Solutions to Financial Management, 9e, 2019 10 December 2018

CHAPTER 1
OVERVIEW OF FINANCIAL MANAGEMENT

NOTE: The questions set for this chapter are intended as a basis for discussion. The suggested solution is
thus not intended to be comprehensive or definitive.

1.1
OBJECTIVE OF FINANCIAL MANAGER
The financial manager is constantly engaged in decision-making. Decisions regarding
investment projects to be undertaken and decisions regarding sources of finance are the
major focus of financial management.

The criteria to be used to measure the effectiveness of decision-making, is the extent to

which wealth has been created by increasing the value of the firm. If the financial manager
is efficient in the task of resource allocation and is making effective decisions, the present
value of the expected future returns generated by the investment will increase.

In the case of the shareholders of a listed company, value is added by investing in projects
with returns on capital that exceed the cost of financing those projects (cost of capital).
The returns for shareholders can be realised in two ways; firstly by a return in the form of
dividends which is cash paid to shareholders from the earnings of the company. Secondly
by market forces, which drive the share price of a successful company upward, thus
creating the opportunity for the shareholder to sell the shares, recovering the capital
invested plus a capital profit. Dividends and capital gains thus constitute the return to
shareholders. This may be expressed as a return on funds invested. The financial
manager’s fundamental objective is to ensure that the return to shareholders is maximized
by making decisions, which will result in returns that exceed the cost of capital.

There are numerous subsidiary objectives that the financial manager may have. In most
instances they are designed to ensure that the fundamental objective is achieved. Some
of the more commonly cited objectives would be:

❖ To ensure that the market price of the shares remains as high as possible.
❖ To set and pursue targets for expansion and growth of the company.
❖ To reduce the risk of the company through appropriate diversification.
❖ To ensure that financial leverage (borrowings) is used effectively.
❖ To attract providers of loan capital and ensure that their investment is protected and
that interest commitments are paid on time.
❖ To increase revenues and reduce costs
❖ To adopt a socially responsible attitude in financial decisions which will ensure the
long-term sustainable future of the company.

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1.2

Deregulation will increase the number of suppliers in an industry sector. This will result in
an increase in competition and should result in lower prices for customers. If returns are
falling in a sector this may result in a reduction in the investment in plant and equipment.
However, the competitive environment may also mean that companies will invest in new
plant and equipment that will result in lower costs and higher quality levels. Eskom
operates as a monopoly for the supply of electricity in South Africa.

If other companies are permitted to operate in the sector, then electricity rates could fall
and there will be an increase in operating efficiencies. However, the cost of building new
power stations is high and only very large firms would be able to compete with Eskom.
The deregulation of the gas sector could result in a company such as Sasol, which is
increasing its role in the supply of gas, perhaps diversifying into sectors such as electricity
supply. Gas can be used in powering turbines for the supply of electricity and we could
see gas-powered power stations. Therefore, Sasol is widening its horizons and may
diversify across the energy sector.

Telkom has faced competition from a second fixed line operator Liquid Telecom (Neotel).
This has resulted in Telkom being more competitive on telephone rates and achieving
operating cost efficiencies. However, Neotel initially experienced operating difficulties and
failed to achieve a significant market share. In 2015, the proposed acquisition of Neotel by
Vodacom, was not permitted to take place and in 2016 Neotel was acquired by Liquid
Telcom. Telkom is a listed company and is therefore required to also focus on achieving
returns for its shareholders. The company is currently facing competition from the major
cellular operators. Increasingly, customers are not using fixed lines and the revenue from
international calls (due to Skype, WhatsApp and other operators) is falling significantly.

Competition from a second fixed line operator is also forcing Telkom to improve its level of
service and range of products. The company also intends to become a leading Information
and Communications Technology (ICT) solutions provider. We expect an improvement in
services from Telkom, a focus on achieving cost efficiencies and lower tariff increases in
the future if Liquid Telecom (Neotel) achieves an improved level of service. Up to 2013,
Telkom was not able to achieve an improvement in operating and financial performance
and a number of CEOs resigned after a short stint at the helm of Telkom. This is never a
good sign. However, Telkom since then has been focused on reducing its operating costs,
improving its services and improving its competitive offerings to its customers. Its share
price has rallied from about R15 in the dark days of early 2013 to R55 in 2018. Telkom is
also growing strongly in Mobile and experiencing strong growth in broadband subscribers
as it rolls out its optical fibre network. Telkom also has an extensive property portfolio.

