Chapter 1: Concept Review and Critical Thinking Questions

University Canada West

FNCE 623 (Financial Management)

decision, give an example of a business transaction that would be relevant?

Answer 1: Three type of Financial management decisions are:-

1. Capital Budgeting

2. Capital Structure

3. Working capital management

Let’s discuss all these three financial management decisions in detail:-

Capital Budgeting

The company's long-term investments are the subject of the first Concern. Capital budgeting is

the process of organizing and overseeing a company's long-term investments: The financial

manager looks for investment opportunities that are more valuable to the company than they will

cost to obtain while capital budgeting. This suggests that the cash flow created by an asset is

worth more than the item's cost. The kinds of investment opportunities that are normally taken

into consideration rely in part on the business model of the company.

Financial managers need to think about more than just how much money they anticipate

receiving; they also need to think about when and how likely it is that they will. The core of

capital budgeting is assessing the quantity, timing, and risk of future cash flows. In the upcoming

chapters, we go into great detail on how to do this.

In simple words, Businesses examine possible significant projects or expenditures using the

capital budgeting process. It is a way of calculating how financially viable a capital investment

will be over its whole life. Instead of accounting for revenues and expenses resulting from the
investment, capital budgeting involves determining the cash inflows and outflows. This method

is intended to develop a quantitative assessment of each proposed fixed asset investment,

providing a sound foundation for judgement. For businesses of all sizes and in all industries,

capital budgeting offers an objective way to decide how to deploy capital to boost a company's

worth. Using capital budgeting, one can determine whether to allocate funds to a specific new

project or investment.

Furthermore, A business may examine the lifetime cash inflows and outflows of a potential

project as part of its capital budgeting process to ascertain whether the potential returns it could

produce would be sufficient to achieve the company's target benchmark. By including the

anticipated cash outlays and inflows, capital budgeting is a structured strategy to address these

issues and to help manage the financial risks associated with these capital-intensive and

strategically significant projects.

Example: 1)The decision to build new stores is an example of a business transaction that might

be pertinent to capital planning. This decision, which is an example of a capital budgeting

decision, necessitates management to examine the cash flows related to the new stores.2) The

choice to invest in new technology is yet another kind of business transaction that would be

pertinent to capital budgeting. For instance, a business may have to choose between upgrading its

computer systems and purchasing new software. This choice is an illustration of a capital

budgeting choice that calls for management to examine the cash flows connected with the

investment.

Capital Structure
The firm's strategy for obtaining and managing the long-term finance necessary to sustain its

long-term investments is the second key question for the financial manager. The capital structure

(sometimes referred to as the financial structure) of a company is the particular proportion of

short-term debt, long-term debt, and equity that the company utilizes to finance its activities. The

financial manager is worried about two things here. First, how much should the company

borrow, or what combination works best? The combination selected has an impact on the firm's

risk and value. Secondly, what are the firm's least priced funding options ?

If the company were a pie, its capital structure would dictate how the pie was divided. In other

words, what proportion of the company's cash flow goes to shareholders and what proportion to

creditors? A company's management has a lot of freedom in deciding on its financial structure.

The core of the capital structure question is whether one structure is superior to all others for a

specific firm.

The financial management must choose exactly how and where to raise the money in addition to

choosing the financing mix. Different options must be carefully considered because raising long-

term funding can incur significant costs. Additionally, firms access the Canadian and worldwide

debt markets in a variety of unique and occasionally exotic methods, borrowing money from a

range of lenders. The finance manager is also responsible for selecting lenders and loan types.

In simple words, the capital structure of a firm is the particular ratio of debt to equity utilized to

fund its assets and activities. A firm uses a certain blend of debt and equity to fund both its

general operations and expansion. In contrast to debt, which takes the form of loans or bond

issuance, equity capital results from owning shares in a firm and claims to its future cash flows

and earnings. The capital structure is also thought to include sho

of financing are among the sources of capital that a company can raise. These monies are raised

for business operations. Maximizing shareholder capital while lowering overall capital costs are

both benefits of a sound capital structure. A sound capital structure gives businesses the freedom

to adjust their loan capital in response to market conditions.

In conclusion, a company's capital structure refers to the mix of owner capital (equity) and loans

(debt) from outsiders that it uses to finance its overall operations and investment activities.

Example: The issuance of bonds by a corporation to raise money for a new project is an example

of a business transaction that would be important to capital structure. A business can employ

bonds as a form of borrowed financing to finance both its current operations and future

expansion. When a corporation issues bonds, it incurs debt that must be repaid with interest,

which could change the capital structure of the firm as a whole. In order to raise money for the

project, the corporation may also decide to issue equity capital, such as additional shares of

stock. The project's financing strategy, which includes a combination of debt and equity, will

have an effect on the company's total capital structure and may change the cost of capital. To

raise the required money while lowering its overall cost of capital, the company must carefully

analyze the project's ideal capital structure.

