Instructions: Read through the material below, follow the instructions for exercises and check for discussions on the forums.
This topic is broken into six study units which correspond to six chapters in your prescribed textbook. At the start of each
chapter the textbook indicated a few learning objectives. These objectives should be read and you should make sure that you
achieve the these objectives by then end of studying the chapter as they will guide you towards mastering the work in order to
be able to fulfil the assessment criteria set out above. In turn, by doing so, you will achieve one of the specific outcomes of the
module. Remember, you will be assessed (examined/ tested) based on the assessment criteria in order to ascertain whether
you have mastered the specific outcomes of the module.
READ IN YOUR TEXTBOOK: Chapter 1 [Always make sure to note the learning objectives] OVERVIEW
Refer to figure 1.1 in chapter 1 of your prescribed textbook. This figure provides a condensed overview of the financial
management function. In this overview here below, we elaborate on the overview in your prescribed book to clarify the
financial management function in detail (1-2 to 1-3).
The enterprise’s financial function involves all the activities that have a bearing on its financial affairs. This function, which can
scarcely be separated from the other business functions, relies on methods and information provided by disciplines such as
economics, accounting, cost accounting and mathematics. While the scope and organisation of the financial function differ
from one enterprise to another, depending on their form, size and line of business, the fundamentals of financial decision
making remain basically the same. The frame of reference for the purposes of this course will be a listed company (1-5 to 1-7).
Success is typically measured in terms of value. Financial decisions invariably concern the future, which is unknown and
therefore uncertain; and this being so, each financial decision should most carefully weigh the anticipated risk against the
expected return in order to maximise benefits to the owners. The importance of financial theory is that it offers both a frame of
reference and a source of knowledge for this decision making process (1-11 to 1-13).
To produce goods and services a modern enterprise requires a virtually endless range of real assets. Many of these are tangible,
for example machinery, equipment, plant, buildings and offices, while a large number, such as technical know-how, trademarks
and patents, are intangible. Since the company needs funds to acquire and pay for these assets, it sells financial assets or
securities such as shares and bonds (debentures). These securities possess value in as much as they represent claims on the
enterprise’s real assets. Besides equity and bonds, financial assets also include options, bank loans, hybrid securities and lease
commitments (1-14 to1-15).
The financial manager faces two fundamental problems: firstly, which assets to invest in and how much to invest in them; and
secondly, how to acquire the necessary cash to do so. The answer to the first question concerns the enterprise’s investment
decisions; the answer to the second concerns its financing decisions. It is the task of the financial manager to find those
answers which will maximise the wealth of the owners (shareholders) (1-14 to 1-17).
If the goal of financial management is to maximise shareholder wealth, we need to be able to measure this wealth in order to
be able to maximise it. Share price value is a common measure of shareholder wealth as it directly relates to the amount of
wealth that a shareholder holds. This is intuitive in the sense that if the share price is $15 instead of $13, the shareholder has
more money due to the higher price. On the other hand we should also consider this wealth over a longer term as this wealth is
not worth much if the price falls immediately after achieving such a peak. Therefore we can measure shareholder wealth in
terms of a share price over a period of time. There are also other measures that attempt to also gauge the value of the firm
such as Economic Value Added which is considered one of many important measures of the value of a company.
, EVA is an interesting concept which we will encounter again later in this module. For the moment a brief explanation should
give you an idea of why it may be considered a measure for shareholder wealth and also give some insight into how the actions
of the financial manager can impact upon it:
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.
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