risks in financial decision making process

8/9/2019 Risks in Financial Decision Making Process

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Rik in Finncial Deciion Making Proce


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Abtact

n rgnization trategy mut be appropriate fr it reource, environmental

circumtnce, nd cre objective. The proce involve matching the compny'

internal reource nd capabilitie to the external buine environment the rgnization

face. trategy frmulation involve doing a ituation nalyi: both internal nd external;

objective are et viion, miion tatement, overall crprate objective. The pln

provide the detail of how to achieve thee objective. Thi trategy will determining

where you are now, determining where you wnt to go, nd then determining how to get

there . Buine trategie mnagement involve: mnaging reource eg:-finncial,

peronnel, time, nd infrmation technology. trategic mnagement i actually a olid

foundation r a framewrk within which all the functionning mnagerial operation are

bundled together. Thi i the highet level crprate activity that et the term nd goal

fr a compny that it hould follow.


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Table of Content

Finncial Rik Mnagement .......................................................................................... 19

Deciion Criteria ............................................................................................................ 20Mnagement Of Wrking Capital ..................................................................................21

The Finncing Deciion ................................................................................................. 22Capital Invetment Deciion ........................................................................................ 23

Methodology ..................................................................................................................33

Data Collection .............................................................................................................35

emi-tructured Data Collection .................................................................................. 35Untructured Data Collection ....................................................................................... 36

Dicuion ......................................................................................................................39

Managerial Implication ............................................................................................... 63


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Chapter One: Introduction

The imprtnce of mnaging knowledge nd intellectual aet a increaing

rgnization value i mnagement of humn reource. Humn reource (HR) practice

have greater impact rgnization productivity. Mnaging humn reource men

integrating deciion about people with deciion about the reult n rgnization i

trying to obtain . By integrating humn reource mnagement (HRM) into the agency

plnning proce, emphaizing humn reource activitie that upprt broad agency

miion goal, nd building a trong relationhip between HR nd mnagement, agencie

are able to enure that the mnagement of humn reource contribute to miion

accomplihment nd that mnager are held accountable fr their HRM deciion. Thi i

epecially imprtnt puh to align all agency activitie, including HRM, toward achieving

defined agency trategic goal nd miion. (Kanen nd Trigergi, 2003, 294-309)

Finncial mnagement i imprtnce to provide the neceary finncial reource

to enable the agency afer, nd to enure a high tndard in the mnagement of finnce.

Finnce nd finncial mnagement encompa numerou buine nd governmental

activitie. In today' buine environment, crprate finnce addree iue relating to

individual firm. pecifically, the field of crprate finnce eek to determine the

optimal invetment that firm hould make, the bet method of paying fr thoe

invetment, nd the bet way of mnaging daily finncial activitie to enure that firm

have adequate cah flow. Finncial mnagement influence all egment of crprate

activity,. Through the acquiition of fund, the allocation of reource, nd the tracking of

finncial perfrmnce, finncial mnagement provide a vital function fr ny

rgnization' activitie. (Kanen nd Trigergi, 2003, 294-309)


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In today' economy, the peed of infrmation acce r delivery often pell the

difference between ucce nd failure. Infrmation i often locked up in multiple

ytem, making it hard fr uer to acce the data they need when they need it. To

unlock thi infrmation, rgnization hould conider uing Infrmation nd Technology

that incrprate buine proce. With IT achieved buine infrmation by query data

acro multiple department: warehoue, operational, web, nd external data ource in

real time. The value of infrmation chnge with the timele of it deliver to deciion

maker. Mot rgnization deliver reprt that ummarize pat activity. Thi hitrical

help mnager nd executive undertnd the effectivene prir trategie, pln nd

initiative nd alo identify emerging pattern nd trend that could affect future pln.

While hitrical infrmation i critical, it doent help rgnization identify problem r

opprtunitie a they occur, r take immediate action to optimize the reult. With the

pace of buine quickening, compny cnt alway affrd to wait until the next day, next

week, next month to review progre. They need mre timely infrmation to monitr,

mnage, nd optimize operational procee that affect button line reult. Depite the

imprtnt of data nd infrmation a n aet nd a reource in providing competitive

advntage nd utaining their ucce . (Kanen nd Trigergi, 2003, 294-309)

By integrating nd conideration the humn reource, people nd infrmation nd

technology mnagement in the buine trategy i imprtnce to enable long run of

uccee buine operation.

Three Fundamental Concept


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There are three fundamental concept that underlie the mot imprtnt finncial

deciion making tool nd procee. They are the three crnertone of making

deciion that maximize the firm economic value. They are alo the three fundamental

concept that are ued to value ecuritie, project, nd entire firm. Thee three concept

are the Time Value of Money, the Rik-Return Relationhip, nd Cah Flow. In general,

cah flow are dicounted to preent value uing time value of money calculation nd

ome type of rik adjutment proce. The reulting preent value are interpreted a the

intrinic value (r economic value) of the aet generating the cah flow.

Finncial Aet

Finncial aet are invetment in a broad rnge of ecuritie uch a common

tock, preferred tock, bond, nd other finncial aet uch a lon, nnuitie, mutual

fund hare nd derivative ecuritie. Fr ecuritie uch a tock nd bond, mny

valuation model are baed on dicounted cah flow valuation approache that rely on

thee three fundamental concept identified above. Thi men that the dicounted cah

flow to the invetr repreent a fair market value fr the ecurity. (Kanen nd

Trigergi, 2003, 294-309)

trong, embedded relationhip hift actor' motivation away from the puruit of

immediate economic gain toward the enrichment of relationhip through trut and

reciprocity (Powell, 1990; mitka, 1991). The importance of etablihing trut (or

confidence) in the bank-firm relationhip ha been dicued in the bank marketing


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literature (e.g. Gill et al., 2006; Hawke and Heffernan, 2006). Uzzi and Gillepie (1998)

howed that ocial tructure and relationhip baed on trut play an important role in the

capital tructure of ME and the bank-firm relationhip. They determined that the

quality of the relationhip between an organiation and it lender affect the ME'

financial deciion making. Firm will alter their level of borrowing if the bank-firm

relationhip i rich in trut and reciprocity. The rationale for thi i that if the bank trut

the firm, the bank can lower it monitoring cot, which in turn enable the bank to offer

capital at price that are more competitive than would have been poible in the abence

of an embedded relationhip.

Reearch ha hown that identity i alo an important component in the formation

of relationhip and ocial tructure becaue it aign value to the tranaction and

enriche the exchange of ocial capital between partner in the network (Porte and

enbrenner, 1993). Organiational identity i a key intangible apect of any organiation.

It affect not only how organiation define themelve but alo how problem are

defined and reolved (e.g. Dutton et al., 1994; Dutton, 1997). Dicrete identity field, et

of actor clutered around ocially contructed identitie, affect the contruction of an

organiation' reource and core capabilitie (Hunt et al., 1994). Porac et al. (1999)

define identity contruction a an explicit claim that the organiation i of a particular

type. Intitutional theorit have ued the term field to denote the grouping of

organiation that are imilar, have common practice or hare a certain focu of

attention, uch a a market. DiMaggio and Powell (1983) define organiational field a

thoe organization that, in the aggregate, contitute a recognized area of intitutional


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life: key upplier, reource and product conumer, regulatory agencie, and other

organization that produce imilar ervice or product. According to DiMaggio and

Powell (1983), mutual information proceing within a group of organiation i a vital

ign of field formation. Laron (1992) and Helper (1990) reported that thicker

information on trategy, profit margin and production know-how i tranferred through

embedded tie. Uzzi (1996, 1997) refer to uch information a fine-grained information.

Exchange of thicker, or fine-grained, information i unlikely in the abence of trut

becaue information could be ued opportunitically (Helper, 1990; Laron, 1992).

Baed on previou reearch, there i reaon to believe that identity field may

have an impact on the formation of embedded relationhip. Previou reearch ha hown

that the quality of firm-financier relationhip affect the financial behaviour of ME

(Uzzi and Gillepie, 1998). Therefore, it i poible that identity field may influence the

financial deciion making of ME, an iue that ha not previouly been addreed.

Becaue current knowledge only take u thi far, exploratory reearch i neceary. In

ubequent ection, I firt decribe the exploratory approach ued to illutrate the iue.

Next, I decribe the financial deciion-making proce of a jewellery deign firm, noting

how relationhip with the bank and an invetor are affected by the firm' identity and

how the firm relate firm identity to the perceived identity of the financier. I then

ugget a framework for thinking about how identity field may affect the ME'

financial deciion making. I conclude with a dicuion of the ME' financial deciion

making and the effect on the capital tructure and ugget implication for bank.


