University:
California State University, Northridge
Course:
FIN 502 | Managerial Finance
Academic year:

2023
Views:

106

Pages:

7
Author:

Carissa Thomas

1.1 Finance and the Firm (1 of 7) • What Is the Goal of the Firm? – Maximize Shareholder Wealth  The primary goal of managers should be to maximize the wealth of the firm’s owners  In most instances this is equivalent to maximizing the stock price – Maximize Profit?  Does profit maximization lead to the highest possible share price?  For at least three reasons, the answer is often no: – Timing – Cash Flows – Risk Example 1.1 (1 of 2) Nick Dukakis, the financial manager of Neptune Manufacturing, a producer of marine engine components, is choosing between two investments, Rotor and Valve. The following table shows the EPS Dukakis expects each investment to earn over its 3-year life. Earnings per share (EPS) Investment Year 1 Year 2 Year 3 Total for years 1, 2, and 3 Rotor $1.40 $1.00 $0.40 $2.80 Valve 0.60 1.00 1.40 3.00 Example 1.1 (2 of 2) If Dukakis thought he should make decisions to maximize profits, he would recommend that Neptune invest in Valve rather than Rotor because it results in higher total earnings per share over the 3-year period ($3.00 EPS compared with $2.80 EPS). 1.1 Finance and the Firm (2 of 7) • What Is the Goal of the Firm? – Maximize Stakeholders’ Welfare?  Some suggest a balanced consideration of the welfare of shareholders and other firm stakeholders – Stakeholders include employees, suppliers, customers, and even members of the local community where a firm is located 1.1 Finance and the Firm (3 of 7) • What Is the Goal of the Firm? – Maximize Stakeholders’ Welfare?  Flaws in neglecting shareholder wealth maximization: – Maximizing shareholder wealth does not in any way imply that managers should ignore the interests of everyone connected to a firm who is not a shareholder – To maximize shareholder value, managers must necessarily assess the long-term consequences of their actions – The stakeholder perspective is intrinsically difficult to implement, and advocates of the idea that managers should consider all stakeholders’ interests along with those of shareholders do not typically indicate how managers should carry it out 1.1 Finance and the Firm (4 of 7) • What Is the Goal of the Firm? – Maximize Stakeholders’ Welfare?  Flaws in neglecting shareholder wealth maximization: – Many people misinterpret the statement that managers should maximize shareholder wealth as implying that managers should take any action, including illegal or unethical actions, that increases the stock price 1.1 Finance and the Firm (5 of 7) • The Role of Business Ethics – Business ethics are the standards of conduct or moral judgment that apply to persons engaged in commerce – The goal of such standards is to motivate business and market participants to adhere to both the letter and the spirit of laws and regulations concerned with business and professional practice