Corporate Finance: Theory Meets Practice

The provided content is related to corporate finance, bridging the gap between theory and practice. It includes various articles and online resources that discuss capital budgeting decision-making, macroeconomic policy coordination, fraudulent financial statements identification, and other relevant topics in the field of finance.

FINANCIAL
ECONOMIC
LITERACY FOR MANAGERS

TABLE OF CONTENTS
Introduction .....................................................................................................................................3
TASK ..............................................................................................................................................3
Question 1........................................................................................................................................3
a) The classification of production along with examples ...........................................................3
b) Explaining opportunity cost with example..............................................................................4
c) Explaining the purpose of the UK standard industrial classification.......................................4
d)Explaining the concept of shift in demand curve and movement along the curve ..................4
e) Explaining the income and substitution impact on increase in price ......................................5
Question 2........................................................................................................................................6
a) The types of market along with examples ..............................................................................6
b) The public good and its example. ...........................................................................................6
c) Explaining the ways in which government intervene in the market........................................6
d)Explaining the four key macro economic policy objectives.....................................................6
e) Explaining the circular flow of income involving the inner flow, withdrawal, injection etc. 7
Question 3........................................................................................................................................8
a) Defining the four major areas of finance with examples ........................................................8
b) The determinants of market interest rate with different types of risk premium. ....................8
c) Explaining the four basic financial statements .......................................................................8
d) Calculating ratios of M&S.....................................................................................................12
Question 4......................................................................................................................................13
a) Describing the importance of capital budgeting decisions ...................................................13
b) Describing the use of NPV technique for investment decisions ..........................................13
c) Explaining the yield curve involving the reason for difference.............................................14
d) Calculating expected return on two projects .......................................................................14
Conclusion ....................................................................................................................................14
REFERENCES .............................................................................................................................16
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INTRODUCTION
The managers hold position within the organisation as are responsible for entire control
and management of firm or group of employees. They are in charge of specific group of task.
The profitability, long term success and sustainability of company depends upon the
effectiveness of decision taken by managers (MacNeilage, 2012). In this report, various aspects
of financial, economic literacy for managers will be studied in the context of Marks and Spencer.
It is multinational company of UK that is renowned for its fashion apparels, home and luxury
food products. In this report, ratio analysis of M&S in UK economy will be provided. The yield
curve will be explained along with reason for its difference. Further, description about the NPV
technique and its use in making investment decision will be discussed.
TASK
QUESTION 1
a) The classification of production along with examples
The production function refers to modification of different inputs into needed output. It is
method that determines the way in which manufacturing function is executed in M&S. Further,
production system is classified into various types which are explained as follows:
 Continuous production: In this method, the products are manufactured for the stock and
not for particular orders. The main feature of this system is that it have standardize
production process as it use specific processes, plant and equipment ( Weale and Blake.,
2015). For instance, food industry use this production system.
 Mass production: This system aims at manufacturing of discrete components using a
constant method called mass production. Here, manufacturing system is reasoned due to
bulk production. Example, Ford motors have mass production.
 Job shop production: It is featured by producing few or one quantity of products
designed and manufactured as per the customized requirement of customers within
predetermined time and cost. The repair shop, commercial printers etc have this kind of
production method (Rapetti, 2013).
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b) Explaining opportunity cost with example.
The opportunity cost can be defined as cost of an option that must be forgone so as to
pursue a specific action. It further help in understanding the relationship between scarcity and
choice. The aim of this is to assure optimum utilization of limited resources (Baker, Singleton,
and Veit, 2011). For example, employee of M&S want to leave its job and attend higher
education for career growth. Here, opportunity cost of such decision is loss of remuneration for a
year.
c) Explaining the purpose of the UK standard industrial classification
The standard industrial classification (SIC)is a four digit code system that ascertain the
mode of economic function. It was initiated in 1948 in UK with the objective of categorizing
business enterprises and other statistical units by the kind of economic functions in which they
are involved. The SIC codes are allotted as per the common features in business offerings,
manufacturing and delivery system of a business (Borras and et.al., 2011).
d)Explaining the concept of shift in demand curve and movement along the curve
The shift in demand curve represent the state when demand changes in market. It means
modification in the components other than the price of offerings . Example, increase in income
of customer may cause him/her to purchase more products offered by M&S. Such as in
following diagram price is consistent at 15 $but quantity demanded increased from 8 to 12 units.
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Illustration 1: Shift in demand curve