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mall to medium-ized enterprie (ME) and new buinee have become

increaingly important for economic development (e.g. Deni, 2004). A central concern

for thee firm i the capital tructure problem: What mix of ecuritie and financing

ource hould be ued to finance the buine? Loan financing i the mot important

ource of external financing for mot European enterprie, 99 per cent of which have

fewer than 250 employee. It ha been recognied that acce to loan financing depend

on the cloene of the relationhip between enterprie and bank (European

Commiion, 2001). The embedded finance literature i a promiing new line of reearch

that addree thi iue. It ha found that when the bank i embedded in the ocial

tructure of the ME and there i a trong bank-firm relationhip, both the ME and the

bank benefit. ME that have embedded tie with banker can overcome information

problem and accumulate ocial capital that can be ued to acce capital at price that

make bank financing more attractive to firm. By etablihing a trong, embedded

relationhip with their ME cutomer, bank alo receive many benefit, including an

enhanced ability to reduce the cot aociated with writing loan contract, to retain

client, and to decommodify financial capital (Uzzi and Gillepie, 1998; Uzzi, 1997). The

importance of developing and maintaining the bank-firm cutomer relationhip ha been

emphaied in the bank-marketing literature (e.g. Ennew and Bink, 1996; Madill et al.,

2002; Proena and de Catro, 2005). Although pat tudie in different line of reearch

have generated knowledge regarding the importance of banking relationhip, ome

quetion need further invetigation, uch a what factor may be important to the

etablihment of relationhip between ME and financier, which in turn may affect the

ME' choice of financier.


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Adapting an embedded perpective on financial deciion-making, thi reearch

addree a quetion that ha not been dicued previouly: are there pecific

organiational formation or characteritic that are of importance to the etablihment of

embedded firm-financier relationhip? How do uch characteritic affect the formation

of embedded tie to financier, and how doe they affect the rationale behind the ME'

financial deciion making? Becaue there i little previou knowledge about thi ubject,

exploratory reearch i needed. Thi reearch preent a new framework for thinking

about how ME make financial deciion, taking into account the firm' organiational

identity. To illutrate the framework, I preent a longitudinal tudy of a jewellery deign

firm that follow it financial deciion-making proce. The firm i categoried a a

fahion deign firm. Financing ha been found to be an urgent problem for fahion firm

(undberg, 2006), which motivate further invetigation of the financial deciion-making

proce for fahion ME. Managerial practice and organiational pattern that are

typically oberved in fahion indutrie are frequently at odd with our etablihed view

of managing organiation. The main difference i that in thee organiation identity

contain contradictory element: normative artitry and utilitarian economic coexit.

The finding preented in thi paper contribute to an increaed undertanding of

firm financial deciion-making and thu provide new inight into the capital tructure

problem. In contrat to the pecking order theory of finance, which ugget that firm

follow a pecking order from mot to leat preferred internal fund, friend and family,

bank and equity market (Myer, 1984; Myer and Majluf, 1984) thi tudy offer an


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alternative explanation to how firm may hierarchically order their dependence on

different ource of financial capital. The finding and framework uggeted in thi

reearch alo provide clue a to how bank could market themelve to tart-up firm.

Invetment Project

Fr invetment project, the focu i on incremental after-tax operating cah flow

adjuted fr the time value of money nd fr rik. The um of all dicounted cah flow

i referred to a a Net Preent Value (NPV) that repreent the intrinic value of the

project. Thi NPV i ued a the bai fr the firm deciion to invet in the project.

By accepting poitive NPV invetment opprtunitie, owner, mnager nd employee

of the firm cn maximize the firm economic value. A the economic value of the firm

i maximized, it owner nd employee cn hare in the benefit of the greater value.

The following diagram illutrate thi proce. Incremental after-tax cah flow

are identified nd ome method of rik adjutment i ued when arriving at the

dicounted, rik adjuted, net preent value of the project. If the dicounted net preent

value i poitive, the project i accepted. Acceptnce of a poitive NPV invetment

project increae the economic value of the firm. thi increaed value cn then be hared

by owner, mnager, nd employee. (Haye nd Garvin, 2002, 71-79)


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Incremental

After-Tax

Cah Flow

Accept

Poitive

Net

Preent

Value

Economic

Value of

the Firm

Increae

Owner,

Mnager,

nd

Employee

hare

Increaed

Value

Rik

Adjutment

Valuation of the Firm

Fr entire firm, whether privately r publicly owned, the dicounted cah flow

generated by all the firm' invetment project added together repreent the intrinic

value of the entire firm. Fr public firm, if the finncial market are pricing the common

tock crrectly, the market value of the firm' equity will equal thi intrinic value. Fr

private firm, the intrinic value repreent a fair market value. (Haye nd Garvin, 2002,

71-79)

Reearch Quetion

1. How much external nd Internal fund impact on Crprate finncial deciion

nd how?


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2. How crprate capital tructure effect the finncial deciion making?

3. Ha tax effect in crprate finncial deciion? If ye how nd how much?

Reearch Objective

1. To find out the finncial deciion making proce of a compny nd the

baic idea on which that deciion i baed.

2. To identify how taxe effect the proce of finncial deciion making

proce nd how much the effect will be?

3.To find out how different type of invetment effect the finncial deciion

making proce nd how much the effect will be?

4. To reearch how cn we reduce the rik of deciion making in the indutry

uing crprate finncial deciion, how a compny hould make it deciion nd which

apect a compny hould be concerned about while making n invetment deciion?


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Chapter Two: Literature Review

The primary goal of every crpration i to maximize hareholder wealth,

primarily through cah dividend nd hare value appreciation. To thi end, the role of the

finncial mnager i to act in accrd with thi premie. RoWeterfieldJaffe (2004)

tated, The mot imprtnt job of a finncial mnager i to create value from the firm

capital budgeting, finncing, nd net wrking-capital activitie. Mreover, how do

finncial mnager create value? They mentioned to way to do it: Firt, the firm hould

try to buy aet that generate mre cah thn they cot. econd, the firm hould ell

bond nd tock nd other finncial intrument that raie mre cah thn they cot .

Finncial mnager overee the preparation of finncial reprt, direct invetment

activitie, nd implement cah mnagement trategie. Their dutie vary with their

pecific title, which include controller, treaurer, credit mnager, nd cah mnager.

The role of the finncial mnager, particularly in buine, i chnging in repone

to technological advnce that have ignificntly reduced the amount of time it take to

produce finncial reprt. Finncial mnager now perfrm mre data nalyi nd ue it

to offer enir mnager idea on how to maximize profit. They often wrk on team,

acting a buine advir to top mnagement. Finncial mnager need to keep abreat

of the latet computer technology in rder to increae the efficiency of their firm

finncial operation. (Haye nd Abernathy, 2003, 66-77)

BrealeyMyerAllen (2005) found the following:

The finncial mnager tnd between the firm operation nd the finncial (r

capital) market, where invetr hold the finncial aet iued by the firm. The


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finncial mnager role i illutrated in the next figure, which trace the flow of cah

from invetr to the firm nd back to invetr again. The flow tart when the firm ell

ecuritie to raie cah (arrow 1 in the figure). The cah i ued to purchae real aet

ued in the firm operation (arrow 2). Later, if the firm doe well, the real aet

generate cah inflow which mre thn repay the initial invetment (arrow 3). Finally, the

cah i either reinveted (arrow 4a) r returned to the invetr who bought the ecuritie

(arrow 4b). Of coure, the choice between arrow 4a nd 4b i not completely free. Fr

example, if a bnk lend money at tage 1, the bnk ha to be repaid the money plu

interet at tage 4b.

The dutie of finncial mnager vary with their pecific title. A finncial

plnner wrk under the direction of a mnager, perfrming variou finncial r budget

nalye. The enir finncial plnner upervie the taff in perfrming

finncial/economic nalye of new project nd nalye of merger nd crprate

growth policie. The mnager of finncial plnning direct the taff reponible fr

perfrming nalye in everal functional area including profit plnning, capital

expenditure, acquiition, nd budgeting. The Chief Finncial Officer (CFO) advie the

preident of the rgnization with repect to finncial reprting, finncial tability nd

liquidity, nd finncial growth. The CFO alo direct nd upervie the wrk of the

Controller, Treaurer, nd ometime the Internal Auditing Mnager. Other dutie may


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include trengthening relationhip with tockholder, finncial intitution, nd the

invetment community. Frequently, the CFO i a member of the Board of Directr

nd/r the Executive Committee nd a uch, contribute to overall rgnization

plnning, policy development, nd implementation. (Haye nd Abernathy, 2003, 66-77)

In addition, finncial mnager perfrm tak unique to their rgnization r

indutry. Fr example, government finncial mnager mut be expert on the

government appropriation nd budgeting procee, wherea healthcare finncial

mnager mut be knowledgeable about iue urrounding healthcare finncing.

