Question

Your uncle has always owned several companies and has been very successful despite not studying Finance in university. He has heard about several finance methods to evaluate whether to take on a project or not.

1. Explain to him what the three basic decisions that a financial manager must make when overseeing a company.
2. (1 mark) Explain to him what the ultimate objective of a financial manager is.
3. Explain to him what characteristics the best methods have to determine whether or not to take on a project.
4. Provide an evaluation of four methods against the criteria you provided in part (c )
5. He has heard that IRR is a good method, but has one issue. Identify and explain the issue to him.

Answer 1

A. Three basic financial decisions are whether the company is generating enough profits or the company is generating enough cash flows for the company has the sustainability in the long run.

B. Ultimate objective of financial manager is maximization of the shareholders wealth

C. The best project will be determining the value of various projects at the present value and they will be trying to discount the time value factor and they will be also risk adjust in various projects in order to determine whether to accept the project or not after the settlement of addition of the value to the company like we can see in case of net present value or internal rate of return.

D.4 methods can be payback method along with discounted payback method and net present value method and internal rate of return method which will be used for making various decisions . Under payback method, ww will accept the project which has the desired pay back period, whereas under net present value we will only accept the project with positive net present value and under internal rate of return we will accept the project with higher rate of return than hurdle rate.

E.Internal rate of return does not consider the reinvestment rate so it reinvesting at the flat reinvestment rate at every point of time