1.2 Goal of the Firm
LG 3 1.2 Goal of the Firm
What goal should managers pursue? There is no shortage of possible answers to this question. Some might argue that managers should focus entirely on satisfying customers. Progress toward this goal could be measured by the market share attained by each of the firm’s products. Others suggest that managers must first inspire and motivate employees; in that case, employee turnover might be the key success metric to watch. Clearly the goal that managers select will affect many of the decisions that they make, so choosing an objective is a critical determinant of how businesses operate.
MAXIMIZE SHAREHOLDER WEALTH Finance teaches that managers’ primary goal should be to maximize the wealth of
the firm’s owners—the stockholders. The simplest and best measure of stock-
CHAPTER 1
The Role of Managerial Finance
managers to take actions that increase the firm’s share price. A common miscon- ception is that when firms strive to make their shareholders happy, they do so at the expense of other constituencies such as customers, employees, or suppliers. This line of thinking ignores the fact that in most cases, to enrich shareholders, managers must first satisfy the demands of these other interest groups. Recall that dividends that stockholders receive ultimately come from the firm’s profits. It is unlikely that a firm whose customers are unhappy with its products, whose employees are looking for jobs at other firms, or whose suppliers are reluctant to ship raw materials will make shareholders rich because such a firm will likely be less profitable in the long run than one that better manages its relations with these stakeholder groups.
Therefore, we argue that the goal of the firm, and also of managers, should
be to maximize the wealth of the owners for whom it is being operated, or equivalently, to maximize the stock price. This goal translates into a straightfor- ward decision rule for managers— only take actions that are expected to increase the share price. Although that goal sounds simple, implementing it is not always easy. To determine whether a particular course of action will increase or decrease
a firm’s share price, managers have to assess what return (that is, cash inflows net of cash outflows) the action will bring and how risky that return might be. Figure 1.2 depicts this process. In fact, we can say that the key variables that managers must consider when making business decisions are return (cash flows) and risk.
earnings per share (EPS)
MAXIMIZE PROFIT?
The amount earned during the period on behalf of each
It might seem intuitive that maximizing a firm’s share price is equivalent to max-
outstanding share of common
imizing its profits, but that is not always correct.
stock, calculated by dividing
Corporations commonly measure profits in terms of earnings per share
the period’s total earnings available for the firm’s
(EPS), which represent the amount earned during the period on behalf of each
common stockholders by the
outstanding share of common stock. EPS are calculated by dividing the period’s
Parts
» The Prentice Hall Series in Finance
» 1 Merger Fundamentals 716 Major Causes of Business Failure 738
» The Financial Market Environment INTEGRATIVE CASE 1 Merit Enterprise Corp.
» LG 2 1.1 Finance and Business
» REVIEW QUESTIONS 1–7 What is the goal of the firm and, therefore, of all managers and
» LG 5 1.3 Managerial Finance Function
» PART 1 Introduction to Managerial Finance FINANCIAL MARKETS
» 2.3 Regulation of Financial Institutions and Markets
» 3.1 The Stockholders’ Report
» 3.8 A Complete Ratio Analysis
» LG 2 4.1 Analyzing the Firm’s Cash Flow
» 8 3 Coulson Industries has gathered the following data needed for the preparation of
» 4.5 Preparing the Pro Forma Income Statement
» 4.6 Preparing the Pro Forma Balance Sheet
» Evaluate the simplified approaches to pro forma financial statement
» 5.1 The Role of Time Value in Finance
» Explain yield to maturity (YTM), its calculation, and the procedure used
» LG 3 7.2 Common and Preferred Stock
» 7.4 Decision Making and Common Stock Value
» Explain the relationships among financial decisions, return, risk, and
» LG 4 8.3 Risk of a Portfolio
» 12 3 Consider two assets—Lo and Hi—with the characteristics described in the table below:
» LG 6 8.4 Risk and Return: The Capital Asset Pricing Model (CAPM)
» 15 3 In the preceding example for Benjamin Corporation, the risk-free rate, R F , was
» Explain the capital asset pricing model (CAPM), its relationship to the
» Calculate the weighted average cost of capital (WACC), and discuss
» 10.3 Net Present Value (NPV)
» 10.4 Internal Rate of Return (IRR)
» Discuss NPV and IRR in terms of conflicting rankings and the theoret-
» LG 2 11.1 Relevant Cash Flows
» LG 4 11.2 Finding the Initial Investment
» 11.3 Finding the Operating Cash Inflows
» 11.4 Finding the Terminal Cash Flow
» Determine the terminal cash flow associated with a proposed capital
» 12.3 International Risk Considerations
» LG 6 12.5 Capital Budgeting Refinements
» Explain the role of real options and the objective and procedures for
» LG 4 13.2 The Firm’s Capital Structure
» 19 3 We can plot coordinates on the EBIT–EPS graph by assuming specific EBIT
» 14.1 The Basics of Payout Policy ELEMENTS OF PAYOUT POLICY
» 14.2 The Mechanics of Payout Policy
» 14.4 Factors Affecting Dividend Policy
» Explain stock splits and the firm’s motivation for undertaking them.
» LG 5 15.4 Accounts Receivable Management
» LG 2 16.1 Spontaneous Liabilities
» LG 4 16.2 Unsecured Sources of Short-Term Loans
» LG 6 16.3 Secured Sources of Short-Term Loans
» Describe the various ways in which inventory can be used as short-term-
» 17.4 Stock Purchase Warrants
» LG 4 18.3 Analyzing and Negotiating Mergers
» Explain bankruptcy legislation and the procedures involved in reorgan-
» 19.1 The Multinational Company and Its Environment
» 3 3 Assume that the current exchange rate between the United States and the new
» 19.4 Long-Term Investment and Financing Decisions
» 19.6 Mergers and Joint Ventures
» Review recent trends in international mergers and joint ventures.
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