Furthermre, finncial mnager mut be aware of pecial tax law nd regulation that

affect their indutry.

Although the tockholder own the crpration, they do not mnage it. Intead,

they vote to elect a board of directr. In thery, when the finncial mnager act in

accrd with maximizing hareholder wealth, the hareholder benefit through cah

dividend nd hare price gain. With repect to employee, however, maximizing

hareholder wealth i not alway in their bet, peronal interet. Fr example, when a

compny nnounce a layoff to cut cot (which, fr illutration, I aume i with the

intent of maximizing hareholder wealth), tock hare price often increae, a the

econdary market react to the new a n appropriate nd proactive approach to reducing

cot nd increaing cah flow fr other pririty project. From n employee'

perpective, it' a lo of job nd income. (Haye nd Abernathy, 2003, 66-77)

However, it i alo in the bet interet of the compny to attract nd retain a

killed wrkfrce. If a compny ha a reputation fr paying porly, implementing

exceive round of layoff, r other unattractive humn reource policie, retaining a


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killed wrkfrce will be difficult, nd will have a negative effect on hareholder value a

operational efficiencie, product quality, nd peed to market decline. Here, finncial

mnager (wrking in combination with HR) may conider benefit uch a employee

tock grnt nd dicount tock purchae pln (r tock option) (Online, Finncial

Mnager). In thi way, the rgnization cn align the priritie of the employee mre

cloely with thoe of the tockholder.

Mot of the reponibilitie of the finncial mnager are not traightfrward

deciion with repect to maximizing hareholder wealth. Beyond maximizing

hareholder wealth, finncial mnager alo have the reponibility of acting ethically,

particularly in today' finncial market with increaing media coverage nd regulatry

crutiny over crprate finncial cndal, like ENRON nd MCI WrldCom. When

Enron nd WrldCom went belly-up in 2002two of the larget bnkruptcie everno

one demnded that their tockholder put up mre money to cover the compnie debt.

tockholder cn loe their entire invetment, but no mre. (Haye nd Abernathy, 2003,

66-77)

BrealeyMyerAllen (2005) found the following:

Conflict between hareholder nd mnager are not the only principalagent

problem that the finncial mnager i likely to encounter. Fr example, jut a

hareholder need to encourage mnager to wrk fr the hareholder interet, o

enir mnagement need to think about how to motivate everyone ele in the compny.

In thi cae enir mnagement are the principal nd junir mnagement nd other

employee are their agent.

There are ome incentive to preure mnager to maximize tock price:


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1. Threat of firing mnager. But tockholder uually jut ell their tock rather

thn try to chnge mnagement. Recently intitution collectively holding large block of

tock have been known to out mnager (at nnual tockholder meeting where board

of directr are elected).

2. Threat of hotile takeover. If a compny i taken over in a hotile takeover, the

mnager uually loe their job. Hotile takeover are probable only if the common tock

price i undervalued. Therefre, mnager cn dicourage hotile takeover by

maximizing the common tock price.

3. Poitive incentive. Compenation of the mnager cn be tied to the

perfrmnce of the crpration nd it common tock: executive tock option,

perfrmnce hare award, profit-baed alary nd bonue, etc.

In ummary, the tak of the finncial mnager cn be broken down into (1) the

invetment, r capital budgeting, deciion nd (2) the finncing deciion. In other wrd,

the firm ha to decide (1) what real aet to buy nd (2) how to raie the neceary cah.

hareholder wnt mnager to increae the value of the compny tock., they are the

owner of the crpration; the mnager wrk fr the owner. (Gillin, 2006, 38-39)

The goal fr the finncial mnager i to maximize hareholder (owner) wealth,

not jut increaing it r not jut profit. How?: by urviving, avoiding ditre nd

bnkruptcy, beating the competition, maximizing ale r market hare, minimizing cot,

maximizing profit, nd maintaining teady earning growth.

The uual method of maximizing the wealth of the tockholder i to maximize

the price of the crpration common tock. However, neither mnager nr

tockholder cn et the price of the common tock; the market determine the price.


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Crprate finnce i related to the crpration nd the finncial deciion that

are taken by the crpration. There are everal imprtnt concept of crprate finnce

nd everal other finncial tool that are behind all thee crprate deciion. All thee

imprtnt concept of crprate finnce are ued to minimize the finncial rik to which

the crprate ectr i expoed. At the ame time, thee concept are ued to increae the

profitability of the crpration. Thee imprtnt concept of crprate finnce cn be

ued to identify, nalyze nd olve the finncial problem of almot every firm.

Finncial Rik Mnagement

Rik mnagement i the proce of meauring rik nd then developing nd

implementing trategie to mnage that rik. Finncial rik mnagement focue on rik

that cn be mnaged ("hedged") uing traded finncial intrument (typically chnge in

commodity price, interet rate, freign exchnge rate nd tock price). Finncial rik

mnagement will alo play n imprtnt role in cah mnagement.

Thi area i related to crprate finnce in two way. Firtly, firm expoure to

buine rik i a direct reult of previou Invetment nd Finncing deciion. econdly,

both dicipline hare the goal of creating, r enhncing, firm value. All large

crpration have rik mnagement team, nd mall firm practice infrmal, if not

frmal, rik mnagement.

Derivative are the intrument mot commonly ued in Finncial rik

mnagement. Becaue unique derivative contract tend to be cotly to create nd monitr,

the mot cot-effective finncial rik mnagement method uually involve derivative


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that trade on well-etablihed finncial market. Thee tndard derivative intrument

include option, future contract, frward contract, nd wap.

Deciion relating to wrking capital nd hrt term finncing are referred to a

wrking capital mnagement. Thee involve mnaging the relationhip between a firm'

hrt-term aet nd it hrt-term liabilitie. The goal of Wrking capital mnagement

i to enure that the firm i able to continue it operation nd that it ha ufficient cah

flow to atify both maturing hrt-term debt nd upcoming operational expene.

Deciion Criteria

Wrking capital i the amount of capital which i readily available to n

rgnization. That i, wrking capital i the difference between reource in cah r

readily convertible into cah (Current Aet) nd cah requirement (Current Liabilitie).

o the deciion relating to wrking capital are alway current deciion, i.e., hrt term

deciion.

The hrt term deciion of the firm are imilar to thoe of long term in term of

rik nd return, but they differ in mny other way like time factr, dicounting

conideration, liquidity etc. o thee deciion are not taken on the ame bai a long

term deciion. Thee deciion have different criteria like cah flow nd profitability.

The mot imprtnt criterion fr making hrt term deciion i cah flow. nd

the bet meaure of cah flow i net operating cycle r cah converion cycle. It

repreent the time difference between cah payment fr raw material nd cah

collection fr ale. nother apect of cah converion cycle i gro operating

cycle which i ame a net operating cycle except the fact that it doe not take into


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account the creditr deferral period. Cah converion cycle indicate the firm'

ability to convert it reource into cah. Becaue thi number effectively

crrepond to the time that the firm' cah i tied up in operation nd

unavailable fr other activitie, mnagement generally aim at a low net count.

In thi context, the mot ueful meaure of profitability i Return on capital

(ROC). The reult i hown a a percentage, determined by dividing relevnt

income fr the 12 month by capital employed; Return on equity (ROE) how

thi reult fr the firm' hareholder. Firm value i enhnced when, nd if, the

return on capital, which reult from wrking capital mnagement, exceed the

cot of capital, which reult from capital invetment deciion a above. ROC

meaure are therefre ueful a a mnagement tool, in that they link hrt-term

policy with long-term deciion making. ee Economic value added (EVA).

Mnagement Of Wrking Capital

Guided by the above criteria, mnagement will ue a combination of policie nd

technique fr the mnagement of wrking capital. Thee policie aim at mnaging the

current aet (generally cah nd cah equivalent, inventrie nd debtr) nd the

hrt term finncing, uch that cah flow nd return are acceptable.

