Q1
Shareholder theory helps business organizations to look past their basic shareholders to understand that other groups exist whose lives are impacted by the organization’s activities and therefore, their needs must be taken into consideration. In the case of Exxon Valdez oil spill in Alaska, the company failed to identify most of its shareholders and had hence ignored to create positive relationships with them (Seager et al. 2007). The shareholder theory articulates that, in a crisis scenario, established pre-crisis relations which shareholders are crucial. This means that neglecting of shareholders can lead to a withdrawal of support in times of crises. It is sad that Exxon did not recognize most of its potential shareholders before the disaster. As such, this crisis is largely attributable to the company’s poor response and planning. Such events are regarded as a high consequence, low probability events. This is because the chances are extremely low for such a disaster to occur at the same time fewer resources are invested in preparing for disaster contingencies.
Any business entity is expected to maximize its shareholder value (Seager et al. 2007). An analysis of Exxon’s costs of the cleanup and the fines versus maximizing shareholder value and ethical responsibility appears to be a reasonable decision at the time. Obviously, Exxon was ethically liable to prevent the accident from using double-hulled oil tankers since such a move would have stopped the adverse effect on the environment. This means that the company should have acted in an ethical and responsible manner by considering desirable investments in the new oil tankers. The outrage of the company’s behavior and the subsequent fines altered the estimation of future costs for similar situations. Therefore, leaders should take into account their decisions as far as their companies’ cash flows are concerned. Unethical business conduct can lead to large fines, boycotts, protests and lower sales (Seager et al. 2007). Therefore, behaving in socially responsible and ethical manner is highly congruent with the objective of maximizing shareholder wealth.
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Q2a
Drawing from the name itself, an income statement consists of all the company’s income. Such include the company’s net sales. From the net sales, the income statement helps us determine various things. For example, it helps determine the firm’s profit margins through dividing the income metrics by the revenue. Further, the income statement has a calculation of the firm’s earnings per share. To determine this, the company’s net income is divided by the total number of shares that is always listed at the bottom of the income statement (Duhovnik, 2003).
Balance sheet
The balance sheet informs the company’s financial standing. It is divided into three main parts namely equity, liabilities, and assets. The assets must be balanced or equal to the liabilities plus equity. The assets are listed in two groups namely the long term and the current assets (Duhovnik, 2003).
Cash flow statement
A cash flow statement contains information on the overall flow of money out and into the company. The statement contains three sections namely financing, investing and operating (Duhovnik, 2003).
What is the purpose and importance of financial analysis?
Financial analysis plays an important role in the business world, especially in accounting. By examining the current and past financial statements like cash flow statements, income statement, and balance sheets, the company can make decisions regarding investment value as well as projections of future performance. Financial analysis also helps companies to weigh how decisions such as borrowing may affect the business (Duhovnik, 2003).
What are financial ratios?
Financial ratios are currently the most widely used tools in managerial decision-making. Financial ratios are defined as a comparison of one number to another. It involves comparing numerous figures from the financial statements to obtain information regarding a firm’s performance (Duhovnik, 2003).
Q2b
How is the firm’s liquidity? This question helps establish if the company can repay creditors in a timely fashion by comparing the current liabilities to current assets, including the quality of individual current assets.
Are the leaders producing sufficient operating income from the firm’s assets? This question helps to calculate the company’s operating profits, profitability, and turnover ratios to establish the position of the assets.
How is the company funding its assets? This involves calculating the debt ratio and the interest earned
Is the company’s leadership offering a proper return on the capital offered by the shareholders? This is determined by computing the return on equity analysis and compares it to competitors.
Are the company’ managers generating shareholder value? This involves measuring the value created by the managers against the economic value added.
What are the limitations of financial ratio analysis?
Although the financial ratio analysis is a useful tool, it has some limitations. Some of the key disadvantages include:
Assumptions and estimates affect financial accounting data. So, accounting standards permit different accounting policies; in turn, this hampers accountability and thus renders the ratio analysis less useful in such scenarios (Duhovnik, 2003). Different firms are engaged in different industries characterized by different environmental conditions like market structure and regulations. Factors such as these are highly significant such that a comparison of two firms from different industries could be obviously misleading (Duhovnik, 2003).
If we divide users of ratios into short-term lenders, long-term lenders, and stockholders, in which ratios would each group be most interested, and for what reasons?
The short-term lender would be interested in liquidity ratios since they are primarily concerned with the company’s ability to pay short-term responsibilities are they arise (Duhovnik, 2003). Long-term lenders, on the other hand, would be concerned with the leverage ratios since their primary focus is the relationship of total assets to debt (Duhovnik, 2003). Lastly, the stockholders will be focusing on the profitability ratios (Duhovnik, 2003). However, the secondary interest of this group will be liquidity, debt utilization, and other rations. This is because the stockholders are the ultimate company owners so their primary interest includes the profits or return on their investments.
Q3.) a.
The Time Value for Money (TVM) refers to the idea that cash available at present time is worth more compared to the same figure in future because of its potential earning capacity (Horvath, 1995). The concept of TVM is important to companies because a dollar in the company’s account at present is worth than a dollar promised in the future. This is because a company can use the dollar at hand to invest and earn capital gains or interest. Actually, money promised in the future is worth less due to the risk of inflation.
Explain the relationship of discounting and compounding.
Discounting and compounding go hand in hand in accounting. The two concepts ate equally integral in the economics of TVM because they are used to adjust the value of money at a given time (Horvath, 1995). However, the two concepts work in different directions. Discounting is used to express the value of a given amount of cash in the current dollars and compounding is used to determine the current sum of cash in the future dollars. In financial accounting, discounting and compounding is used all the time to evaluate investments. Because the value of money is likely to change with time, it is important to express all the cash in the present and future dollars in order to compare them.
Suppose you were considering depositing your savings, which bank would you choose? Why?
Because I am interested in elasticity, I would choose to deposit in bank C because it compounds daily. A bank that compounds daily on a large scale would allow me to earn more interest given that I can access my money off the cuff (Horvath, 1995). I would not choose bank A and B because the two banks would not allow me to earn much money since they are based on an average compounding.
Q4
In the determination of its cost of capital for making new capital investment decisions, XOM must consider the performance and profitability (Konchitchki et al. 2016). For instance, in case the company wants to create a new oil production plant in a certain location, it must estimate the amount of return expected to justify this specific investment. Another way XOM could approach the determination for making new capital investment decisions is the weight average cost of capital (WACC) (Konchitchki et al. 2016). This technique refers to the average after-tax expenses as it pertains to all sources. It is obtained by multiplying the cost of each finance source against the relevant weight and adding the products. Because XOM already has its upstream and downstream investments, this approach may be deployed in calculating a single corporate cost of capital
References
Duhovnik, M. (January 01, 2003). Financial Accounting: How to Improve Financial Reporting Standards. Economic and Business Review, 5, 61-93.
Horvath, P. A. (January 01, 1995). Compounding/Discounting in Continuous Time. Quarterly Review of Economics and Finance, 35, 3, 315-325.
Konchitchki, Y., Luo, Y., Ma, M. L. Z., & Wu, F. (March 01, 2016). Accounting-Based Downside Risk, The Cost Of Capital, And The Macroeconomy. Review of Accounting Studies, 21, 1, 1-36.
Seager, T. P., Satterstrom, F. K., Linkov, I., Tuler, S. P., & Kay, R. (July 01, 2007). Typological Review of Environmental Performance Metrics (with Illustrative Examples for Oil Spill Response). Integrated Environmental Assessment and Management, 3, 3, 310-321.