Note:
Telkom owned 50% of Vodacom but sold 15% to Vodafone and distributed its remaining shares to its
shareholders so that it no longer has a significant presence in the cellular sector. The entry of Cell C and
Virgin Mobile increased the level of competition in this sector, particularly in relation to data. This will result
in lower rates and/or improved services for customers, which will again place further pressure on Telkom as
it loses the advantage of its lower fixed line pricing structure. At the same time, Neotel has struggled to attract
subscribers. The real competition for Telkom is coming from the cellular operators rather than Liquid (Neotel),
which is a fixed line operator. However, the focus on fibre connectivity and its own mobile network as well as
a focus on improving performance and integration has led to an improved outlook for Telkom.

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1.3
MAJOR FUNCTIONS OF THE FINANCIAL MANAGER
The two major functions of the financial manager relate to the investment decision and the
financing decision.

Firstly, the financial manager is often required to source and find or create investment
opportunities. Investment in the right kind of projects will determine the success of the
firm. Sometimes, a distinction may be drawn between the investment in actual assets
such as machinery and equipment designed to generate income, and investment in the
shares of companies that have existing operations. The former has been referred to as
investing in operating assets. The latter has been referred to as investing in financial
assets, if the financial manager will not be able to obtain operational control.

In both cases the investment decision requires careful investigation and analysis. The
financial manager is required to evaluate the value of each investment project. As
decisions all require an element of prediction, the use of forecasting techniques to
estimate future markets and ultimately potential profits is required. Future cash flows from
an investment, once estimated, are then evaluated in terms of the risk that they may not
transpire, before the investment decision is finally made. The value of any project is driven
by when the cash flows are expected to occur, the riskiness of such cash flows and the size
of each cash flow. The decision to invest is determined by comparing the value of an
investment to its cost.

Secondly, the financial manager must decide on the financing of each investment project.
The owners of the business will be expected to provide the initial capital. In the case of
companies, it is expected that shareholders funds will be used. It is possible that a mixture
of shareholder funds and borrowings from outsiders may provide a better return to
shareholders as a result of financial leverage. This decision is referred to as the capital
structure decision – the optimal balance of debt and equity that the firm should use to
finance projects. The principal function is to raise capital at the lowest possible cost and
apply such funds to investments that yield the highest possible return. It is apparent that
the risk attached to an investment project will impact on the return that is expected as well
as on the cost of funds obtained. A firm with highly risky operating cash flows will tend to
use lower levels of debt finance and higher levels of equity finance.

1.4
GOALS OF THE FIRM AND THE FINANCIAL MANAGER
If a business enterprise is managed by its owner or owners, it is apparent that the goals of
the firm will be congruent with those of the owner. So, for example in the case of a sole
proprietor, the owner will have the objective of supplying goods or services in the most
efficient manner and to ensure that the business is profitable. The profits, which accrue to
the business, also accrue to the owner. With the separation of ownership and
management in the case of companies, it is not intuitive that managers will always act in
the interests of the firm or the shareholders. There may be times when the goals of
management are not congruent with those of the firm. For example, management may
take a view which maximizes short-term returns in their interests, because of their mobility,
but which are not in the longer-term interests of the shareholders. When such
incongruence arises, the cost to the owners is referred to as an agency cost.

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Management act as agents of the owners and the owners must be aware that such
costs may be incurred. Management may decide not to take on risky projects even
though these projects are worthwhile for a set of diversified shareholders. Management
may decide to maximise salaries and perks at the expense of the shareholders so that
even if a company’s performance is poor, management may still obtain sizable increases
in their remuneration. Management may decide to enter into unwise mergers and
acquisitions to increase their power base. The focus in the last decade has been to align
the interests of management with those of shareholders by offering incentives such as
share options and performance bonuses.

