The Firm and its Goals
In technical terms, Shareholder wealth can be calculated by multiplying a firms total number of shares outstanding with the price of the particular firms stock trading in the market, hence, it is the market value of the firms stock. On the other hand, profit maximization is primarily a more stationary concept in the sense that it defines, in simplistic terms, the extra revenue that is generated after paying off all costs. In essence, profit maximization does not really cater to the risk and time elements involved with the calculation of the profit. Shareholder wealth maximization, on the other hand, does include all internal as well as external forces that have an impact upon the firms profit generating abilities.
Shareholder wealth maximization is a more preferred approach than simple profit maximization because it is a long term objective of a company and therefore is more aligned in terms of achieving economic growth. Basically, Shareholder wealth maximization function incorporates all the managerial decisions that have a long run impact upon the firm and therefore is, without doubt, a more comprehensive approach.
Q2. What are some of the forces that cause managers to act in the interest of the Shareholders
The main cause behind managers not acting in the favor of shareholders is defined adequately by the principal agent problem. Since the question has not asked us to go into the details of the reasons behind the problem, lets just move on to some of the policies that help align shareholder and manager priorities upon a common platform. Incentive based measures such as commission on extra revenue generation, profit sharing, frequent performance measurement evaluation and efficiency wages can entice managers to work in the interests of the shareholders. Such incentive based policies primarily work because of the sole reason that both entities, the shareholder and the manager, are gaining from it.
Q3. A company has two million shares outstanding. It paid a dividend of 2 during the past year, and expects that dividends will grow at 6 percent annually in the future. Stockholders require a rate of return of 13. What would you expect the price of each share to be today and what is the value of the companys common stock
We will essentially use the Dividend Discount Model to calculate the price of the share and eventually the value of the common stock.
Dividend Discount Formula Price D1 (k g)
D1 2 x (1 0.06) 2.12
Therefore, Price of share 2.12 (0.13 0.06) 30.28
Value of Common Stock Share price x number of shares outstanding
30.28 x 2,000,000 60,560,000.
Q.4 Discuss the difference between the calculation of shareholder wealth and the concept of Market Value added. Which of the two would appear to be more meaningful from the view point of a shareholder
There are a number of ways through which shareholder wealth can be measured, the most common being the calculation of the EPS (Earnings per Share). Shareholder wealth is primarily defined as the return an investor receives per dollar that he or she has invested. The higher the EPS, the better off the shareholder is. Market Value Added or MVA also works along the same lines in the sense that it is the difference between the market value of the company and the capital contributed by investors. A high MVA, therefore, denotes that the company has been doing well in the past and that it has created substantial wealth for its investors.
Both terms are of importance to the shareholder but in my opinion, Market Value Added is off far more importance because it incorporates managerial decisions that have an impact upon shareholder wealth. The EPS is an extremely basic measurement and can be manipulated whereas MVA provides a far better economic perspective of a firm in regards to investment.
Q.5 Briefly explain why some firms are large and others are small. And list components of transaction cost.
In principle, there are inherent differences between small and large firms. However, the most significant reasoning lies in the sort of product or service the company is willing to sell because eventually that is what determines its size. Some firms specialize in providing products and services that have no substitutes therefore they face no competition and can gain profitability at a relatively small structural size whereas amongst industries that have a large number of competitors, firms in order to cater to larger customer base and demand have to achieve economies of scale in order to cut down on costs and achieve profitability.
Therefore, it can be stated with certainty that profit margins at the smaller level are slightly easier to establish.
Transaction cost, on the other hand, is defined as the cost of doing business with other firms including costs such as investigation, enforcement of contracts and negotiations.
Q.6 State the main factors that have contributed to the growth of outsourcing and give three examples.
The main factors that primarily contributed to the major drive towards outsourcing basically included the need to reduce expenses such as labor costs while also saving on operational costs such as administrative, utilities etc thereby increasing productivity and enabling firms to sell their products at a lower price than their competitors while still maintaining profitability. The global internet network has also provided firms with the ability to facilitate the flow of information from anywhere around the world within seconds. Such efficient linkages between nations have allowed them to utilize each others resources in such a way so as to benefit each other.
The three basic types of outsourcing are Information technology outsourcing, business process outsourcing (Call centers etc) and outsourcing production facilities.
Q.7 List the primary economic and non-economic goals of a company.
The primary economic objectives of a firm are to achieve long term growth in order to promulgate profitability for themselves as well as their shareholders who have invested a large amount of capital. The economic existence of every firm revolves around the concept of profitability. However, on the other hand, the non-economic goals include corporate social responsibility which dictates that the firm must also keep under consideration the view of the shareholders as well as the stakeholders in matters concerning the public at large, such as the firms economic activities affecting the environment. The non-economic goals of a company also include the provision of products and services which maximizes the utility function of its consumers.