1.
What do you mean by financial
management? Explain the function of financial management.
Financial management is the broadest of the three areas, and the one
with the most job opportunities. Financial management is important in all types
of businesses, including banks and other financial institutions, as well as
industrial and retail firms. Financial management is also important in
governmental operations, from schools to hospitals to highway departments. The
job opportunities in financial management range from making decisions regarding
plant expansions to choosing what types of securities to issue when financing
expansion. Financial managers also have the responsibility for deciding the
credit terms under which customers may buy, how much inventory the firm should
carry, how much cash to keep on hand, whether to acquire other firms (merger
analysis), and how much of the firm’s earnings to plow back into the business
versus pay out as dividends. Financial management is used to refer to the
management of funds in the context of a business firm. Financial management is
decision making process of investment, financing and assets management
decision.
The functions of financial management can
be categorized into two types i.e. Executive finance function and Routine
finance function that are explained as follows:
1) Executive
finance function:
2)
Routine finance function:
2.
What is wealth maximization? Why is
wealth maximization superior goal to profit maximization?
Wealth
maximization is almost universally accepted goal or objective of a firm.
According to this goal, the managers should take decisions that maximize the
shareholder wealth. Shareholder wealth is maximized when a decision generates
net present value which is the difference between present value of benefits of
a project and present value of its cost.
Wealth maximization is
superior goal to profit maximization because it has following best aspects than
profit maximization.
a) Shareholder wealth maximization goal is clear:
Shareholder
wealth maximization goal requires that every financial decision be evaluated in
terms of cash flow; the term cash flow is explicit. According to this goal, the
cost and benefits of every decision are measured in terms of cash flow rather
than in terms of accounting profit.
b)
It considers the timing of cash flow:
The cash flow occurring at two different points in time have different
value, hence not comparable.
3.
Differentiate profit maximization and
stock price maximization.
4.
Explain the finance function in the
organization structure of the firm with the help of suitable chart.
Michael
C. Jensen and William H. Meckling at first explained the nature of agency
problem. Generally, agency problem is the conflicts of interest between
shareholders, managers and creditors. In a company, the interests of those
groups become different from which there arise different while making
decisions. In financial management agency problem refers to the conflict of
interest between the shareholders and mangers that can appropriately be viewed
as the principal and agents respectively.
It has long been recognized that managers may have
personal goals that compete with shareholder wealth maximization. Managers are
empowered by the owners of the firm—the shareholder—to make decisions and that
creates a potential conflict of interest known as agency problem. There
are two types of agency problem i.e. agency problem between shareholders and
managers, and agency problem between shareholders and creditors.
i.
Agency problem between shareholders and
managers
Mechanism to resolve the conflict of interests
between Shareholders and Manager
a)
Managerial
compensation
b)
Direct
intervention by shareholders
c)
The
threat of firing
d)
The
threat of hostile takeover
ii.
Agency problem between shareholders and
creditors