1.5
Significant Economic Developments
The economic environment is dynamic and constantly changing. There have been
significant economic and political developments, which have affected the role of the firm.
As a result, the financial manager, who must look forward in order to make decisions,
needs to understand the relationships which exist between the variables in the economic
and political landscape which are likely to impact on risk and return. The economic
environment can be narrowed down from the more remote environment to the company
itself. Some factors are listed below:

Theinternational environment
- State of the world economy
- State of economy of trading partners
- Potential markets
- Sources of offshore borrowing
- Interest rates
- Budget deficits of trading partners
The national environment
- Interest rates
- Foreign currency exchange rates
- Commodity and resource price fluctuations
- Money supply
- Growth in GDP
- Projected inflation rates
- Political sentiment
- Potential markets
- Sources of finance
Company environment
- Prospects for growth
- Whether diversification is necessary (Ex. BHP Billiton are currently focusing
on a portfolio of assets resources with a wide geographical spread to
ensure lower borrowing costs).
- Presence of other companies seeking a takeover ormerger
- Competitive forces
- Shareholder sentiment
- Public perception

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What are some of the major and specific developments in South Africa in the last 20
years?
Deregulation and removal of laws that inhibit economic activity
Changes to the taxation system such as the introduction of Capital Gains Tax, the
dividend withholding tax, and the introduction of VAT
Lower corporate tax rate falling from 48% to 28% over the last 25 years.
Lower interest rates which have resulted in lower borrowing costs and a lower cost of
capital.
Low inflation environment
Privatisation and corporatisation of entities such as Telkom and the Airports Company
of South Africa (ACSA).
Globalisation resulting in greater competition and greater access to world markets
Mergers and acquisitions of firms across national boundaries. For example,
Vodaphone acquired majority control of Vodacom.
Floating exchange rates. Volatility in exchange rates and the fall in the Rand have
negatively affected importers.
Black Economic Empowerment (BEE) transactions are changing the economic
landscape of South Africa.
The growth in imports is having a serious impact on such sectors as textiles and
clothing.
Fall in mining activity. South Africa has experienced lower mining activity particularly
in gold mining and more recently in the platinum sector.
Growth in derivative markets. This means that firms are able to effectively hedge
positions and sell forward their future production.
The entry of private equity firms in South Africa is changing the ownership and
financial leverage of South African firms. For example, Alexander Forbes, Pepkor and
Edcon were subject to takeovers by private equity firms but these were not always
successful

1.6
OPERATING AND FINANCIAL ASSETS

Operating assets refers to the ownership by the company of the assets, which are
producing the product or service, which generates the income. Financial assets refer to
the ownership by the company of shares in another company, where the other company
owns the income generating assets and the shareholder is not able to acquire operational
control of the underlying assets. Unless the investing company aims to be an investment
holding company, it seems preferable to be an operating company as it is then possible to
be in control of investment and financing decisions. Once a majority shareholding of
greater than 50% is acquired, control is assured, as the shareholders are able to appoint
the board of directors. However, a shareholding of 35% (or even less) in a listed company
may be sufficient to ensure effective control.

A company may wish to have investment in a certain sector which offers strong cash flows
but which has little growth potential. To invest in further operating assets thus entering an
already saturated market would not be optimal. Buying into an established company
through the acquisition of financial assets would be more appropriate. Further, the cost of
acquiring shares in companies with operating assets may be significantly lower than the
replacement cost of such operating assets. If the company acquires effective control, then
the underlying assets become effectively operating assets. If the company acquires a

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Where an existing company wishes to expand through integrating forward, toward the
consumers or backward toward the raw material supplies, it is often convenient to acquire
the shares of existing companies rather than establish new facilities through the
acquisition of operating assets. In addition, an existing successful company is likely to
possess expertise peculiar to their product or service.

1.7
CAPITAL AND MONEY MARKETS
Capital markets are generally distinguished from money markets on the basis of the term
of the investment. Money markets provide short term funding while capital markets
provide permanent or long-term funding.

Most companies experience cyclical or seasonal fluctuations that result in their financing
requirements not being constant over the year. As a result, they are likely to have a large
element of financing from capital markets and enter the money market when additional
funding is required for short-term seasonal or cyclical fluctuations. For example, a
company may finance its investment in property, plant and equipment with long-term
debentures or equity and may finance the investment in inventory for the summer season
by obtaining a short-term loan.

