How would each of the following events change the equilibrium financial market value of a company?...

How would each of the following events change the equilibrium financial market value of a company? (a)an increase in its cost of production; (b) an increase in its cost of financing; (c) an increase in the market’s discount rate; (d) an increase in its sales revenue; and (e) an increase in its projected future profits.

Solutions

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Solutions

(a)An increase in its cost of production

When cost of production increases, it will add pressure on margins of the product. So profit will decrease. It will create a sudden supply in market. As a result, market price of the share will go down and financial market value of the company will decrease.

(b) An increase in its cost of financing

It is also an adverse sign for a company when its cost of financing is increasing. As a result, company will pay more interest. So sellers will be more in market and hence market price of the share will go down and financial market value of the company will decrease.

(c) An increase in the market’s discount rate

If market’s discount rate will increase, then it will put a negative impact on valuation and estimates. As we take market discount rate to find present value of cash flows and based on this different stock’s price are estimated, if this discount rate is increased then we will get less present value. So there will be more sellers in market which will force the share to go down and financial market value of the company will decrease.

(d) An increase in its sales revenue

It is a positive sign. It will increase the stock’s demand in share market. Market will reward this and market price of the share will go up and financial market value of the company will increase.

(e) An increase in its projected future profits.

It is a positive sign. Future profits will encourage investors to invest in market. Demand of share will rise. So market price of the share will go up and financial market value of the company will increase.

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