings with reference to the total value of an investment that has been made by the firm. However, the objective of profitability has some limitations because it has paid extra attention to the short term corporate efficiency. For example, if an organization finds a reduction in profit due to an increase in interest cost because the company has made some investment in a long term project, then the business entity would find the increment in business profit in upcoming years. Therefore, this tool cannot cover the wealth management practices of a firm in an efficient manner.

In the selection of alternative business goals, risk-adjusted returns to a shareholder should offer great support in developing long term relationships with different shareholders and investment. This is because this concept determines the investment’s return with consideration of the level of risk involved in the generation of particular returns. It can be expressed as a rating. It plays a critical role in influencing the investment decisions of individual investors in securities trading. The risk rating presents the efficiency of different business strategies in handling different critical business operations. On the contrary, it does not provide a clear review of the efficiency of managerial practices such as risk elements in the long term investment plan. Moreover, the slight reduction in corporate earnings reduces the returns for shareholders that could hurt the perception of stakeholders of the company.

In the context of the contemporary business environment, corporate governance is being emerged as an important alternative objective of an organization that influences business entities for the consideration of environmental safety, appropriate remuneration for staff, working conditions and customer satisfaction. All these elements assist management in improving the efficiency of different business operations with consideration of fair corporate policies and managerial practices. This is because the goodwill and brand value of a company is significantly influenced by different corporate governance practices. However, there are frequent changes identified in legal norms related to environmental safety and the welfare of society that influence the negative impact on the corporate governance strategies of the firm. Therefore, the management should have to appropriate balance in different performance targets in an appropriate manner.

c) Employees remuneration in the context of the company’s senior employees

In the context of the contemporary business environment, the remuneration of the company’s senior employees is a combination of two elements that include basic salary and other perks. The company records the employee’s remuneration in the income statement to generate the profit before tax. According to the remuneration policy of senior employees, companies are mainly provided with a low basic salary with additional allowance and performance bonuses. This approach offers great support to influence business performance like sales volume because top managers put extra efforts to increase the overall business revenue that would increase their amount of bonus. Moreover, it helps management in controlling the business expenditure on the salaries to top management because the payment of bonuses would be reduced due to a reduction in sales or revenue of the company. This tool also helps managers to determine the effectiveness of different decisions on business outcomes. However, there are some deviations identified in the remuneration policy of senior management that is linked with low basic salary with additional allowance and performance bonus such as application of unethical practices to influence performance data and misrepresentation or corporate fraud in the accounting of financial transactions. For increasing the performance bonus, top managers can influence sales figures and other performance measures that could reduce the reliability of financial results. It could increase the chances of accounting frauds in which top authorities increase sales volume and reduce business expenditure through unethical tactics. These approaches could have a direct impact on long term business sustainability.

Section B-Question 4

a) The net present value of Machine A for its two-year life

As per the case of XYZ, the calculation of NPV for the proposed investment option of the Machine A is carried out below:

b) The net present value of Machine B for its three-year life.

The calculation of NPV for Machine B is carried out below:

c) Recommendation

The calculation of the net present value of Machine A and Machine B has determined that the management of XYZ Plc should consider the option of Machine B in its investment decision for obtaining new equipment. This is because the NPV of Machine B is £ 3,94,185, which is higher than the NPV of Machine A, that is £ 2,16,966. Therefore, the business entity would find more returns from Machine B.

d) Evaluation of the option of the existing option of Machine C

As per the case, the production manager of XYZ Plc is also considering the existing Machine C in the investment appraisal process. Therefore, the above calculation presents the NPV of Machine C with reference to its current book value of £ 87,000. In this regard, the comparison of NPV of Machine C with the NPV of Machine A and B has determined that Machine C would facilitate maximum returns as a reason for higher NPV. Therefore, the company should consider Machine C for the next five years.

c) Explaining the time value of money and commenting upon non-financial consideration

With reference to the present case, the approach of discounting the cash flow has been considered to evaluate the present value of future returns from different investment proposals. The concept of discounting plays a critical role in determining the time value of money. Time value of money (TVM) is an idea that determines the higher worth of money which is available in the present time as compared to the same amount that would be received in the future. It can be termed as a basic principle of finance in which the value of a certain amount of money would be increased in the near future with an addition of interest. In the context of long term investment and corporate decision-making process, this approach assists investors in evaluating the profitability of different investment projects. It covers several elements in investment planning present value, future value, number of years, interest rate, and the value of payment amount.

Non-financial consideration

In the context of the time of value money, several non-financial considerations are identified that indirectly affect the time value of funds. First of all, the source of funds is also considered an important element that influences the cost of capital along with the time value of money because equity capital has a higher cost of capital as compared to debt financing. Secondly, the change in the interests of people encourages change in their demand for different goods and services that could have a direct impact on the inflation rate. Therefore, the change in interest or change in requirements of people can be considered as non-financial consideration to determine the time value of money. Moreover, the change in government policies related to control business operations and market trends could influence the time value of money. In addition to that, the rate of industrialization and businesses influences the demand for banking and investment services that may influence the investment trends and time value of money.