1.8
The advantages of the company form of business organisation are as follows;

Separate legal entity. The company is a legal person and can enter into contracts
in its own name.
Limited liability. The owners (shareholders) are separate from the company and
have limited liability and are only at risk to the extent that they have invested in the
company. Creditors cannot look to the personal assets of the shareholders to
settle the debts of a company.
Option nature of investment as the upside of any investment in a company is
unlimited yet the loss is limited to the investment in the company.
Separation of management from ownership. Although the shareholders will appoint
the board of directors, a management team appointed by the board will retain
operational control. Shareholders do not maintain operational control.
Ability to raise large sums of capital. Arising from limited liability and the separation
of management and control, means that the company form of organisation is
effective for the raising of large sums of capital for the financing of major projects.
Separate taxation. The company is taxed separately from the owners (income tax
and capital gains tax). The dividend withholding tax (DWT) is a tax on shareholders
although the company will retain and pay over directly to SARS.
Continuous existence. A separate legal identity means that the company can
continue indefinitely and is not subject to the lifespan of the owners.
Transferability and marketability. It is relatively easy to transfer share ownership,
and investments in the shares of JSE listed companies are generally marketable.

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1.9

Criteria that may be used as a basis for discussion are:

Ability to raise capital

The impact of limited liability
The continuity of the entity selected
The marketability of the ownership
The impact of Taxation both personal and entity related.
The likelihood of retaining control of theentity.

1.10
In the initial phase, Mr Knight may set up his business as a single proprietor or sole trader.
The legal and regulatory requirements are low and the costs are minimal. The sole
proprietorship or sole trader form of business organisation is applicable if he is able to
self-finance the initial phase of his business. However, the development and marketing of
the device may require funding which he is unable to provide and he will need to obtain
further financing from other investors who will be offered shares in his business. At this
stage he will need to form a private company and he will issue shares in the company to
investors in exchange for the required financing. He will often be the major shareholder.

The company form of business organisation will allow the separation of ownership and
management and will enable the raising of capital as the new investors will know that they
will have limited liability. Only their investment in the company is at risk. Without limited
liability it would be very difficult to raise capital from outside investors. As the business
grows and as the requirement for financing grows, then he may consider issuing more
shares and will convert and register the company as a public company. This will enable
him to list the company on the JSE to raise capital from a larger number of investors and
financial institutions. Usually this takes place within the context of a company that is
operating nationally and which is considering expanding its level of operations, locally or
internationally.

1.11
Profit maximisation is an important goal, which is in most cases linked to value
maximisation. A company that is very profitable will tend over time to generate strong cash
flows and this will result in value maximisation. However, these terms may be in conflict
where profit maximisation is achieved by changing accounting rules, which have no
economic substance. A company that changes its policy from depreciating assets over 5
years to 10 years, will experience an increase in accounting profit but no increase in value
unless the change in policy arises from a bona fide re-evaluation of the economic lives of
assets. Changes in the accounting for inventory from weighted average to first-in first-out
will result in an increase in profit but not an increase in value. Further, a company may be
able to increase profits and reduce the value of the firm if the actions of management to
increase profit have resulted in an increase in the risk of the firm. A firm may increase
short-term profits by reducing advertising or research and development expenditure but
at the cost of future profits.

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1.12
As the financial manager of a large listed company operating a chain of supermarkets
throughout South Africa, the types of decisions, which need to be made by the financial
manager would include:
Investment Decisions
At a store level, it would include decisions in respect to refurbishments, layout, local
product range and the utilisation of space for trading and storage. This may require
the purchase of fixtures and fittings, refrigeration display units, additional
equipment, and other non-current assets.
At the higher level, it would include the following types of decisions:
o To expand the number of distribution centres
o To consolidate distribution centres
o To invest in a company-owned fleet of trucks
o To invest in logistics and supply management IT systems
o To expand by opening new stores in new areas and regions
o To refurbish and expand existing stores
o To expand by moving into countries outside of South Africa
o To purchase existing businesses which may complement current operations
o To decide on the appropriate product range and whether the company
should introduce or expand house products.

Financing Decisions
Whether to finance the investments with new issues of equity shares.Consideration
will be given to issues of control, dilution of existing shareholders ownership and
whether it will increase risks or returns
The company may use retained earnings to finance expansion as well as creditor
finance as the company will receive cash from sales and can delay payment to
suppliers
Alternatively, finance could be raised through long-term loans or the issue of
debentures or notes, or if the investments have a short duration, short term
financing. Such funds can be accessed through Investment and Commercial
Banks.

