MBA Financial Management

MBA Financial Management
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Question 1
Petty et.al says in their textbook, “However, while it is not necessary to understand finance in order to understand these principles, it is necessary to understand these principles in order to understand financial management.”
Which principles are the authors referring to in the above statement? What is the importance of these principles?
The authors emphasize that there are 10 principles that influence the decisions making process in financial management, and the form the basis for financial concepts in the book. The 10 principles are:
The risk-return trade-off
Time value of money
Cash flow is the source of value rather than profits
Incremental cash flows are relevant
The curse of competitive markets (why it is hard to find exceptionally valuable projects)
Capital markets are efficient and prices reflect the information available
The agency problem/ conflict of interest
Taxes bias business decisions
The risk are not equal[ some can be diversified
There is need for ethical behavior, but decisions makers are also faced with ethical dilemmas in finance
Please explain with the help of detailed examples how any three of these principles can benefit an individual or a corporation financially.
The risk-return trade-off
The risk-return trade-off states that when the risk in undertaking an investment project is high so are the potential returns. As such, when analyzing the viability of an investment plan, the concept of risk return trade off is necessary to make a sound financial decision. The risks in an investment are compared with the expected return. Investing in speculative stocks is an example of the risk-return trade-off, since an investors demands higher returns given that the security has a high risk. However, investing in the T-bills has low returns given that it has low risk, meaning that one would need to evaluate the risk-return trade-off to choose the most optimal decision based on the investment alternatives.
Time value of money
The time value of money represents the idea that money held at the present time is more than the future, given that there is a potential earning capacity. One of the prime examples of the time value of money is investment, where one earns more by investing in the present. On the other hand, if one were to receive the same amount that was initially invested in future, it would be worth less depending on the interest rate. Consequently the discounting process is critical to analyzing different investment plans. The time value of money then helps to achieve the profit maximizing value. Hence, the time value of money is necessary to allocate resources based on the profit maximizing investment ventures and budget constraints.
Cash is the source of value and not profits
Capital-budgeting decisions are based on cash flows and not the profits, after taking into account the time value of money. Corporations that rely on cash flows give a clearer picture about the returns. The cash flows are better measures when evaluating projects compared to profits, since focus on the tax shield, depreciation as well as the operating profits. Hence, a corporation will be ...