Cah mnagement. Identify the cah balnce which allow fr the buine to

meet day to day expene, but reduce cah holding cot.

Inventry mnagement. Identify the level of inventry which allow fr

uninterrupted production but reduce the invetment in raw material - nd

minimize rerdering cot - nd hence increae cah flow; ee upply chain


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mnagement; Jut In Time (JIT); Economic rder quntity (EOQ); Economic

production quntity (EPQ).

Debtr mnagement. Identify the appropriate credit policy, i.e. credit term

which will attract cutomer, uch that ny impact on cah flow nd the cah

converion cycle will be offet by increaed revenue nd hence Return on Capital

(rvice vera); ee Dicount nd allownce.

hrt term finncing. Identify the appropriate ource of finncing, given the

cah converion cycle: the inventry i ideally finnced by credit grnted by the

upplier; however, it may be neceary to utilize a bnk lon (r overdraft), r to

"convert debtr to cah" through "factring".

The Finncing Deciion

Achieving the goal of crprate finnce require that ny crprate invetment

be finnced appropriately. A above, ince both hurdle rate nd cah flow (nd hence the

rikine of the firm) will be affected, the finncing mix cn impact the valuation.

Mnagement mut therefre identify the "optimal mix" of finncingthe capital

tructure that reult in maximum value.

The ource of finncing will, generically, comprie ome combination of debt

nd equity. Finncing a project through debt reult in a liability that mut be erviced

nd hence there are cah flow implication regardle of the project' ucce. Equity

finncing i le riky in the ene of cah flow commitment, but reult in a dilution of

ownerhip nd earning. The cot of equity i alo typically higher thn the cot of debt,


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nd o equity finncing may reult in n increaed hurdle rate which may offet ny

reduction in cah flow rik.

Mnagement mut alo attempt to match the finncing mix to the aet being

finnced a cloely a poible, in term of both timing nd cah flow.

One of the main therie of how firm make their finncing deciion i the Pecking

rder Thery, which ugget that firm avoid external finncing while they have

internal finncing available nd avoid new equity finncing while they cn engage in new

debt finncing at reaonably low interet rate. nother majr thery i the Trade-Off

Thery in which firm are aumed to trade-off the Tax Benefit of debt with the

Bnkruptcy Cot of debt when making their deciion. n emerging area in finnce

thery i Right-finncing whereby invetment bnk nd crpration cn enhnce

invetment return nd compny value over time by determining the right invetment

objective, policy framewrk, intitutional tructure, ource of finncing (debt r equity)

nd expenditure framewrk within a given economy nd under given market condition.

One lat thery about thi deciion i the Market timing hypothei which tate that

firm look fr the cheaper type of finncing regardle of their current level of internal

reource, debt nd equity.

Capital Invetment Deciion

Capital invetment deciion are long-term crprate finnce deciion relating to

fixed aet nd capital tructure. Deciion are baed on everal inter-related criteria.

Crprate mnagement eek to maximize the value of the firm by inveting in project

which yield a poitive net preent value when valued uing n appropriate dicount rate.


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Thee project mut alo be finnced appropriately. If no uch opprtunitie exit,

maximizing hareholder value dictate that mnagement return exce cah to

hareholder. Capital invetment deciion thu comprie n invetment deciion, a

finncing deciion, nd a dividend deciion.

The cae

In thi ection, the firm' financial deciion-making proce i analyed. In

addition to the two founder of the firm, the actor involved in thi proce included the

two banker repreenting the bank where the firm i a cutomer and the invetor who

entered after the firm wa granted debt financing and offered equity financing. The

chronology of the financial deciion-making proce i decribed in Figure 1.

The firm' decription of it buine and it need for finance

According to one of the two deigner, their buine idea wa to create high

qualitative jewellery, with a mix of fahion, art, and craft, and to launch two collection a

year, following the product life cycle of the fahion indutry. The objective for etting

up the buine wa to be able to freely expre their artitic viion. Early on, the firm

received a great deal of attention in the media, in newpaper, in magazine and on

televiion, where it wa portrayed a an example of the recent hype and ucce of

wedih fahion deign.

The deigner' rhetoric invoked their alignment with the artitic world. For

example, they launched their firt collection in an art gallery to demontrate their artitic

ambition. With their rhetoric, the deigner claimed their artitic identity whilt

downplaying their economic identity, and commenurate with their identity claim, they


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defined core capabilitie in term of intangible, uch a artitic talent. The deigner,

however, alo expreed a different et of claim about the identity of their firm, which

wa to generate profit. In a newpaper reearch, they expreed their viion in the

following way: By founding a profitable company we are trying to create our own pace

in the commercial market. Thu, they were aware of the neceity to negotiate a balance

between an idealitic, artitic-viion driven perpective and the revenue-driven realitic

view.

The deigner expreed an intention for the firm to grow and to cover market

in New York and Tokyo. External financing would be needed to achieve thi goal. To

finance their firt collection, they each made a private invetment of EK 10,000 and a

family member granted the firm a loan of EK 40,000, with interet, that hould be

reimbured in two year. Their poue covered their private expene. The univerity

where they had tudied aigned a mentor to the firm. Thi mentor gave them a mall

loan (EK 20,000) when they opened their hop. Encouraged by their mentor, the

deigner decided to apply for bank financing: He told u we needed financing to grow.

The firm' perception of the meeting with the bank

The firm initially applied for and wa granted a bank overdraft of EK 50,000 and

a bank loan of EK 150,000. The deigner accepted the overdraft but decided to

potpone the bank loan becaue of perceived unfavourable interet rate. In thee

meeting, they alo voiced a problem they faced in their buine: they needed to find a

uitable upplier becaue the upplier they were currently uing wa too cotly.

In converation with the banker, the deigner emphaied how their artitically

driven core capabilitie were perceived by other actor and expreed the firm'


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capabilitie in term of intangible: the deign and artitic edge. The banker were

informed of recent event and activitie uch a participation in magazine and TV

interview. The deigner alo mentioned that the firm wa one of three nominee for a

pretigiou fahion award. Thee tactic eemed to imply manifetation of firm identity

and an intention to emphaie ucce in the deign community.

Their intention had been to communicate their intangible artitic core capabilitie.

However, they believed thee artitic capabilitie were not acknowledged a key or

unique reource by the banker. One deigner commented that We mention[ed] our

appearance in magazine and the attention our deign ha achieved, but the banker are

more intereted in the figure. The deigner did decribe the banker a profeional

and a having good intention: We do think they want u to ucceed.

At a later tage, the deigner wanted to extend the bank overdraft and apply for a

larger bank loan. Financing wa needed to arrange the upcoming fahion how that would

launch their third and, o far, mot important collection. The how would take place

during Fahion Week in Augut, and in thi week the winner of the previouly mentioned

award would be announced. Becaue of an increaed demand from tore, they alo

wanted to build up a tock and, hence, place a large order with their upplier for which

they needed financing to make a required advance payment. The deigner alo wanted a

mall financial buffer. Thi application wa rejected; however, the initial bank loan

offer and bank overdraft remained.


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The Bank' Perception Of Meeting With The Firm

The banker' perception of the firm wa that the deigner acted very

profeionally. They decribed the meeting a open and tranparent: The firm brought

their buine plan and budget and hared information, for example on their trategy and

profit margin.

The banker defined the core capabilitie and reource of the firm in different

term to thoe ued by the deigner. Their rhetoric invoked utilitarian economic

reource. One of the banker tated, The deigner how economic thinking, in term of

being careful with their carce reource. Thi i important when etablihing trut in a

firm. Beide being capable of running a buine they are kilful in PR and marketing.

Another banker explained, I do not know much about the firm' market but from the

bank' perpective it i the people behind the tart-up that are the mot important when

evaluating a company.

The banker emphaied that normally the bank would not grant an overdraft or a

loan to a buine like the firm becaue it had not yet generated a profit, it had not been in

buine long enough to how atifying ale figure, and it had no ecurity in term of

fixed aet. The reaon for not extending the bank overdraft and bank loan wa that the

banker were concerned about the uneven cah flow, and they cautioned that artitic

talent alone would not overcome economic iue: cah flow wa the mot important

factor, one of the banker tated. The deigner explained that large fluctuation in cah

flow are common in the fahion indutry. However, the banker decided that the exiting

line of credit and the ize of the bank loan would remain fixed. The bank had already


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tretched the criteria for what would normally be accepted a ground for a poitive

finance deciion.

