Question

In the context of the value-maximisation model of a firm, the expected value of the firm rises with:

A)   new foreign competitors enter the market, all else held constant

B)   an increase in the firm’s costs of production, all else held constant

C)   a rise in interest rates, all else held constant

D)   an increase in the time horizon, all else held constant

Answer 1

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Abstract

In general terms it is assumed that managers of corporate firms or owner-managers of self-owned business enterprises seek to maximise short-run profits.

It has often been observed that firms sacrifice some short-run profits for the sake of higher profits in the future years.

Therefore business owners aims at maximising long-run profits. It is because of business enterprises incur huge expenditure on research and development, new capital equipment and expensive promotional schemes for their products.

Therefore, incorporation of time in the analysis of decision making by managers of business enterprises is essential.

Modern theory of the firm assumes that primary objective of the firm or their managers are to maximise value of wealth or shareholder’s wealth.

Solution

Therefore Option A) "new foreign competitors enter the market, all else held constant" is Incorrect because - of below reason :

Competitors will try to win market share by cutting costs, improving efficiency, lowering price and innovating by either creating new products and services or improving upon old ones.

Therefore Option B) " an increase in the firm’s costs of production, all else held constant"  is Incorrect because

if production costs increase, the quantity supplied at a given price will decrease. Higher costs mean that producers will have to produce less to be able sell a product at a given price.

Therefore Option C) " a rise in interest rates, all else held constant" is Incorrect because of below reason :

An increase in interest rates can affect a business in two ways: Customers with debts have less income to spend because they are paying more interest to lenders. Sales fall as a result. Firms with overdrafts will have higher costs because they must now pay more interest.

Therefore Option D) "an increase in the time horizon, all else held constant"  is Correct because of below reason :

When investors have longer time horizons, they generally take on more risk. This is because the extended amount of time allows the market to recover from a downturn.

For instance, if an investor has a time horizon of 35 years, their portfolio is likely to include more equities than bonds.

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