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The Principles of Finance

The Principles of Finance



 The Principles of Finance


Companies are required to have records of the details of each and every report so that they can show it to its shareholders, its managers and to the investors. The principles of finance determine that with these information what the investors, shareholders and mangers are going to do. In broader term we can say that finance works for decision making for the organization based on the details and information gathered by it. The financial principles used for the decision making for the investment and for the decisions related to finance. The decisions are taken on the basis of operating, investing and financing.Some of the principles of finance are: Time value of money: It is determined by the value of the money. The value of the money decreases with the time passed.  Hence it is very important to think about inflation before you do investment.Risk and return principle: This is mainly concerned with the investor’s risk and return process during the investment. As the finance says that higher the risk is, higher will be the profit. Hence, for more return an investor will have to take more risk.

4.     Principle of diversity: This principle determines the diversity of the portfolio of an investor. Basically it helps to reduce the risk so that you go with the principle that never put all eggs in one basket.

5.      Hedging principle: This principle is concerned with taking loans from various sources and in the short term we can have it and use it for long term benefit  Liquidity and Profitability: This is the most important principle especially for the investors. The profitability and liquidity both are important for investors. Liquidity is basically deals with the fact that how we can have cash by selling the investment.Also investors invest for the purpose of maximization of its profit.


ANS 1.

As we know that for the purpose of decision making it is important to maximize the shareholder value and it has become the main goal for the shareholders for the effectiveness of decision making. The shareholder value is determined by the market price of a firm. The maximization of shareholders value represents that an organization should focus on maximizing the present value of the expected future returns to the shareholders of the organization (Andreff, 2014).Basically present value is the value of today of some future payment and it is calculated by discount rate.Also the wealth of shareholder are measured by the market value of shareholders that they own in stocks.

Source: (Andreff, 2014)

 It has various advantages that shareholders look forward to maximize its wealth. The main benefit is that the risk of the return expected by the investment and it helps to take the decisions in financial terms. The 2nd benefit is that through this first objective the shareholders can check its consistency and it helps the organization to increase its market value as well (Andreff, 2014).


 Good and  fl improving cash fow: Buyers mainly look the company’s good and improving cashflows and this is one of the important factors for the company which contributes for the company’s growth. It basically keeps record of improving revenue of the company and it growth (Billett, et. al., 2018). Diverse Customer base: It is mainly concerned with the diversified customers so that the company does not lose it customers. It helps the organization to analyze its loyal customers

3.  Competitive advantage: Competitive advantage is offered by a company so that the customers will buy product or service from you. For company’s promotion and protection competitive advantage is important for the organization.

4   Recurring Revenue that is sustainable and Resistance to commoditization: As an investor you will always want to make profit from an organization and will be continuing in the future because the company products are resistant for being commoditized. Hence the value of the firm will be determined by the company’s revenue sustainability and resistance to commodities (Billett, et. al., 2018).

5.      Demonstrated Scalability: It means that profit increases when revenue increases. Some value drivers for example the financial model and operating activities system can improve the profit margins and revenue margin as well. If such value drivers will help the organization the scale of the business will be increased by establishing new branches and stores in various locations.

6.   foresight and controls: It has two aspects. The first one is concerned with the financial controls and reports. Sometime many companies does not have the reliable financial reports that buyers are not able to find out that what the company is gaining the profit from, it means they cannot determine the source of the revenue. And the second aspect is concerned with gr    Financialowth of the company (Billett, et. al., 2018). The growth could be determined by the appropriate cash flow of the organization.

The main two principle financial decisions that corporation face are:

1.     Investment Decision: It relates to the decision of investment in the organization that the quantity of the assets in the firm. Mainly the composition of the assets is the factors that helps to make perception for the investors. Business risk complexion is also one of the factor included in that (Billett, et. al., 2018). It is considered to be the most important financial decision for an organization and it can be classified into two categories. The first one is long term investment decision and the second one is short term investment decision. The long term investment decision includes capital budgeting and short term decision include the working capital management.

2.      Dividend Decision: It is also considered to be the major financial decision for the organization. It includes the disbursement of profit to the investors who provides capital and revenue to the firm. The concept of dividend says that dividend is a part of profit of a company which has to be distributed among its shareholders.