1.13

A firm should firstly evaluate the investment decision and thereafter should decide on how
best to finance the project. If a project is offering a return of 10% and the estimated
financing cost is 12%, then it does not make sense to raise the finance and incur debt. If
a company raises debt finance and then cannot find profitable investment projects, it will
incur interest costs which will exceed any interest receivable. Of course, what may happen
is that a firm has undertaken a preliminary assessment of a project and then evaluates
whether the company will be able to raise the required financing. However, thefirm has
firstly evaluated the investment decision. The firm may check that it qualifies for debt
financing but it will not make a financing decision and enter into bank loans until it has
made the investment decision.

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Sometimes companies have a lot of cash on the statement of financial position and
management may be tempted to invest unwisely in poor projects, simply because they
have the cash. In a sense this is a case of the investment decision following the financing
decision. We have the cash - therefore why not spend it? This is often the path to failure.
A firm should find the projects and evaluate their returns relative to the cost of capital. If
the return exceeds the cost of capital, then the firm should accept the project and then
acquire the financing for the project.

1.14
THE ACCURACY OF FINANCIAL STATEMENTS
Financial statements mostly use the depreciated historical cost accounting model as well
as accrual accounting. This means that accountants do not purport to reflect current
values in their statements of financial position. Rather, the application of generally
accepted accounting practice, through the selection and application of appropriate
accounting policies, results in a database of numbers, which are based on accounting
principles. However, International Financial Reporting Standards (IFRS) require firms to
use fair value (market value) to report certain assets and liabilities such as financial
instruments.
Financial statements can be considered as accurate from the perspective that they
accurately record and report on transactions, which have taken place. However, reporting,
based on the accrual system, requires numerous estimates and judgements to be made
by accountants, which detract from their accuracy in reflecting real current values.
In order to use this database for financial management decisions, the financial manager
needs a thorough understanding of the nature of accounting policies employed in order to
grasp the implications for cash flows
Financial managers tend to base most financial decisions on the impact which the
decision will have on cash flows and current values. They therefore use the data and
ratios from financial statements to estimate future cash flows.

1.15
Net income is determined by deducting expenses from revenue. However, the expense
relating to the financing of a company is not deducted except to the extent that the
company employs debt financing and deducts borrowing costs. The implied cost of equity
financing is not deducted from income as it represents an opportunity cost and not an
actual cost.

EVA includes the implied cost of all sources of financing. The firm’s economic value added
(EVA) is defined as operating income minus the cost of capital multiplied by the firm’s
invested capital.

EVA = Operating income – (invested capital x cost of capital)

If a firm’s operating income is R100m and its invested capital is R1200m and its cost of
capital is 10%, then although the firm has a positive operating income, it has an EVA of
-R20m [R100m – 10% x R120m]. Although the company has a positive net operating

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The chapter refers to Enron that depicted a positive EPS (earnings per share) but a
negative EVA. Whilst a company can live with a negative EVA for a few years, this is not
sustainable in the long term.

1.16
Accounting profits are dependent on accounting policies and management may select
policies that are not appropriate for the business.
Management may increase profits by retaining earnings, which earn a return that is lower
than the firm’s cost of capital. The maximization of accounting profit does not directly
consider the time value of money so that accounting profit of R5m over 3 years is
equivalent to R15m in one year.
Accounting profits may not reflect cash flows and the value of a firm is determined by a
firm’s future cash flows.
Accounting profit does not include the cost of equity financing. Investors may compute a
firm’s EVA to deal with this issue. However, the correct valuation method is to discount a
firm’s future cash flows at the cost of capital, which includes the cost of all sources of
financing.

1.17
The management of many large listed companies own a very small proportion of the equity
of a company. The management are agents of the shareholders and should take actions
to maximise the wealth of shareholders. Yet there could be a conflict of interest where
management take actions that maximise their own remuneration and perks at the expense
of shareholders. Management could have a greater preference for expenses thatresult in
direct or indirect benefits for themselves. This could be indicated by excessive
remuneration levels, expensive corporate jets and head office structures. Further,
management will be more risk averse than shareholders as their position and survival is
determined by the survival of the firm, whilst shareholders will own a diversified portfolio.
Management may endeavour to maximise the size of the firm and undertake unnecessary
diversification to ensure a continuation of their position.

