Question

Limited liability is one of the benefits to shareholders of a limited company explain the meaning limited liability? (3 marks) Provide an example of the conflicts of interest between shareholders and managers. (4 marks) Briefly discuss the significance of capital budgeting? (6 marks) Write short notes on the following: Mutually exclusive projects (3 marks) independent projects (3 marks) Accounting rate of return (3 marks) Internal rate of return (3 marks)

Answer 1

Limited Liability - The limited liability of a shareholder of a corporation commences the moment he purchases stock in a company and throughout the entire period of ownership. Also, if the shareholder sells his stock, he remains protected for any claim made for something the corporation did during his period of ownership, even if the claim is made following his stock sale. The corporation's obligation to protect his personal interests continues.

Conflict of Shareholders and Manager - there can be situations where conflict arises between shareholders and Managers , For example - shareholders have an inclination to take riskier projects than bondholders do and may prefer that the company pay more out in dividends. But Managers may not agree or take risk averse projects.

Capital Budgeting - Capital budgeting is a detailed process that businesses use to determine the merits of an investment project. The decision of whether to accept or deny an investment project as part of a company's growth strategies, involves determining the investment rate of return that such a project will generate. However, what rate of return is deemed acceptable or unacceptable is influenced by other factors that are specific to the company as well as the project. Capital budgeting is important because it provides accountability and measurability. Any business that seeks to invest its resources in a project, without understanding the risks and returns involved, would be held as irresponsible by its owners or shareholders. Furthermore, if a business has no way of measuring the effectiveness of its investment decisions, chances are that the business will have little chance of surviving in the competitive marketplace.

Mutually Exclusive projects - Mutual exclusive projects means only one project can be executed in one time, that only one project can be selected out of a particular set of projects. A decision to undertake one project from mutually exclusive projects excludes all other projects from consideration.

Independent Projects - it is a project in which decision of investment is totally independent from the decision to invest in any other project. A project that is not part of or dependent on any other project. Thus, the funding of an independent project does notdepend on another project receiving funding first.

Accounting rate of return- It is the return calculated by dividing the accounting profit earned during a particular period by the capital employed. It does not consider the time value of money and is the basic and very general method of calculating return. Accounting profit is the profit reflected in financial statements prepared as per GAAP and Accounting Standards

Internal Rate of Return - it is the rate of return at which the NPV of the project becomes Zero, that means a return which will break even the investment made in the project and attains a no profit no loss situation. it is calculated to identify the Minimum required rate of return from any project.