Question

1. Dividend Policy Question: When a company announces that they intend to reduce their dividend payment we understand that there could be many relative issues. (For example the company has more future investment opportunity or the company is facing a decline in their product market demand.)

a) Provide several possible relative issues (or reasons) for the dividend change and briefly discuss their logical reaction in capital investment activities. 

b) Discuss the available theories describing the dividend reduction, and describe what might be the announcement effects predicted by these theories.

2. Corporate Cash Flows Question:

a) Describe the nature of net operating assets, and operating business cash flows.

b) Discuss the unique features of Free Cash Flow (FCF) and weighted average cost of capital (WACC), and the advantage(s) to using FCFs and the WACC in the evaluation of a company.

3. Corporate Governance Question:

a) What is the major (most important) corporate governance problem in corporate finance? Explain why it is the most important in theory and practice. 

b) Describe the function played by the board in dealing with corporate governance issues. [5 Marks]

c) Discuss how a CEO’s compensation package may influence the decisions made by the top management team.

 

Answer 1

1(a) The possible relative issues or the reasons for the dividend reduction is that company has an plan or any opportunity for investment in future and another one is that company may immediately know about any contigent liability which may get fixed in near future and another one is that company is facing with reduction in market demand and another reason is that company wants to make payment for the debt holders or doing buyback of the shares. Buy back can reduce the company shareholders equity and increase the debt equity ratio and if company can make payment to debt holders some thing point may occur about trading on equity

1(b)The available theories describing the dividend reduction are as follows :-

1. The MM dividend irrelevance theory – This theory states that firm dividend policy has no impact on the company stock price. The assumption taken in it that company stock price is depend on the business risk and its earning power

2. The residual dividend theory – This theory said that the amount of dividend is residual. The amount which left after the investment in all opportunity can be distributed not at earlier of that

3. The bird-in-the-hand theory - This theory said that investors are not indifferent there are two choice one is to take dividend or alternative of it is that to earn capital gain over the company stock

2 (a) The nature of operating assets is that which can be used in daily activities and requires operating expenses. And operationg expenses cash flow are such as making payment to creditors or taking money from debtors and daily needs expenses etc…

(b) the unique feature of FCF is that this money has no burden to use it in any expense it is totally free means it can also be invested in risky investment and WACC is the weighted avg cost of capital means the total average cost of the money invested in business

The advanteage of FCF is that on this money we have no burden to use it and specific purpose and Wacc is used to find the minimum return earned necessary by the company

3 (a) The most important problem in corporate govenmance of finance is to making the payment of it means to make a expenses of it It is the major problem because it can reduce our profitability.

(b) The function played by the board in dealing with it is to make a budget for the expense of it. And taking the proper benefit of the expense incurred in the corporate governmance

(c) CEO is the top management member of the company His compensation package may influence the decisions made by the top management team. Because his compensation may show the experience knowledge and his decision making capability as we know all major decision taken from yop committee