The factors that may ensure an alignment of the interests of shareholders and
management are as follows:

The threat of any take-over will ensure that management will act to maximise the
share price and thereby make any potential take-over much more expensive and
reduce the willingness of shareholders to accept any offer. The management of
poor performing companies are often replaced in a take-over.
Management incentives such as share options, which are linked to the share price
and performance bonuses that are linked to variables such as accounting earnings
or operating cash flow.
The shareholders can appoint the board of directors that may change the
management team if performance is inadequate.
The market for managers may mean that to move up the CEO ladder, management
will have to show excellent performance. If management is easy to replace than

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management will be motivated to perform, although this may only reflect short-
term performance, which may be at the expense of longer-term performance.
The growth of institutional investors, which now hold onto sizable shareholdings in
many companies means that these investors have become increasingly ready to
act to use their voting rights to replace poor management.
Increasing focus on companies to adopt effective corporate governance measures
means that management is increasingly under pressure to act in a responsible
manner.

Management have become increasingly focused on cost reduction and maximising

efficiencies. This is also due to the growing importance of EVA to monitor management
performance.

It is also relevant to note that as share options become a larger component of

management remuneration, this may in fact lead management to take on projects with
higher risks. This is because they gain from the profits but do not share in the losses

1.18
If a company decides to invest in highly profitable but high-risk projects, then the
shareholders and the investors or management who hold share options have all the
upside, but if the project fails then the bondholders may share in those losses. Therefore,
the potential payoffs for shareholders are higher but for the bondholders, the potential for
losses is greater. Therefore, the price of ordinary shares may rise, the value of share
options will rise even more and the value of bonds will fall.

Let’s take an example. Transnet is the national rail and ports operator. Transnet’s cash
flows are reasonably stable and the company has monopoly control of South Africa’s
ports. The company is able to raise prices unlike Eskom. The Bonds issued by the
company will be highly valued because the company is low-risk and the company earns
stable cash flows. If Transnet starts investing heavily in another sector, say
telecommunications, then the risk rises, as does the potential return from investing in the
shares of Transnet (assuming it was a private entity). However, for bondholders the risk
of the bonds has increased due to a greater risk of loss and the value of the bonds will fall.

1.19
Time Value of Money
The time value of money is one of the most important principles of finance. Value is
affected by the size, risk and timing of cash flows. If an investment will result in a future
cash inflow of R1m, then this should be valued differently depending on when the cash
flow is received. If investment X results in R1m in a year’s time and investment Y results in
a cash flow of R1m in two years time, then we have to value these two amounts differently.
The reason is that the R1m to be received at the end of year 1 can be reinvested for one
year so that it grows to a larger amount at the end of year 2. If the interest rate is 10%,
then the value of X at the end of year 2 will be R1.1m. The adjustment for the time value
of money occurs by discounting future cash flows by an interest rate per period. What this
means is that we cannot simply add cash flows that occur at different points in time until
we have made an adjustment for the time value of money.

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Investors prefer investments with low risk. Risk occurs when there is a potential of loss
and future returns and cash flows are subject to uncertainty. Often, we measure risk in
terms of volatility of returns. High levels of volatility will often imply high risk and investors
will require a higher return from projects with a higher level of risk. This means that the
discount rate will be adjusted to account for the risk of each investment.

The discount rate used to discount future cash flows will be made of a risk-free rate plus a
risk premium. The risk-free rate considers and factors in the time value of money.
Diversification of investments reduces specific risk but all companies are subject to the
risk arising from such macro-economic factors as interest rates, inflation rates, currency
rates and changes to the tax system.

1-20
The sole proprietor is sole owner In a partnership, control vests in the In a private company, the majority In a public company, control vests
and has complete control over partners according to the shareholder will exercise a high in the majority shareholder (>50%),
management and operating partnership agreement. Often degree of control. Minority however, a holding of 35% may
decisions. However, lenders may partners will have a high level of shareholders will have very little ensure effective control. There is a
Control impose constraints. control. control over operating decisions. high level of compliance and
reporting requirements for
listed
companies.
The sole proprietor will carry all the In a partnership, the partners will In a private company, the In a public company, the
risk relating to the business bear personal liability for the debts of shareholders will have limited liability shareholders will have limited
operations and his personal assets the partnership and are jointly and and only their investment in the liability and only their investment in
Risk will be at risk if the business fails. severally liable for the risks of the company will be at risk. Banks may the company will be at risk.
business. require personal sureties.