Financial Deciion Making Take A New Turn Enter The Invetor

hortly after the firm wa denied the extended bank overdraft and bank loan, the

firm won the award. Commenurate with the contradictory identity element of fahion

firm, the jury explained, The firm i appointed the newcomer of the year becaue they

have in a hort period of time managed to balance unique deign, high quality, and a

ditinguihed buine thinking. The award meant increaed interet from the pre, both

national and international. For example, the firm received a one-page reearch in the top

wedih buine newpaper, where it emphaied it need for financing and buine

expertie. In the reearch, one of the deigner commented that We are looking for a

partner with experience and finance that want to grow with u into a profitable

company. The award reulted in an increae in ale volume and an increaed number of

retailer. hortly after winning the award, the firm received two large order from two

department tore, but the problem of finding a uitable upplier remained.

After learning that the firm had won the award, an auction houe pecialiing in

high-quality jewellery, contacted the firm. The firm and the auction houe et up a

meeting to dicu poible form of cooperation. The deigner explained their buine

ituation and tated what they aw a their mot urgent problem: To obtain external

finance in order to invet in growth-promoting activitie, uch a participating in

international trade how and being able to make the advance payment to the upplier.

They alo needed to find a uitable upplier who wa le cotly but who could maintain


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atifactory quality. The repreentative from the auction houe declared that hi firm

admired the firm' artitic qualitie; hence, he voiced what the firm had portrayed a their

core capability. However, he admitted that he wa not able to give the firm the name of a

pecific upplier right away. The auction houe' main objective wa to become a private

invetor in the firm; in exchange for a 30 per cent hare of the company, it wa willing to

give the firm EK 200,000 and help the firm in it operation and in expanding it

buine.

The Firm' Financial Deciion

The bank overdraft and the bank loan would have covered the expene and

invetment for which the firm needed external financing; however, the firm choe not to

accept the bank' offer. Intead, the firm accepted the invetor' offer and wa content

with the term of the agreement. The deigner decribed their deciion a motivated by a

perception of haring imilar value, uch a the appreciation of high-quality deign.

Furthermore, the deigner oberved that We are in the ame buine, which make it

eaier to undertand each other. The bank only eemed intereted in how much we ell

each day or month. Another rationale for the financial deciion wa that the auction

houe might be able to ait the firm in it operation and in finding olution to market-

oriented problem, uch a finding uitable upplier. One of the deigner explained that

Even though they could not recommend a upplier immediately, they would probably

know how to find a upplier becaue of their experience in the buine. Thu, alluding

to artitic identity attribute legitimized the private invetor in the mind of the deigner.

In contrat to the bank, the auction houe focued on the firm' deign capabilitie and


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what the firm identified a it core capability it artitic talent. Another factor that had

influenced their financial deciion wa the notion of being diimilar to the bank: In

contrat [to the auction houe], we do not feel that we have much in common with the

banker. It hould be noted that the initial loan offer and bank overdraft would have

covered the expene for the how and advance upplier payment.

Theory Development Identity Field-Embedded Financial Deciion

In thi tudy, the rationale for preferring equity intead of bank financing i

explained by the notion of being cloer or more imilar to the invetor than to the

banker and the bank. In the bank marketing literature, it ha been found that perceived

imilaritie between cutomer and banker do play an important role in building an

initial relationhip and can contribute toward the etablihment of trut (Gill et al.,

2006). For the firm, the perception of cloene or imilarity i derived from the notion of

belonging to the ame field, of haring identity attribute and value. It can be

anticipated that when actor cluter around ocially contructed identitie, there i a

void between group of actor. Weber (1946) ued the term phere to ditinguih

different group of actor. Fahion deigner may be conidered member of what Weber

referred to a the aethetic phere, which i characteried by the importance put on

aethetic value. Weber wa one of the firt to write about the clahe between the

economic and aethetic phere. According to Weber, the firm conidered the bank to be

a member of the economic phere, which may explain the perceived ditance from the

banker. The invetor, on the other hand, could be conidered a a member of the ame

phere. Applying bank marketing terminology, the firm perceived the invetor to be


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imilar, wherea the banker wa perceived a diimilar. The invetor wa perceived to be

embedded in the ame aethetic phere, wherea the banker were not.

Organiation tend to incorporate organiational form, tructure and practice

that are ocially legitimate that i, iomorphic or conitent with intitution operating

in that environment (Meyer and Rowan, 1977; DiMaggio and Powell, 1983). Kotova

(1996) invetigated the effect of a country' pecific intitutional environment on

organiational practice. Organiation operating in different countrie may experience

intitutional ditance a a conequence of the difference/imilarity between countrie'

intitutional environment. Hence, organiational practice reflect the intitutional

environment of the country where they have been developed and etablihed. Thi

intitutional ditance between countrie can be identified by a et of quantifiable

meaure. Applying the notion of intitutional ditance to the concept of identity field

may help identify a quantifiable meaure of the ditance between different field. Hence,

thi quantifiable meaure can verify that firm operating within the ame intitutional

environment or field form embedded tie more eaily than firm operating in different

intitutional environment.

The notion of haring the ame identity attribute eem to promote not only

actual but alo perceived component of embeddedne. In parallel to Glynn (2000), I

found that information proceing, field formation and perception of imilarity are

mutually reinforced through ocial interaction and the language of the profeion. The

fact that the firm and the invetor are in the ame indutry facilitated communication

between the partie becaue the ocial relationhip permeated information with meaning

beyond it face value. uch information i time-aving becaue educating potential


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invetor take time, energy and money (tiglitz and Wei, 1981). Furthermore, thi

tudy indicated that the notion of belonging to the ame identity field conveyed the

perception that the invetor could provide the firm with valuable information. For

example, the deigner expreed an expectation that the invetor would be able to

ugget a upplier to uit the firm' pecific requirement. imilar identitie alo convey a

perception, on the part of the firm, that the invetor could conider the firm from a more

holitic perpective than the bank could. In addition to providing the firm with external

financing, the invetor could addre other problem. Thi notion could alo be expreed

a a higher degree of what eal (1998) refer to a competence trut in the invetor than

in the banker in relation to the ability to ait the firm in it buine development.

Previou reearch ha found that embedded tie develop primarily from third-

party referral and previou peronal relationhip (Uzzi, 1996). The evidence from thi

tudy ugget, however, that the perception of belonging to the ame identity field et

expectation of trut and tranfer of private information between the newly introduced

partie. Therefore, field identification facilitate the formation of embedded relationhip

between the ME and the invetor.

The finding made in thi tudy ugget that other factor in addition to purely

monetary one need to be conidered in the context of ME' financial deciion making.

The notion that cutomer of financial bank ervice make their choice of ervice upplier

baed on factor other than price ha alo been recognied in the bank marketing

literature (e.g. Molina et al., 2007).


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Chapter Three: Reearch Methodology

Thi reearch aim

How much external and Internal fund impact on Corporate financial deciion

and how?

How corporate capital tructure effect the financial deciion making?

Ha tax effect in corporate financial deciion? If ye how and how much?

To find out the financial deciion making proce of a company and the baic

idea on which that deciion i baed.

To identify how effect the proce of financial deciion making proce and how

much the effect will be?

To find out how different type of invetment effect the financial deciion making

proce and how much the effect will be?

To reearch how can we reduce the rik of deciion making in the indutry uing

corporate financial deciion, how a company hould make it deciion and which

apect a company hould be concerned about while making an invetment

deciion?

Methodology

The tudy wa conducted a longitudinal, ingle embedded cae tudy (Yin,

2003). The puret form of a longitudinal field tudy, daily participant obervation, wa

not feaible. I could viit the reearch ite only once or ometime twice a week.

Therefore, ome data were obtained through retropective report gathered hortly after

event occurred. However, a longitudinal tudy involving a erie of multiple interview


34/75

about recent event offered the obviou benefit of proxy in time to current event,

thereby increaing the likelihood that I could determine the equence and nature of event

accurately. Wherea multiple retropective tudie increae the external validity of a

reearch deign, a longitudinal, real-time tudy can increae internal validity by enabling

the reearcher to track caue and effect (Leonard-Barton, 1990). A cae tudy

methodology i a preferred method when how or why quetion are being poed,

when the invetigator ha little control over event, and when the focu i on a

contemporary phenomenon within ome real-life context. The rationale for conducting a

ingle cae tudy wa that the firm contituted a cae of deviation from the pecking order

(Yin, 2003). According to iggelkow (2007), it i often deirable to chooe a particular

organiation preciely becaue it allow one to gain certain inight that other

organiation would not be able to provide. Although individual cae cannot prove a

theory, they can ufficiently point to poible omiion in the theory.

