Question

Which of the following are real assets, and which are financial?

a. A share of stock.

b. A personal IOU.

c. A trademark.

d. A factory.

e. Undeveloped land.

f. The balance in the firm’s checking account.

g. An experienced and hardworking sales force.

h. A corporate bond.

Which of the following statements always apply to corporations?
a. Unlimited liability.
b. Limited life.
c. Ownership can be transferred without affecting operations.
d. Managers can be fired with no effect on ownership.

F&H Corp. continues to invest heavily in a declining industry. Here is an excerpt from a
recent speech by F&H’s CFO:
We at F&H have of course noted the complaints of a few spineless investors and
uninformed security analysts about the slow growth of profits and dividends. Unlike
those confirmed doubters, we have confidence in the long-run demand for mechanical
encabulators, despite competing digital products. We are therefore determined to invest
to maintain our share of the overall encabulator market. F&H has a rigorous CAPEX
approval process, and we are confident of returns around 8% on investment. That’s a far
better return than F&H earns on its cash holdings.
The CFO went on to explain that F&H invested excess cash in short-term U.S. government
securities, which are almost entirely risk-free but offered only a 4% rate of return.
a. Is a forecasted 8% return in the encabulator business necessarily better than a 4% safe
return on short-term U.S. government securities? Why or why not?
b. Is F&H’s opportunity cost of capital 4%? How in principle should the CFO determine
the cost of capital?

Answer 1

Answer(1): Real Assets- These are the assets, used in production or sale of the product or service of a company. Real assets can be of two types;

Tangible assets- These are physical assets that can be seen or touched. For e.g. Machinery

Intangible assets- These cannot be seen or touched. For e.g. Patent, Trademark etc..

In this question, Real assets are-

• Trademark
• Factory
• Undeveloped land
• An experienced and hardworking sales force.

Financial assets- Are the financial instruments that are contractual agreements. These assets are not in physical form. These are the liquid assets that get their value from contractual claims. For e.g. shares, bonds etc.

In this question, Financial assets are:

• A share of stock
• A personal IOU
• The balance in the firm’s checking account
• A corporate bond.

Answer(2): Option "c" and "d" are correct.

c. Ownership can be transferred without affecting operations.
d. Managers can be fired with no effect on ownership, these option always apply to corporation.

Corporation has perpetual life and in corporation, ownership can be transferred without affecting any operations. Managers can be fired if they are found guilty, with no effect on ownership. Other form of businesses have limited liability or life.

Answer(3):

(a): As the mechanical encabulators market is risky and the industry is in decline phase, Investment into U.S. Government securities is better as it is safe with no risk, company will face high risk if invests more money into encabulators' industry. The return in Government securities is lower but safe and fixed.

(b): Their cost of capital will be higher if the financial assets are not safe and are risky.

CFO should determine the expected return on asset with similar risk.