The sole proprietor will transfer his Transferability of a partnership Transfer of ownership is represented Transfer of ownership isrepresented
interest in the underlying assets interest is subject to the partnership by the transfer of shares in the by the transfer of shares in the
and liabilities of the business. There agreement and the individual company and the process can be company and the process can be
is no liquid market and partners. The disposal of an interest completed quickly. However, there completed quickly. If a company is
transferability is restriced and a is subject to restrictions. may be restrictions on the transfer as listed, then shareholders are able
Transferability tedious process. existing shareholders may have first sell shares onthe JSE, without any
option on any sale of shares. There restrictions being imposed by other
is no active market for shares in shareholders.
private companies.

The tax rate facing the sole The tax rate facing the partners may The corporate tax rate is 28%. The corporate tax rate is 28%.
proprietor may be the marginal be the marginal individual tax rate of [Dividends are subject to a dividend [Dividends are subject to a dividend
individual tax rate which can go up each partner which could amount to withholding tax (DWT) of 20% but this withholding tax (DWT) of 20% but
Tax rates to 45%. a maximum of 45%. is a tax on shareholders rather than this is a tax on shareholders rather
a corporate tax] than a corporate tax]

1-21
A wide range of discussion on this topic is possible. Alternative emphases are acceptable.
The key financial objective of a company is normally considered to be the maximisation of
shareholder wealth. However, most companies now have multiple objectives, some
financial and some non-financial.

The objectives of Company A are out of line with those of most companies these days.
Company A’s focus is strongly on the maximisation of global shareholder wealth, yet
companies have many other important stakeholders. These include: the managers and
directors of the company, other employees, customers, suppliers, banks and other
providers of non-equity finance, the government and society/the local community.

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Solutions to Financial Management, 9e, 2019 10 December 2018

The balance between financial and non-financial objectives will differ between companies.
Many companies specify non-financial objectives which might include growth of sales or
market share, survival, technological leadership and product quality.

Increasingly companies are focussing attention on the needs of the community and the
protection of the environment both of which will tend to use cash resources and might
reduce shareholder wealth. However, it is sometimes argued that if a company acts
responsibly towards society and the environment this will create a good public image that
ultimately leads to an increase in shareholder wealth. The impact of non-financial
objectives on shareholder wealth is difficult to judge.

Company A intends to use sophisticated measures to maximise cash flow in each country
where the company operates. Even if other stakeholders were to be ignored maximising
cash flow in each country might not lead to the maximisation of group cash flow and
shareholder wealth.

If company A wishes to focus on cash flow maximisation it should be from the perspective
of cash flows in its home currency, not many local currencies which could change in value
relative to the home currency. The company’s share price will depend on the expected
cash flows in the currency in which its sharesare denominated.

It is a difficult ethical question as to whether or not a company should outsource

internationally. Many examples of this have occurred in recent years, particularly with
respect to the manufacturing activities and call centres moving from developed countries
to less developed countries where wage costs are much lower. When this occurs there will
normally be redundancies in the developed countries. How much should a company
consider this against increased profits, and possibly enhancement of the standard of living
in less developed countries?

If company A wishes to focus on financial objectives it might be better to relate them to

cash flows rather than profits.

Company B has adopted totally different objectives. There is no financial dimension to the
stated objectives. It might be that the company expects financial success to result from
these objectives, but that would not automatically occur.

The focus on customer satisfaction is increasingly common, and if successful should

enhance sales. However, reducing price might satisfy customers yet it might also lead to
cash flow problems and the destruction of value rather than its creation. High quality
products are fine, as long as the quality is not at the expense of any profit. Increasing
market share is also desirable, but needs to be accompanied by considerations of cash
flow and potential wealth creation. Outstanding levels of sales and delivery service are
sensible objectives, although again these need to be achieved in the context of managing
the associated costs.