Time et a frame of reference for what change are een and how thoe change

are explained. The reearcher' theoretical framework ugget jutification for the

beginning and ending of data collection (Pettigrew, 1990). The framework may focu on

major ocial drama or breakpoint in a firm' hitory, which indicate the beginning of

period of continuity and change (Pettigrew, 1985). The time frame of thi tudy covered

the critical period beginning when the firm recognied the need for external finance and

continuing through the deciion-making proce.


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Data Collection

For a period of 13 month, during which I followed the firm in their financial

deciion-making proce, I gathered data addreing archival ource through both emi-

tructured and untructured method. Public information about the firm wa reviewed,

including pre account and material generated by the firm (e.g. promotional material).

emi-tructured Data Collection

emi-tructured data collection included a number of emi-tructured interview

eion with the deigner and their banker. I conducted even emi-tructured

interview with the two deigner and two eparate interview with their two banker.

Interview averaged from one to two hour in duration, were tape-recorded and

trancribed within 24 hour with my own reflection added. Data collection from

interview with the deigner provided a equence of event for the hitory of the firm,

inight into how they had reaoned during pat deciion concerning the financing of the

buine and how they reaoned during the time period when I tudied the firm, a well a

inight into future goal and viion of the buine. The objective of thee interview

wa to undertand why certain deciion and choice were made and how thee deciion

were related to the deigner' decription of their buine, miion, and objective. The

interview conducted with the banker were intended to provide inight into how the

banker perceived the deigner and their buine, and how thi influenced their deciion

to offer financing to the firm.


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Untructured Data Collection

Untructured data collection included note taken a part of obervation at the

firm during it daily operation, including meeting with partner, economic conultant,

and their mentor. Obervation at the firm normally lated from one to three hour. The

objective of thee obervation wa to gain an undertanding of the identity of the firm

and how thi influenced deciion about and relation with the bank. Obervation were

alo made during meeting between the firm and the bank. Thee obervation allowed an

encompaing view of the dynamic of buine-financier relationhip and aimed to

capture the interplay between the firm and the bank. The obervation of meeting

between the bank and the firm were tape-recorded, trancribed and complemented by my

own reflection. After the firm' meeting with the bank, I conducted interview with the

deigner to invetigate their reaoning and perception of the meeting. A compilation of

the interview and obervation are preented in Table I.

There are two main approache to data collection: quantitative and qualitative and

each comprie of advantage and diadvantage. One of the main advantage of

quantitative approach to data collection i the relative eae and peed with which the

reearch collection can be accomplihed. However the ytematic and analytical

influence which can be gained from tatitical analyi mut be et againt the iue of

ample repreentativene, error in meaurement and quantification (Collin and Huey

162:2005)

Qualitative data collection method provide a more real bai for analyi and

interpretation. It can be extenive and time conuming. Moreover qualitative approach

preent problem relating to inflexibility and ubjectivity.


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Company webite, financial market webite uch Bloomberg, financial time,

company report would be ome of my major ource of data.

Interview are the bet method to interact with the conumer. It i the mot appropriate

method when a topic i confidential and enitive and it i the bet and appropriate

method to pick conumer brain (Hoyer 2004:27).

In thi reearch reearcher will record interview o that afterward it will be eay

to examine the reult for quantitative and qualitative analyi. The reearcher planned to

conduct 10-12 in-depth interview containing both one-to-one and

Likewie, interview involve direct contact with conumer. Interview are

generally conidered to be more appropriated than focu group when the topic i

enitive, embarraing, confidential, or emotionally charged. They are more appropriate

when the reearcher want to pick conumer brain (Hoyer 2004:27). Reearcher

often record interview for alter trancription o they can examine the reult uing

qualitative or quantitative analyi (ibid.). In thi project, the reearcher plan to carry 5-

10 in-depth interview. Thi will be done on telephone interview and one-to-one

interview through which reearcher can get more information about the topic.

The data collected will be preented in table, chart by uing P (tatitical

Package for ocial cience). The reearcher decide to ue thi ytem becaue P i a

comprehenive ytem for analyzing data. It can take data from almot any type of file

and ue them to generate tabulated report, chart, and plot of ditribution and trend,

decriptive tatitic, and complex tatitical analyi (www.p.com 2007). The

reearcher hope to gain a clear, detailed undertanding of the cutomer involved in

reponding to the interview, what they think about making financial deciion and how


38/75

much tax and invetment made an impact on their buine and what point they

conider before making the deciion. In addition, the reearcher hope to provide valid,

reliable, and applicable information for related or intereted future to make the right

deciion at the right time doing the right thing at right place whether to make that

invetment deciion on the bai of certain point or after inveting what will be the tax

ratio and how much etimated profit he can achieve with appropriate channel.

With regard to the third phae which concern the diviion of theory teting and

theory forming. Thi reearch would fall into a deductive approach norm, that i, a theory

teting reearch. The reearcher i going to rely on econdary information and literature

earch, undertand the baic conumer behaviour theory and eential model ued in

interpreting conumer proce of purchae, ue and dipoing product and ervice,

deign quetionnaire under the reearch philoophy guideline, carry a few in-depth

interview if poible, analyze the data, and finally deductively and qualitatively tet the

ene of the deciion bai on particular point.


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Chapter Four: Analyi and Dicuion

Dicuion

According to financial economic, debt convey le tranaction cot than equity.

Firt, the lender require a lower rate of return than ordinary hareholder becaue debt

financial ecuritie preent a lower rik than hare for the finance provider becaue they

have prior claim on annual income and in liquidation. In addition, ecurity i often

provided. econd, the tranaction cot aociated with raiing and ervicing debt i

generally le than for ordinary hare. For ME, the rationale for preferring debt to

equity i primarily motivated by a notion of loing control of the firm (e.g. ogorb-Mira,

2005). Applying the cot of capital a a rationale for preferring one certain ource of

financing to another, firm generally prefer retained earning to debt finance. However,

reearch ha indicated that thi order of preference can be reviited a a conequence of a

trong embedded bank-firm tie that convey debt financing at lower price than in the

abence of embedded bank-firm relationhip, thu making the firm more prone to debt

financing (Uzzi and Gillepie, 1998). A evidenced in thi tudy, factor other than the

cot of capital or lo of control may affect the firm' financial deciion making and

influence the ME toward equity rather than debt financing. The perceived imilarity of

identity field wa an important prerequiite for the etablihment of embedded

relationhip between the ME and the financier, which in turn affected the firm'

financial deciion making.

Why did the firm in thi reearch prefer equity financing to debt financing? Did

the bank fail in it marketing effort in thi cae? Relationhip marketing ha become a

prominent theory in reearch focuing on the marketing of financial ervice to both retail


40/75

and buine market (e.g. Ennew and Bink, 1996). The analyi put forth in the preent

paper ugget that the perception of belonging to the ame identity field a the invetor

induced an embedded relationhip and et expectation of trut and fine-grained

information tranfer, which made the invetor a more adequate financier than the bank.

The framework preented in thi paper offer an alternative and complementary

explanation for the ME' financing tructure. In parallel to the embedded finance

literature, I offer an alternative explanation to financial theory, uggeting that the quality

of the relationhip between an organiation and the upplier of capital affect the pecking

order of ME. The framework offer a complement to the embedded finance literature

by propoing a way of thinking about the context in which embedded relationhip

between ME and upplier of equity are formed. It alo offer inight into the bank

marketing perpective, in term of what factor may influence the bank-firm relationhip.

In thi tudy, I have focued on the demand ide of finance. Addreing the upply

ide of capital to ME, variou tudie have hown that the availability and cot of

financing, epecially long-term invetment capital, are ome of the mot important

contraint on the formation and development of ME (e.g. Bink et al., 1992). A

confirmed in thi tudy, bank uually conider firm without fixed aet and atifying

cah flow to be too riky. Therefore, buine angel or private invetor are often the

only ource of early tage capital for buinee that have exhauted peronal and family

ource. Normally, the firm would not be in a poition to make a financial deciion baed

on it own preference. The cae preented in thi reearch i unique, however, in the way

the firm had the opportunity to chooe which upplier of finance to employ.