Now on the basis of all the profits which has to be distributed and by maximizing the shareholders wealth a company can make decisions related to its dividend earned. The organization also seeks its stability of dividend, Stock dividend and cash dividend while making the decisions on dividend.


Agency cost is basically concerned with the disputes between the company’s managers and it shareholders. Shareholders always wants to increase the value of share and they want the same from the company’s managers whereas managers focuses on expanding the business of the organization and make their personal benefit too by increasing their salaries etc.When there is an involvement of debt agency cost takes its toll on company’s share price. Both the shareholders and bondholders have disputes on interest but shareholders always have the power of administration (Ferran and Ho, 2014). Although, it becomes critical for accounting purpose because we cannot ignore agency cost in accounts. Also the managers have more detailed information and they can use it as an advantage. The advantage could be in the decision making for the company.


The principle agent problem refers to the problem when one agent says yes to the work for another agent. And the return will be offered by the party who is offering the work. This kind of agreements includes larger cost for the agent. And the problem arises due to conflict in interest and moral hazards. Sometime the agent avoids the interest which he is going to have and focuses on another agenda. Hence, problem arises due to such behavior (Ferran and Ho, 2014).

There are some consequences of principle agent problem. Market failure is one of the examples of principle agent problem. It leads when there is not appropriate allocation of resources is maintained. This also leads to distortion in the market and due to distortion in the market it creates inefficiency in the market.


There are various advantages of a corporation as a form of business organization.  The organization of a company in the form of corporation helps it to make a independent firm form its owners and business (Ferran and Ho, 2014).

Some of the advantages are:

1.      Making money: By making the firm as a corporate form it allows it to raise money a lot like the company can issue stock and can increase the profit and expand its business as well which will help the company to increase its investors and will grow to a great extent.Protection of personal assets:  It gives right to the owners to protect its personal assets of the company. In the time of incorporation of business the owners have limited liabilities towards its assets. It protects the owners from the creditors not to pursue the owner’s personal assets for recovering the company’s liabilities (Ferran and Ho, 2014).

3.      Transferring owners: In a corporate form of company it can transfer the owner easily. Also one more advantage is that investors can invest against the sole proprietorship.

4.      Creditability: It helps to increase the creditability for the organization. As per the report customers, vendors and investors feel more pleasant when it comes to deal with corporation. And no doubt a corporation is quite professional in terms of its work and its environment in comparison with other non-corporate businesses.

Source: (Ferran and Ho, 2014)

Cash has been made by selling financial assets in the capital market or financial market. Also cash used for buying real estate by investing in firm’s operational activities. Eventually cash are to be raised by operational activities of the company. At the end cash are to be distributed among its investors (Ferran and Ho, 2014).




First of all let us understand that what IPO which stands for initial public offer is. This is the process where companies which are not listed in stocks exchange and they sell new security and offer to the public first time. Before issuing an IPO a company is to be called private with small numbers of investors (Gitman,et. al., 2015). After an IPO company becomes listed company in a stock exchange.

The steps of issuing IPO are:

1.Bank selection: Here the company has to choose the investment bank to suggest the company on IPO and it provides the services related to underwriting.

2. Due diligence and filing: Through the underwriting process a bank acts as a broker between IPO issuing company and to the public who invests. Some are the underwriting arrangements are there which has to be fulfilled during the raising an IPO. Like firm commitment, Best effort agreement and syndicate of underwriter etc (Gitman,et. al., 2015).

3.Prcing: Once the IPO is approved the pricing is the next step to follow on. The issuing company and the underwriter decide the offer price like the price at which the share will be sold by the company (Gitman,et. al., 2015). Some of the factors which affect the pricing are the condition of market economy and company’s long term goal etc.

4. Stabilization: Some analyst recommendations are to be done once the pricing and approval has been done.

5.Transition:  The last step is transition which takes place after 25 days of issuing IPO for the company. There is a big role of underwriter on the evaluation and valuation of issuing company.


IPO which stands for initial public offer. This is the process where companies which are not listed in stocks exchange and they sells new security and offer to the public first time. Before issuing an IPO a company is to be called private with small numbers of investors.

Pricing an Initial Public Offering: The Dutch auction Approach

In this case study the company found that the process of issuing an IPO is called book building. As followed the steps of issuing an IPO the potential investors are supposed to decide the appropriate price of the share to the public. At the end as a dutch auction, a company decides to invite small investors for invest in the company and also decides to become a small version of Google (Kampf, et. al., 2016).


