Question

Answer the following: a) Discuss FOUR basic principles of Finance b) Explain the role of securities markets as intermediaries in bringing companies and investors together. c) Why is the goal of financial management to maximize the current value of the company’s stock? In other words, why isn’t the goal to maximize the future value? d) Discuss how company shareholders can encourage their managers to act in a way which is consistent with the objective of shareholder wealth maximiz

Answer 1

Answer for:

(a) Some basic Principles of finance are

• Risk requires a reward: The greater the risk of an investment, the higher will be the investor's required rate of return, and, other things remaining the same, the lower will be its value.

• Money has time value: A dollar received today is more valuable to the recipient then a dollar received in the future.

• Market Prices Are Generally Right: product market prices are often slower to react to important news then our prices in financial markets, which tend to be very efficient and quick to respond to news.

• cash flow matters:Incremental cash received (and not accounting profits) drives value.

Answer for:

(b)  Securities markets can attract the investors as it offers higher return to the investment portfolio. This investment portfolio easily can draw more savers in the investment process that in turn involves institutions like brokerage house, investment banking, money investing firms etc. It is the most vital components of a free-market economy. It provides companies with access to capital in exchange for giving investors a slice of ownership.The stock market allows companies to raise money by offering stock shares and corporate bonds. It lets investors participate in the financial achievements of the companies, making money through dividends. Dividends are cuts of the company's profits as they may payouts. Investors also make a profit by selling appreciated stocks. This is known as a capital gain

Answer for:

(c) The goals of financial management can be classified in many ways.Maximization of return on investment and market value per share may be termed as official goals of financial management.Market share is calculated by taking a company's sales over a given period and dividing it by the total sales of its industry over the same period. This metric provides a general idea of a company's size relative to its market and its competitors. Companies are always looking to expand their share of the market, in addition to trying to grow the size of the total market by appealing to larger demographics, lowering prices or through advertising. Market share increases can allow a company to achieve greater scale in its operations and improve profitability & by this market value of company stock increase.

Answer for:

(d) Wealth maximization is the concept of increasing the value of a business in order to increase the value of the shares held by stockholders. The concept requires a company's management team to continually search for the highest possible returns on funds invested in the business, while mitigating any associated risk of loss. This calls for a detailed analysis of the cash flows associated with each prospective investment, as well as constant attention to the strategic direction of the organization.Shareholders can take some decisions which are not in their favor in short term to encourage their managers to take strict decisions like not to receive frequent dividends & capital investment decisions of a firm have a direct relation with wealth maximization. All capital investment projects with an internal rate of return (IRR) greater than 1 or having positive NPV creates value for the firm. These projects earn more than the ‘required rate of return’ of the firm. In other words, these projects maximize the wealth of the shareholders because they are earning more than what they can earn by investing themselves.

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