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In addition to the rik of loing property or control of the firm, one argument for

preferring private invetor to bank financing could be to avoid the requirement to pay

interet to the bank regardle of the cah flow of the buine. Another argument in

favour of a private invetor could be acce to the private invetor' buine network and

entrepreneurial experience. Paul et al. (2007) found that for tart-up firm, rather than

equity being viewed a expenive, it i viewed a good value becaue a well-choen

invetor can add buine kill and ocial capital in the form of commercial contact and

acce to relevant network. In the cae preented in thi reearch, however, the firm wa

promied neither private information nor network connection. The deigner' rationale

wa explained by expectation of fine-grained, holitic, private information tranfer. uch

expectation may be explained by the fact that the owner of mall firm often control all

firm activitie, and therefore do not eparate problem poed to their buine. There are

numerou tudie on how firm earch for olution to problem (e.g. Cyert and March,

1963; DiMaggio and Powell, 1983). The framework uggeted in thi reearch indicate

that the proce of earching for olution to financing problem may affect, and be

affected by, the earch for non-financing information, uch a finding uitable upplier.

The goal of thi tudy wa to outline a new framework for explaining the financial

deciion-making proce of ME and to ue an in-depth cae analyi a an illutration.

Clearly, more empirical work need to be done to dicover how embeddedne affect the

financial deciion-making proce of ME. For example, the correlation between

financial and non-financial benefit, uch a cultural capital generated by embeddedne

in an identity field, need further invetigation.


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Analytical Tool

Depending on the type of invetment that i owned or under conideration by an

invetor, variou tool may be ued to meaure and evaluate the return or value of that


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invetment.


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Net preent value (NPV) i a method ued in evaluating and ranking invetment,

whereby the net preent value of all cah outflow (uch a the cot of the invetment)

and cah inflow (uch a the invetment' return) are calculated uing a given dicount or

hurdle rate. An invetment i conidered acceptable if the NPV i poitive. NPV i ued

to rank different invetment option, from the highet NPV to the lowet NPV. An

invetment i rejected if the NPV i negative ince thi indicate that the invetment doe

not improve the invetor' current net worth.

Internal rate of return (IRR) i the dicount or hurdle rate at which the preent

value (PV) of all of the future cah flow of an invetment exactly equal the total cot of

the invetment. The IRR i a pecial cae of the net preent value calculation becaue the

IRR i the rate of return at which the NPV of an invetment equal zero. An invetor

hould compute both the NPV and the IRR for each potential invetment in order to


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verify, or in order to provide additional inight into, the merit of a particular invetment

choice. Without the ue of a computer or financial calculator the calculation of the IRR i

done by a proce known a iteration, which can be extremely time-conuming and

frutrating.

IRR rank variou invetment differently than NPV if:

1) Two project have different initial invetment, and when

2) The timing of the cah flow from the invetment i different.

Capitalization (Cap) rate can be referred to a the capitalization rate of an aet.

The Cap rate i the interet rate ued to convert a erie of future payment into a ingle

preent value (PV) and i mot commonly ued in valuing real etate.

Payback period i the length of time required to recover an initial invetment. The

payback period i calculated a the original invetment divided by annual cah flow. It

can alo be referred to a a cah recovery period.

Dividend dicount model (DDM) i a valuation technique ued for etimating the

intrinic value of a tock. DDM model calculate the dicounted preent value of all

future dividend or future earning. DDM decribe the relationhip between a tock'

current price and the preent value of all future dividend payment or earning. Thi

model can be ued to determine the value of a common tock.

The Gordon growth model (alo known a the contant growth DDM)

where

P0 = current market tock price


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D0 = current dividend jut paid

D1 = dividend paid 1 year from now

k = required rate of return on a tock invetment

g = long term utainable growth rate of the tock

Return on equity (ROE) i the after-tax profit earned by a company compared to

the total cot of it equity hare. Return on aet (ROA) i the after-tax profit compared

to the firm total tangible aet.

Return on invetment (ROI) or return on inveted capital can be defined a the

after-tax profit earned by a corporation compared to the firm total inveted capital. Total

inveted capital include common and preferred equity plu all funded debt.

Keeping core: Type Of Return

Invetment return are the reward for inveting. Return include both realized

current income (interet, dividend, rent, realized capital gain or loe) and any

unrealized capital appreciation or depreciation.

Type of return include:

Nominal return. The named or tated rate of return.

Real return. Adjut the nominal return for the effect of inflation, and it i

etimated a the rate of return minu the rate of inflation equal real rate of return.

Effective annual rate (EAR). The effective annual rate adjut the nominal interet

rate for the effect of compounding, when interet i compounded more often than

annually.

Rik-free return i the return on a rik-free aet that i earned with perfect

certainty. Thi hypothetical return i uually proxied by federal government


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ecuritie that have the ame term to maturity a the invetor' time horizon. For

example, an invetor with a five-year time horizon would chooe a five-year

government of Canada bond a the rik-free benchmark.

After-tax real rate of return. Adjut the nominal rate of return for the effect of

inflation and income taxe and it i etimated a the nominal return le income

taxe and the effect of inflation.

Holding period return (HPR). The difference in value of an aet (current income

plu or minu capital change) that occur from the time that the aet i acquired

until ome future ubequent time, uually when the aet i dipoed of.

Realized v. non-realized gain/loe. A realized gain on an aet i one that i

actually taken and the invetor ha cah in hand. An example of a realized gain i

when a rental property purchaed for 200,000 i old for 250,000, thu realizing

a 50,000 gain. An unrealized gain on the other hand, i merely a paper profit and

might be lot if the aet' value decline. No fund are exchanged and no ale i

completed in the cae of an unrealized gain.

What i value?

Value ha a number of meaning and will be defined and ued differently by

variou financial advior. Value can be tated a the book value. Book value i an

accounting term, which employ hitoric cot a oppoed to the current cot of an aet.

Book value i typically the value hown on the balance heet of a company.

Current fair market value (FMV) i the oberved value of an aet a it trade in the

marketplace or the appraied value.


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Liquidation value i the value that an aet would bring if it were to be old.

Intrinic value i the preent value of all future cah flow.

Although there are many type of value definition, in general, the value of an

aet i determined by three factor:

1. The amount and timing of expected future cah inflow,

2. The rikine of thee future cah flow, and

3. The invetor' required rate of return.

Quetion.

1) How can a capitalization rate (Cap rate) be ued by an invetor?

The capitalization (Cap rate) rate i typically ued when evaluating and analyzing

real etate invetment. The Cap rate i calculated by dividing net operating income

(NOI) by the property' current fair market value (FMV). Alternatively, thi formula can

alo be rearranged algebraically, and can be ued to calculate the maximum amount that

an invetor would be prepared to pay for a piece of real etate, when the Cap rate i

known.

2) Why hould an invetor ue mathematical tool when inveting?

Many individual are frightened by the thought of having to perform

mathematical calculation no doubt dredging up ditateful memorie of high chool

algebra clae. However, with the ue of technology in the form of hand-held calculator

and computer program, thi anxiety and tre i unneceary. We have included everal


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Webite in thi book that we have found particularly ueful in aiding tudent and

invetor to overcome the dread of mathematic.

The mathematical tool are important to an invetor in everal repect. The ue of

mathematic i neceary and helpful when an invetor i etting goal and determining

the realim of thee objective. Mathematic i ued to determine the amount that i

required to be aved on a regular bai in order for an invetor to achieve the type of

retirement deired. The knowledge of mathematic alo allow the invetor to formulate

"what if" cenario. For example, the invetor may wih to know how long their

retirement net egg will lat, given a certain level of conumption in retirement, or the

interet rate that i required to achieve their retirement objective. The invetor may wih

to invetigate the effect of different interet rate on their required aving or on their

level of conumption during retirement. Employing modern portfolio theory, ince rik

and reward are related, it tand to reaon that if an invetor require an interet rate of

20%, to reach their retirement goal, then an invetor will obviouly have to conider

their rik tolerance in their choice of invetment compared with an individual who

require a 5% return in order to achieve the ame level of conumption during retirement.

Many companie provide invetor with excellent mathematical tool. However, the

invetor mut bear in mind that thee companie are not altruitic and that they have other

motive, which may not be preciely identical to objective of the invetor. If the invetor

i unaware of the method ued in a computation, then the invetor mut rely on the

aumption and method of the other party. Baic mathematic kill allow the invetor

to make their own deciion and ue their own aumption in order to arrive at

individual anwer to their own quetion. No one ha a greater take in an individual'


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retirement plan than the individual himelf or herelf. In other word, the bet defene i a

good offene!

3) A term depoit pay 5% interet. What i the nominal rate?

The nominal rate i a named or tated rate. In thi cae, the nominal rate i 5%.

