Running head: FINANCE QUESTIONS Finance Questions Goes Here al Affiliation Goes Here Finance Questions Provide three examples of situations in which business ethics play a role in the financial management process. Explain your rationale, and how these situations may affect the value of the firm. i). If a company adopts shady financial management processes, then the shareholders (or management) may get short-term monetary rewards but in the long run the value of the firm shall fall when shareholders find the truth. ii). A bank gains substantial profits from hidden fees imposed on customers, but in the long run customers will shy away from such banks and such unethical gains shall turn into lost customers and revenue soon. iii).
A hedge fund manager may realize substantial monetary gains if he/she acts on any undisclosed material information. Although unethical, if he waits until full public disclosure of the information before acting, it would cause the company in terms of lost profits, but the business ethics shall be preserved, which is more important. 2. What is an opportunity cost? Provide two real-life examples of opportunity costs for a project.
Should opportunity costs be included in the project analysis process? Why or why not? Explain your rationale. Opportunity cost is the costs of maximum probable profits relinquished by opting for any project. For example if an investor provides credit for a project which yields a return of return a paltry 2% over the year, against placing the same money in buying a share which would have yielded 5%, then in this case the opportunity cost is 3% (5% - 2%). Suppose if a company opts to invest in a project which requires an initial investment of 1 m USD and the return generated after one year is 10%.
However, if the same amount was invested in the Stock Market, it would have yielded 15% at the end of one year. Therefore the Opportunity Cost in this case is (15-10%) = 5%. Project Analysis process includes opportunity costs as they are the benefits forgone for pursuing this project. This inclusion of opportunity cost is done via incorporating the cost of forgone benefits into the Weighted Average Cost of Capital for the project.
3. What is the difference between business risk and financial risk? If Company A has a higher business risk than Company B, should its cost of capital be higher? Why or why not? Explain your rationale. Financial Risk Financial risk is the risk of the companys cash flows not being sufficient to pay off creditors and realize additional financial liabilities. (Eckbo, pp. 12-18, 2007) The more debt a business is indebted, the more probable it is to fail to meet its financial obligations. Business Risk Business risk is the risk of lower than estimated profits, or that the company will experience a loss rather than a profit.
If Company A has a higher business risk than Company B, it means Company A has a higher asset beta, also known the unlevered beta. This shall increase the cost of capital for the company. 4. What are some important elements of the collection policy? The important elements in a Collection Policy are as follows: A. Consistency and Credibility A thoughtfully planned mission statement is fundamental for an effective collection policy. It is essential that a consistent attitude is maintained while dealing with debtors.
B. Goal Statement The Collection Policy should spell out who is sanctioned to negotiate and who can grant concessions. Collectors must realize how much leverage they have in handling payment related matters with debtors. C. Practices within the Policy The policy should define clearly the modalities of dealing with debtors – related prospects are infinite, but a few major questions include who will send due statements reminders, who will issue collection letters, who will call to remind debtors, who will meet them face to face etc. D. Enforcing the Policy The strength of the collection policy is determined by the company’s willingness to enforce it.
References Eckbo, Espen; (2007); Handbook of Corporate Finance, Volume 1: Empirical Corporate Finance; North Holland; ISBN-13: 978-0444508980, pp. 12-18,