Working capital management

Working capital management is the subject of the third important query. Working capital is the

distinction between a company's short-term assets, such as inventory, and its short-term

obligations, such as amounts owed to suppliers. Managing the company's working capital is a

routine task that guarantees the company has the resources to carry on with its activities and
prevent expensive interruptions. This covers a variety of tasks all connected to the firm's cash

reception and distribution processes.

The following are a few of the working capital-related concerns that need to be addressed. How

much inventory and cash should we have on hand? Should we offer terms for credit purchases?

How can we get credit for a short time? Will we pay cash or use a short-term loan to make a

purchase? When, how, and how much should we borrow on a short-term basis?

In Simple words , working capital is the money a company utilizes to maintain and execute its

everyday operations. It enables businesses to make regular payments and guarantees efficient

business operations. Working capital is the difference between a company's current assets and

current liabilities. Inventory management and the control of accounts payable and receivable are

both included in working capital management. Through the effective use of its resources,

working capital management can enhance a company's ability to control its cash flow and the

quality of its results. Working capital management shows how a company's short-term assets and

short-term obligations are related. It tries to make sure that a business can afford both current

investments and day-to-day operational costs.

Example: An acquisition or merger is an example of a business deal that might be important to

working capital management. In the majority of M&A deals, the parties multiply the target

company's earnings before interest, taxes, depreciation, and amortization (EBITDA) by a

predetermined multiple to determine the purchase price. But buyers will frequently add some

safeguards, such indemnification clauses, a third-party escrow, or other holdbacks. To protect

against sudden liquidity problems, this frequently calls for a minimum amount of "working

capital" to be present on the balance sheet when the sale closes. As a result, managing working
capital effectively is essential to the operation of a business and is frequently considered when

estimating a company's value.

Question 5 – What goal should always motivate the actions of the firm's financial manager?

Answer 5: The goal of financial manager is to maximize the current value per share of the

existing stock

Financial managers aim to maximize the current value per share of the existing stock as it

represents the interests of the shareholders and can contribute to their wealth. Maximizing the

value of a company to its owners should always be the primary motivation behind the decisions

made by its financial manager. This indicates that the ultimate objective of financial management

is to maximize the earnings for the shareholders. The finance manager should strive to take on

tasks that will increase the business's earnings and revenue. To do this, the financial management

must make sure that the business has sufficient money and funding sources to meet the objectives

specified by the board of directors. The company's overall financial stability must be

continuously maintained by the financial management. If the finance manager is ineffective, the

business may run out of money at a crucial juncture in its development and struggle to secure

financing.

In conclusion, the primary objective that should always drive a company's financial manager's

actions is to maximize the value of the company to its owners by preserving the financial

stability of the business and making sure it has enough cash to achieve its objectives.

Question 15 – What are the major types of financial institutions and financial markets in

Canada?

Answer 15: Major types of financial institutions and financial markets in Canada: -
Financial Institutions

Financial institutions serve as an intermediary between fund suppliers (investors) and companies

seeking funding. By offering a range of services that support the effective use of resources,

financial institutions serve to justify their own existence. A medium via which people can save

and borrow money is provided by these organizations, which also act as middlemen for

households and individuals. Individuals and households have the option of saving money in a

variety of ways, including tax-free savings accounts, registered education savings plans, and

standard savings and checking accounts. Financial institutions in Canada include licensed banks

and other depository institutions such trust companies, credit unions, investment brokers,

insurance firms, pension funds, and mutual funds.

According to market capitalization in 2019, Table 1 lists the top publicly traded financial

institutions in Canada. They consist of one alternative asset management firm, three life

insurance firms, and the Big Six chartered banks. Canada's chartered banks are sizeable on a

global scale since they are allowed to diversify by operating in all provinces.

Table 1
Financial Markets

Financial markets can be classified as either money markets or capital markets. The money

markets trade a wide range of short-term debt products. These shorter-term debt securities,

sometimes known as money market instruments or IOUs, are debt obligations. An example of a

money-market instrument is a bankers' acceptance, which indicates short-term borrowing by

firms. A short-dated debt of the Canadian government is in the form of Treasury bills. The

Toronto equity Exchange, for instance, is a capital market since they are the marketplaces for

long-term debt and equity shares.

The money market is an exchange for dealers. Dealers typically purchase and sell items at their

own risk for their own benefit. A car dealer, for instance, buys and sells cars. Brokers and agents,

on the other hand, arrange transactions between buyers and sellers without really owning the

product. For instance, buying and selling homes is not typically done by a broker or real estate

agent.

Investment dealers and chartered banks are the biggest money market dealers. The money market

has no actual physical location because all of its participants' trading facilities are electronically

connected through phone and computer.

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