On the other hand, movement along the demand curve represent the state when the
quantity demanded changes with the change in price of commodity. Such as in following
diagram, at price 15 quantity demanded was 6 (Al Mutairi and et.al., 2012). While, with the
decrease in price at 10 the quantity demanded increased by 4 units.
e) Explaining the income and substitution impact on increase in price
The substitution impact determines how the increase in price force customers to use other
products over company offering. This effect assumes that income of individual remain same
while price changes. Foe example, increase in price of M&S goods with 8% while Sainsbury
increase by only 5% than it is possible customer start buying Sainsbury products (Bierman and
Smidt, 2012). On the other hand, income effect determines the change in customer or economy
income affect the quantity of products demanded. Example, at income of $800 X is buying non
branded clothes while increase in income up to $1200 can cause it to purchase branded offerings.
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Illustration 2: Movement in demand curve
Illustration 3: Substitution effect

QUESTION 2
a) The types of market along with examples
Broadly, there are two types of market which are described as follows:
 Perfect Competition: It is kind of market situation where there are large number of
sellers offering homogeneous products to wide audience. In this type of market, firms
face tough competition due to free entry and exit process. The customers have proper
knowledge of prevailing prices (Bennouna, Meredith and Marchant, 2010). Hence
increase in price by entity can stimulate them use rivals products. For example, grocery
market where many vendors gather to offer fruits and vegetables.
 Monopoly Market: In this market situation there are one seller that provide unique
product. The company further enjoy right to charge high price by exercising control over
supply. The different barriers to entry restrict the firm to enter the competition (Monopoly
market. 2016). Such as before 2006 there was monopoly of Royal mail group in UK
regarding postal services.
b) The public good and its example.
The public good represents those commodities that have features like non excludable and
non rivalrous. Here non excludable goods are those which can be used by everybody irrespective
of their paying capacity. Example, atmosphere, national defence, service of police and fire
department, flood control system etc (Healy and Palepu, 2012). Further, the factor non rivalrous
relates to the fact that consumption of a product does not minimize its significance to others.
Such as, street lights, public beach, road or parks.
c) Explaining the ways in which government intervene in the market.
The government interfere in the economy through various ways. The government
intervene to maintain its control over the operation of company, individuals etc. To address the
issues of inefficiency, the government have to interfere in market. Such as, it can make
modification in economic and other policies, make new laws etc (Lehavy, Li and Merkley,
2011). Increase in bank rate to reduce demand of public borrowings is method through which
government reduce chances of inflationary situation.
d)Explaining the four key macro economic policy objectives
The four major types of macro economic policy objective are as follows:
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 Full employment: It is situation where economy aims at providing full employment in
productive work to all labour force.
 Price stability: It means that average price must not increase more than 2% in a year.
This will help in keeping low inflation (Humpherys and et.al., 2011).
 Economic growth: The objective of macro economic policy is to grow sustainably so
that national income enhance in real terms so as to sustain in future without causing
economic issues (Macro economic policy. 2016).
 Payment stability: It means stability in balance of payment so that country is able to pay
off its debt in the global market.
e) Explaining the circular flow of income involving the inner flow, withdrawal, injection etc.
It is the model of economy that showcase the flow of money within the economy. It
further consider factors like leakage and injection. Here, leakage means withdrawal of money
from the flow such as savings by entities and households (Circular flow of income. 2013). In
addition to this aspect, import, tax payment are kind of leakage that minimize the flow of
income. On the contrast,injection means introduction of additional income into the flow. For
example, direct investment by foreign entity, export or government expenditure.
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Illustration 4: Circular flow of income
(Source:Shinoda, 2010)