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Aligns to SAICA competencies:
A1.1 Governance fundamentals
Use different worldviews and theoretical underpinnings to interpret key stakeholder roles
a)
and responsibilities (agency theory, shareholder/stakeholder theory, Ubuntu)

A2.1 Strategy development process

Following a multi-capital management approach, analyse and align the overall purpose of
a) an organisation (to provide sustainable value to the organisation and its stakeholders) with
its context, vision, mission, values, and mandates
b) Facilitate and advise on the strategy development process of the organization
Review key stakeholder roles and responsibilities in the organisation’s
c)
business plan and the execution of its business strategy
Review the organisation’s strategic direction and highlight areas of
d)
potential value and risk

A2.3 Implementing strategy

Review context relevant models to appraise the organisation’s capabilities to achieve the
a)
business strategy and purpose
Identify and evaluate significant business risks, strengths, weaknesses, opportunities and
b)
threats associated with the organisation’s external and internal environments

Prepare a strategic response to the organisation’s competitive environment by applying

c)
strategic analysis tools to identified external and internal factors
d) Assess the risk tolerance of the entity’s stakeholders’ and its balance with opportunity
e) Identify priorities and actions either to mitigate critical risks or capitalise on opportunities
f) Formulate insights into the impact of future opportunities and risks

A4.1 Finance plan

Evaluate the organisation’s finance plan in the context of its business needs, overall
a)
finance strategy and business strategy

B3.1 Risk management systems and processes

Advise on the integration and standardisation of risk management processes across the
a) organisation – consider the organisation’s risk management philosophy, risk management
strategy and risk management processes
Identify and assess the impact and likelihood of strategic, operational, financial and
c) informational risks to achieving business objectives (e.g., business sustainability and value
creation over the short, medium and long term)
Monitor changes in the organisation’s risk environment to diagnose significant, unusual
d) and emerging risks to which the business is exposed (use metrics such as key risk
indicators)

C5.1 Valuation of a business

Assess the influence of the entity’s competitive, economic, social, political and internal
c)
factors (culture, incentives) on the results

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 Evaluate the critical assumptions and facts that underlie the valuation estimate, for review
and input by others, including – ownership structures (e.g. shares or assets, private
f) company, partnership, listed or not) legal risk (e.g. completeness of liabilities), risks
related to both business sustainability and general sustainability growth strategies and
growth prospects

C5.2 Valuations of intangibles

Analyse and evaluate the impact of mergers, acquisitions and divestitures on business
a)
strategy
Advise on merger, acquisition and divestiture scenarios by considering: The structure of
the transaction (e.g., percentage ownership, assets v shares, expansion through
c) franchising / alliance / joint venture) Financing options and terms, Systems, information,
confidentiality and disclosure requirements, Key risks and rewards, and potential fit with
strategies, Due diligence procedures
Evaluate post-implementation reviews of the selected mergers, acquisitions and
e)
divestitures transactions and evaluate the outcomes

Z1 Business internal environment

Describe an organisation’s business model taking cognisance of its various capital

resources used to optimise value creation for stakeholders (e.g. customers (provide
d)
revenue by buying products), shareholders (provide capital), employees (provide talents
and skills) and suppliers (provide products and services internally or externally)

III1 Self-development
Adopt an attitude of life-long learning and stay abreast of current trends and emerging
a)
issues
b) Take responsibility for one’s own development needs and opportunities
Actively seek appropriate learning opportunities (technical and other professional
c)
development) in a variety of different ways
Set and monitor personal learning and development objectives through a wide range of
d)
life-long learning opportunities
III2 Adaptive mind set and agility
Acquire new knowledge, skills and experiences to remain relevant, adapt career goals,
a)
and empower others
Identify and distinguish between the need to learn, unlearn and relearn, so as to facilitate
b)
adaptation to changing practices, roles and work contexts
Demonstrate the mind set and behaviours required to work in an agile way to deal with
c)
complexities

X6 Self-management
a) Manages self by working independently, diligently
b) Adapt to different professional settings and cultures
Develop time management, planning and task coordination skills and techniques to
c) prioritise tasks (recognising their resource constraints) so as to achieve professional
commitments
e) Set appropriate goals, monitor and self-reflect on own performance

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X8 Emotional intelligence
Exercise self-awareness and self-discipline; Apply self-reflection and self- awareness skills
a) and techniques to ensure continuous learning and growth. Accept constructive feedback
from others.
c) Show persistence and resiliency in pursuing goals despite obstacles and setbacks

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