1) An important concept in week 4 is that of earnings management. Earnings management refers to managers selecting accounting policies and/or accounting estimates to report a desired level of earnings.
I want you to provide one example of how earnings management could be employed in your organisation (this will require you to think of an accounting policy or estimate that would be required in your organisation, and how it could be altered to affect the reported earnings). Your earnings management could be an attempt to report higher or lower earnings. Explain why your organisation would want to increase/decrease earnings (you may like to explain why by referring to a user or group of users that management is trying to keep happy).
2) This week we look at the last financial statement which is the Statement of Cash Flows. Prior to this financial statement being mandatory, many companies in the 1980’s were reporting high profits, but were running out of cash and investors were at risk of being misled.
There is a common belief that since this statement is prepared based on cash flow, rather than using accrual accounting, it cannot be manipulated and is the most reliable of all the financial statements.
I want you to comment on whether you think the Statement of Cash Flows can be manipulated or it is truly the most reliable of all financial statement? Explain your decision. If you think it can be manipulated, then please provide a specific example of how this could be done.
Finance
1) For this week’s topic we apply the time value of money techniques from chapter 3 to estimate the value of a company share, or a debt security such as a bond or debenture.
In practice these discounted cash flow techniques (present values of future cash flows) are used extensively by investment banks and stockbrokers to forecast company share prices, and prepare research reports including recommendations to investors on whether to buy, sell or hold the company shares. These research reports are sold for a fee to the client.
You may or may not have read one of these research reports, if you haven’t read one then you could view some basic information about Wesfarmers using the link below (it is free so you don’t get much information, if you pay brokers or have a trading account you get more comprehensive reports):
http://www.investsmart.com.au/shares/asx/Wesfarmers-WES.asp
This report makes a recommendation to hold Wesfarmers based on a 12 month target price of $35.961.
Would you rely on the research report to make an investment decision? Explain why or why not. If you believe there is a better method of estimating the value of a company share (other than discounted cash flow techniques) you should include this in your comments.
2) The topic for this week includes different methods of evaluating projects. Remember that the ultimate goal of the organisation should be to maximise shareholder wealth, so project selection should be consistent with this goal.
There are different decision tools (evaluation methods) which include Net Present Value (NPV), Internal Rate of Return (IRR), Benefit-Cost Ratio, Accounting Rate of Return (ARR) and Payback Period (PP). The 2 discounted cash flow methods are NPV and IRR.
Comment on the following:Manager 1 says: “Since NPV and IRR are both discounted cash flow methods it makes no difference which one I use. I think the IRR is better as the IRR only needs to be greater than my required rate of return to accept the project”.
Manager 2 says: “No you have it wrong. Accounting rate of return is the better method as it uses profit, which the accounting team have already determined and this is a more objective way of assessing a project”.
Which manager do you agree with? Explain and provide reasons for your comments.
Economics Competitive Advantage
1) Explain how smoking can simultaneously generate positive and negative externalities. Is there too much or too little smoking? Explain why smoking bans on bars and restaurants do not efficiently solve an externality problem.
2) What is a public good? Is it necessary for government to provide a public good? Apply your answer to national defense. Apply your answer to a lighthouse. Could either be privatized?
Last Completed Projects
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