QUESTION 3
a) Defining the four major areas of finance with examples
The main area of finance are as follows:
 Corporate Finance: It refers to capital structure, source of funding used by business
entities to enhance the value of firm to the shareholders. Example, funds obtained from
the sale of stock.
 Investment: It means purchase of monetary asset with the objective of appreciation in
future so that it can be sold at a higher price. Such as, buying of land.
 Financial institutions: It refers to short and long term borrowings obtained from
financial institutes such as commercial bank, investment bank, investment companies,
brokerage houses and insurance companies etc (Humpherys and et.al., 2011).
 International finance: It is field of financial economies that deals with monetary
systems and economies over the nations frontiers.
b) The determinants of market interest rate with different types of risk premium.
The rate of interest is amount due in particular period. The market interest rate means the
rate at which interest is paid by borrower to lender for the borrowed amount. The interest rate is
determined by following factors:
Supply and demand: The interest rate changes with the increase in supply or demand of money
in economy. Such as with more in the economy the government may increase the bank rate to
reduce the excess of money in the economy (MacNeilage, 2012).
Liquidity premium: It refers to rate charged by lenders to show the concept that some
securities cannot be changed into cash on short notice at fair market prices. Example, treasury
bills.
Default risk premium: It represent the chance that the borrower may fail to pay interest or
principal amount at the declared time and in the stated amount.
c) Explaining the four basic financial statements
The four major financial statements are as follows:
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 Balance sheet: It is statement of asset, liabilities and capital of company at specific time
period. It help in understanding the financial position and worth of business in market at
particular time period. The formal of balance sheet is
 Income statement: It is statement that represent profit after subtracting expenses for
provided time period closing at particular date. The main purpose of preparing income
statement is to check the profitability of business.
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Illustration 5: Balance sheet
(Source: Types of financial statement. 2010)

 Statement of owners equity: This statement represent the modification in retained
earning due to change in factors like, income and dividend (Humpherys and et.al.,
2011).
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Illustration 6: Income statement

Cash flow: It is statement that represent inflow and outflow of cash in business. It help in
knowing that inflow in company must be more than its outflow. As per IAS7 there are direct and
indirect method for preparation of cash flow company can use any of them as per its preference.
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Illustration 7: Owner equity statement

(Source: Types of financial statement. 2010)
d) Calculating ratios of M&S
Ratio analysis
Ratios Formula 2014
Liquidity ratios
Current ratio Current asset/current liabilities 0.58:1
Market value ratio
Return on equity Net income/Shareholders equity 20.14%
Debt management ratio
Debt equity ratio Debt/Equity 0.61:1
Asset management ratio
Asset turnover Total asset/sales 1.33:1
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Illustration 8: Cash flow statement