4) If a cutomer it i charged 2.75% interet rate, compounded monthly, on a department

tore credit card, how much i the annual interet rate?

An individual who doe not undertand the time value of money would imply

calculate that the annual interet rate i 12 (0.0275) which equal 33%. Thi i known

a the annual percentage rate (APR), and although it i commonly ued, it doe not take

compounding into account. In order to calculate the annual interet rate that i actually

charged the invetor mut ue the effective annual rate (EAR), which account for both

the frequency of compounding and the nominal rate. The effective annual rate i

calculated a: EAR = =

which equal 38.48% annually, a ignificant difference!

The following quetion can be anwered uing a financial calculator.

where the neceary keytroke on the calculator are a follow:

n = number of compounding period

i = interet rate per compounding period

pmt = periodic payment

PV = preent value


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FV = future value

NPV = net preent value

CFo, CFi,CF2,CF3 = cah flow function key

IRR = internal rate of return

5) An invetor i putting 2,000 per year into a mutual fund that average a return of

9% per year. How many year will thee payment have to be made before the fund will

be worth 100,000 (rounded to the nearet whole number of year)?

i = 9%, pmt = (2,000), FV = 100,000 Compute n.

n = 20 year (rounded up to the nearet whole number)

6) The common tock of XYZ i currently elling in the market for 36.67. XYZ ha jut

paid it annual dividend 2.00, and the dividend i expected to grow at 10% per year

indefinitely. What rate of return can an invetor expect to earn on thi invetment in XYZ

tock?

Thi quetion can be anwered by algebraically manipulating the formula for the contant

growth dividend dicount model, and olving for k.

Therefore, an invetor in the tock of XYZ can expect to earn a 16% rate of return.


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7) An inurance aleperon offer an annuity contract that will pay 100,000 after 20

year if the annuitant pay 2,000 per year with the firt payment due immediately. What

rate of return i being offered?

Note: thi quetion require the ue of an annuity due in the calculation! Be ure to witch

calculator to Begin mode.

n = 20 year, pmt = (2,000) per year, FV = 100,000, Compute i.

i = 8.10%

8) Find the Net Preent Value (NPV) of the following cah flow chedule uing a 10%

dicount rate:

Year Ca h Flow

0 (3,000)

1 (5,000)

2 2,000

3 4,000

4 6,000

5 (1,000)

Thi quetion ue the net preent value function of the financial calculator.

CFo = (3,000), CFi = (5,000), CF2 = 2,000, CF3 = 4,000, CF4 = 6,000, CF5 =

(1,000),

i = 10%, Compute NPV.

NPV = 589.86


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9) Calculate the internal rate of return (IRR) of a 10,000 invetment that i expected to

produce the following cah flow:

Year Cah Flow

2 7,000

3 6,000

4 3,000

Thi quetion ue the internal rate of return (IRR) function of the financial calculator.

CFo = (10,000), CFi = 0, CF2 = 7,000, CF3 = 6,000, CF4 = 3,000, Compute IRR.

IRR = 19.00%

NOTE! Be ure that the firt cah flow (CFi) i entered a a 0 value.

10) The earning of the ABC Company are currently 2.00 per hare. If the earning

per hare grow over the next five year at an annual growth rate of 10%, how much

will they be at the end of that time?

n = 5 year, i = 10%, PV = 2.00, Compute FV.

FV = 3.22

11) A tock i expected to pay an annual dividend of 0, 2, and 4 per hare at the end

of each of the next three year, repectively. At the end of the third year, the tock i

expected to ell for 80 per hare. If the tock i currently elling at 50 per hare, what

i the expected return on a three-year invetment in thi tock?

Thi quetion can be olved uing the internal rate of return function of the financial

calculator.


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CFo = (50), CFi = 0, CF2 = 2, CF3 = 4+80=84, Compute IRR.

IRR = 20.00%

NOTE. The third cah flow include the 4 dividend plu the 80 ale price of the tock.

The firt cah flow of zero dollar at the end of the firt-year mut be entered into the

calculator.

Key Term

Annual percentage rate (APR). An annualized interet rate that ignore the

effect of compounding. It i calculated by multiplying the periodic interet rate by the

number of period in a year. Bond yield are typically calculated by thi method.

Book value per common hare. Auming no preferred hare outtanding, the

book value per common hare i calculated a the total aet minu total liabilitie

divided by the average number of common hare outtanding.

Capital cot allowance (CCA). The amount an owner of an income producing

aet i allowed to deduct for income tax purpoe a a reult of owning a depreciable

aet. CCA i a tax hield that allow an invetor to deduct the cot of depreciating capital

aet from income. Under the Income Tax Act, Canada Cutom and Revenue Agency

(CCRA) regard thi a a neceary expene for producing income. Invetor calculate

CCA o that it allow a recovery over time, of the original amount inveted. Generally,

invetor may claim only 50% of the allowable CCA expene in the year of acquiition.

Capitalization or capital tructure. Total dollar amount of all permanent

ource of financing. Calculated a the total of all negotiated debt, preferred and common

tock, contributed urplu and retained earning of the company.


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Capitalization method. A method of appraiing real etate. Calculated a net

operating income (NOI) divided by the property' current fair market value (FMV).

Cah flow. One meaure of a company' financial tatu. Cah flow can be

calculated directly or indirectly. One technique of recontructing a cah flow tatement

calculate cah flow a net income for a period plu any non-cah deduction, uch a

depreciation, amortization, depletion, deferred income taxe, and minority interet.

Depreciation. Depreciation i an accounting expene that allow for the

deduction of the initial cot of an aet over ubequent period. The amount by which

the value of improvement ha decreaed over time, becaue of wear and tear. The

periodic cot of owning depreciable aet (uch a building and equipment) that are

ubject to deterioration. No depreciation expene can be taken on land.

Dilution. The reduction of earning per common hare auming all convertible

ecuritie are converted to common hare.

Fair market value (FMV). The current market price at which an aet pae

from a willing eller to an intereted buyer.

Fixed aet. A balance heet item. Tangible, long-term aet that are held for ue

by the buine and ued to earn revenue. Example are real etate or equipment.

Effective annual interet rate (EAR). The interet rate a if it were compounded

only once per year. The periodic interet rate time the number of compound period in

the year equal the effective annual rate (EAR). The EAR i the actual interet rate

earned/paid after adjuting the nominal or tated interet rate for the frequency of

compounding employed.


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Effective interet rate. The periodic interet rate conidering both the frequency

of compounding and the nominal rate of interet.

Equity or hareholder' Equity or tockholder Equity. The reidual

ownerhip interet of common and preferred hareholder. It i calculated uing total

aet minu total liabilitie of a company. Alo referred to a net worth.

Income method or invetment method. An appraial method typically ued for

valuing rental real etate. Thi valuation tool convert the net income tream produced by

the property into a market value by uing a capitalization rate.

Inflation riki the likelihood that the real return of the fixed-income invetment

will be le than the nominal (dollar) return. Inflation rik i referred to a the rik of

unanticipated increae in future inflation.

Intangible aet. An aet with no phyical form, e.g., goodwill.

Intrinic value. The real and true value of a ecurity. Thi value can be different

from the market price, and it can be different from the accounting book value.

Iteration. A mathematical proce in which a erie of operation i repeated until

an anwer i derived. It i a method of approximating and deriving an anwer by

repeatedly re-computing until a olution i arrived at.

Leverage. The ue of debt to finance the purchae and ownerhip of invetment.

The ue of debt magnifie the potential variation of yield on the equity portion of the

invetment.

Net operating income (NOI). Gro revenue minu vacancy allowance, bad debt

allowance, and total operating expene. NOI i calculated excluding income tax,

mortgage payment, and depreciation expene.


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Opportunity cot. The earning potential of an invetment that i paed up in

favor of current conumption or by chooing an alternate invetment.

Phyical depreciation. The lo in value of a depreciable aet due to wear and

tear.

Preferred tock. The nonvoting cla of hare capital that i entitled to a dividend

payment before the company pay dividend to the common hareholder. Preferred tock

alo ha preference over the common hareholder with repect to claim on the

company' aet in the cae of liquidation.

traight-line depreciation method. One of the allowable method ued to

calculate depreciation expene for accounting purpoe. The annual depreciation expene

i calculated a purchae price minu expected alvage value divided by the economic

lifetime.

Real interet rate. The nominal rate of interet minu the inflation rate, where the

inflation rate i defined a t

risks in financial decision making process

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