Shelf registration is the process of registration in SEC by filing security offering which has to be represented in public market. The numbers of share outstanding is not going to be affected by the shelf registration until it is not sold out in the market. Some of the advantages of shelf registration are like securities can easily issues without any dribs and drabs. Also securities can be issues on short notice of time. There are some more advantages like issuer advantage, administrative advantages etc (Kampf, et. al., 2016). The issuer advantage is when the market is not favourablethe issuer can release the securities to the public within the time of 2 year window.


Source: (Kampf, et. al., 2016)

Private Placement is the process of funding of the securities which has to be sold by IPO. The small numbers of investors are chosen in this process. These are not offered publicly and this has to be done with the selected investors of the company (Kampf, et. al., 2016).


SEC 144 A is the modification of a rule of two year holding period which are required by the institutional buyers to trade the positions among themselves. This rule has been adopted because of many things like selling restricted securities could be complicated process. Hence SEC has to modify the rule 144A. It provides a kind of exemption on public resale of restricted or controlled securities.


Some of reasons that why there is need of fireball between analysts and underwriter are-

The analyst focuses on the research of the industry or basically he does the whole analysis on industry by using the securities whereas an underwriter sells the securities of the company. Although both are equally important for the company’s economic of scale. Hence the fireball is needed for both analyst and underwriter because works have been assigned differently for both of them and this will help the organization to bring various information (Kampf, et. al., 2016).


For increasing the intrinsic value of any product the winner’s curse is to be used for the winning bid in an auction. Sometimes some of the emotions affect the bidders while bidding because of the lack of information and it gives tough time to the bidders by determining the true value of the product (Kampf, et. al., 2016). Hence sometime the product’s value which has been overestimated coul


ANS 5.






A.    Net present value is basically a difference between the cash inflow and cash outflow which takes place in particular year and in particular project where investment has been done and we calculate and analyse the present value of asset or products based on the market price, market size and fixed cost of the company. There are some evaluation on NPV which has to be done while calculating it. Like when the NPV is positive, it means that the project is acceptable and it takes place when present value of cash inflow is greater than the present value of cash outflow. When NPV is zero, the project is acceptable too and it happens when the cash inflow is equal to cash outflow. Whereas when NPV is negative, the project should be rejected and it takes place when the cash inflow is less than the cash outf









Financial management is one of the biggest and important aspects for an organization because it deals with each and every aspect of the organization where it is related to company’s profit, its growth and its market value. It helps the organization in long term financial planning and helps them to allocate the resources properly so that the firm can earn more profit and make itself a successful business. Overall financial management helps the organization in a wider way so that it can be successfully stabilize itself in an economy.









Andreff, W., 2012. The winner's curse: why is the cost of sports mega-events so often underestimat Billett, M.T., Floros, I.V. and Garfinkel, J.A., 2018. At-The-Market (ATM) Offerings. Forthcoming in the Journal of Financial and Quantitative AnalysisFerran, E. and Ho, L.C., 2014. Principles of corporate finance law. Oxford University PressGitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson Higher Education AU Kampf, R., Majerčák, P. and Švagr, P., 2016. Application of break-even point analysis. NAŠE MORE: znanstveno-stručni časopis za more i pomorstvo, 63(3 Special Issue), pp.126-128. Lloyd, J., Bond, F.W. and Flaxman, P.E., 2013. The value of psychological flexibility: Examining psychological mechanisms underpinning a cognitive behavioural therapy intervention for burnout. Work & Stress, 27(2), pp.181-199Morano, P. and Tajani, F., 2017. The break-even analysis applied to urban renewal investments: a model to evaluate the share of social housing financially sustainable for private investors. Habitat International, 59, pp.10-20OFFER, B., BANC, E. and TO, P., 2018. I. SHELF REGISTRATION. SELL, 3, pp.1-1Zhao, Y.F., Xia, X.P., Tang, X.X., Cao, W., Liu, X.Y. and Fan, Y.H., 2015. Private placements, cash dividends and interests transfer: Empirical evidence from Chinese listed firms. International Review of Economics & Finance, 36, pp.107-118.




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