 Current ratio- It is one of the kind of liquidity ratio which helps in measuring a firm's
ability in order to pay off its short-term liability using its available current assets.
 Return on equity- Another important ratio which helps to determine the return on equity
to know that the business owner has invested its own equity in the business and get the
amount back in terms of return (Borras and et.al., 2011).
 Debt-equity ratio- It helps to determine the efficiency of a business by calculating the
ability of firm by identifying the proportion of debt in terms of its equity held by them. It
reflects the position of firm is stable but not very good.
 Asset turnover- It is another common method of identifying the turnover rate of total
assets in comparison with its sale turnover (MacNeilage, 2012). It shows the positive
result and higher than 1 which is regarded as a favourable condition for firm.
QUESTION 4
a) Describing the importance of capital budgeting decisions
The capital budgeting decision help in determining whether the investment is profitable
or not. It facilitate management to avoid unfruitful business decision that cause huge amount of
loss or closure of business. It help in avoiding various risk and uncertainties. Since, the decisions
of investment are irreversible and likely to cause loss of tantamount. They must be taken wisely.
Further, capital budgeting decision ave long term impact on the future proficiency and cost
structure of the entity ( Weale and Blake., 2015). Thus appropriate decision can lead to fruitful
outcomes while wrong decision can cause threat to existence of the corporation.
b) Describing the use of NPV technique for investment decisions
The NPV means the current value of net cash flow rendered by a project involving
salvage value. It help inn knowing the time value of money. On the basis of NPV method
company can decide whether its should accept or reject a investment proposal such as buying of
new machine, land or building etc. It help in knowing the net yield of a project by taking into
account the future value (NPV method. 2010). According to this technique , M&S has to select
those projects only in which there is possibility of higher-returns.
c) Explaining the yield curve involving the reason for difference
The yield curve is curve on a graph where the return of fixed interest bearing securities is
plotted against the particular time period. It can be also refereed as graphical presentation of the
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state between the yield on bonds of the alike credit quality but various maturities. Therefore, the
major reason for difference in yield curve is change in maturity.
d) Calculating expected return on two projects
Project
A Pv@10%
Present
value Project B Pv@10%
Present
value
Initial investment 50000 50000
1 15625 0.893 13951 0 0.893 0
2 15625 0.797 12456 0 0.797 0
3 15625 0.712 11122 0 0.712 0
4 15625 0.636 9930 0 0.636 0
5 15625 0.567 8866 99500 0.567 56459
6 0 0.507 0 0.507 0
Total 56325 56459
NPV 6325 6459
Interpretations
As per the above analysis of two projects A and B on the basis of onbe of the common
technique of capital budgeting that is Net present value. The Project A shows positive NPV on
the contrary Project B shows positive as well as higher NPV than project A. The decision
regarding selecting of appropriate project is not taken on the basis of high amount of NPV as
project higher Npv by generating higher cash inflow in the 5th year which is not suitable in case
of the business. In business the cash inflow or sales revenue needs to be continuously generated
to meet out the other and daily expenses. The project A generated NPV is less as compared to
project B but should be selected as it generates good amount of revenue throughout the year.
CONCLUSION
Summing up the entire report, it can be concluded that financial and economic literacy
help in taking better business decision. It enable manager to make proper use of available capital,
invest in profit generating sources, have proper knowledge of financial market. The interest rate
is affected by various factors like, supply and demand. With the help of capital budgeting
decision can have proper control on the cost of capital outlay projects. There are two types of
market, perfect competition and monopoly.
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REFERENCES
Books and Journal
Al Mutairi, M. and et.al., 2012. Corporate governance and corporate finance practices in a
Kuwait Stock Exchange market listed firm: a survey to confront theory with practice.
Corporate Governance: The international journal of business in society. 12(5). pp.
595-615.
Baker, H.K., Singleton, J.C. and Veit, E.T., 2011. Survey research in corporate finance:
bridging the gap between theory and practice. Oxford University Press.
Bennouna, K., Meredith, G.G. and Marchant, T., 2010. Improved capital budgeting decision
making: evidence from Canada. Management decision. 48(2). pp. 225-247.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
Borras Jr, S.M. and et.al., 2011. Towards a better understanding of global land grabbing: an
editorial introduction. The Journal of Peasant Studies. 38(2). pp. 209-216.
Healy, P.M. and Palepu, K.G., 2012. Business Analysis Valuation: Using Financial Statements.
Cengage Learning.
Humpherys, S.L. and et.al., 2011. Identification of fraudulent financial statements using
linguistic credibility analysis. Decision Support Systems. 50(3). pp. 585-594.
Lehavy, R., Li, F. and Merkley, K., 2011. The effect of annual report readability on analyst
following and the properties of their earnings forecasts. The Accounting Review.
86(3). pp. 1087-1115.
MacNeilage, P.F. ed., 2012. The production classification Springer Science & Business Media.
Rapetti, M., 2013. Macroeconomic policy coordination in a competitive real exchange rate
strategy for development. Journal of Globalization and Development, 3(2). pp. 1-31.
Shinoda, T., 2010. Capital budgeting management practices in Japan: a focus on the use of
capital budgeting methods. Economic Journal of Hokkaido University. 39. pp. 39-50.
Weale, M., Blake., 2015.Macroeconomic Policy: inflation, wealth and the exchange rate.
Routledge.
Online
Circular flow of income. 2013. [Online]. Available through:
<http://www.romeconomics.com/circular-flow-income-explained/>. [Accessed on 3rd
August 2016].
Macro economic policy. 2016. [Online]. Available through:
<http://www.economicsonline.co.uk/Managing_the_economy/Macro-
economic_policy_objectives.html>. [Accessed on 3rd August 2016].
Monopoly market. 2016. [Online]. Available through.
<http://www.economicsonline.co.uk/Business_economics/Monopoly.html>. [Accessed
on 3rd August 2016].
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NPV method. 2010. [Online]. Available
through:<https://www.efinancemanagement.com/investment-decisions/why-net-present-
value-is-the-best-measure-for-investment-appraisal/>. [Accessed on 3rd August 2016].
Types of financial statement. 2010. [Online]. Available through:
<http://www.quickmba.com/accounting/fin/statements/>. [Accessed on 3rd August
2016].
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