Financial management revision question and answer

CPA-Financial-Management-Section-3 Revision kit

Many enterprises begin as sole proprietorships and then as they grow ad become successful, the need arises for them to convert to companies and eventually go public.

Required:
(a) List and explain the advantages a company derives from going public.

(b) Highlight the factors that a firm should consider when inviting an initial public offering (IPO).

ANSWER
(a) Advantages of going public
(i) Permits diversification – selling some of their shares to the public, a company can diversify their holdings reducing the riskiness of their personal portfolios.
(ii) Increases liquidity
(iii) Facilitates raising of further cash where needed e.g. through a right issue
(iv) Establishes value of a firm – the value of shares of a company are determined the forces of the market and thus no uncertainty.
(v) Financial management discipline – once a firm goes public its finances and its managers are open to scrutiny shareholders and risk of corporate raiding in case of non-performance.

(b) Factors to consider when inviting an initial public offering (IPO)
(i) The size of the volume of the expected future cash flow returns which the share is expected to generate.
(ii) An estimate of the investors required rate of return from the prospective investment.
(iii) Succession plans in place for key executives.
(iv) Long-term performance – since most IPO‟s are under priced, managers have to think of long-term performance of the stock and how to bring it to the right place.
(v) Track record of improving internal business processes.

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