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Question 1

What are the key differences of financial issues between small companies and large companies? Discuss the main implications of the differences for small companies‟ financial decision making?
Suggested solution:
Key characteristics of SME finance
•Greater reliance on internal sources of funds
–Proportion seeking external finance fell from 65% (1987-1990) to 39% (1995-1997).
–Problem of information asymmetries is serious.
•The importance of and changes in bank loans
–Banks play a vital role in financing SMEs
–Use of bank loans differs over size of business.
–Bank loans for SMEs increased over the recent years either in number or in value.
–Bank loans changed from overdraft to term loans.
•External equity and venture capital
–External equity is less used (5% in UK).
–VC and business angels are more active in US.
•More ‘diversified’ sources of finance
–H/P and leasing come after bank loan.
•The cost of borrowing
–Margins ranged between 1% and 8% over base rate.
–Market discrimination exists.
•Government intervention
–Loan guarantee schemes

Implications for SME financial decisions
•Capital budgeting
–Over-invest or under-invest?
•Is capital available at the same costs as the large firms?
•Is SME capable of performing optimising calculation?
•Bias to estimation of cash flow?
–Asymmetric information problem exists with heterogeneous expectations
–SME may under-invest due to a shortage of internal funds under a pecking order regime.
•Capital structure
–SMEs rely on different sources of funds.
–The value of limited liability is reduced.
–Strategic bargaining is more important.
–Optimal capital structure will in most part determined at the personal level.
–Debt may be used for various purposes not related to the capital structure decision.
–Risk attitudes vary amongst SMEs.
–SME may have a financial growth cycle.
–Organisational forms may affect the ability to carry debt.
•Dividends
–Founders/entrepreneurs may have different expectation on dividends.
–If dividends would ever be paid at all?
–Negative dividends are unique to small businesses.
•Liquidity
–Liquidity is more important for SMEs.

Question 2

There were 110 mergers and acquisitions happened worldwide in 1980. The number of deals increased to 14,905 in 1990 and 42,760 in 2000. Meanwhile, studies of past merger waves have shown that two of every three merger deals have not worked. Discuss (1) the motives of mergers and acquisitions of why many mergers and acquisitions cannot achieve their initial expectations.
33 marks
Suggested solution
(1)
 Rapid means of corporate growth
 Creation of new synergies-economies of scale/scope
 Increased market share and market power
 Internalisation of crucial upstream or downstream activities
 Transfer of assets to more effective management
 Means of gaining new competencies/knowledge

(2)
 A bad gamble: most M&A transactions involve a premium of 35-50%.
 Synergies often fail to be realised.
 Integration is rarely as smooth as expected.
 Linking distribution systems is often difficult.
 Information systems often ve