mbo - Aswath Damodaran 1 Packet 1: Corporate Finance...

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Unformatted text preview: Aswath Damodaran 1 Packet 1: Corporate Finance B40.2302 - Fall 2006 Aswath Damodaran The Objective in Corporate Finance The Investment Principle Aswath Damodaran 2 The Objective in Corporate Finance “If you don’t know where you are going, it does not matter how you get there” Aswath Damodaran 3 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate . • The hurdle rate should be higher for riskier projects and reFect the ¡nancing mix used - owners’ funds (equity) or borrowed money (debt) • Returns on projects should be measured based on cash Fows generated and the timing of these cash Fows; they should also consider both positive and negative side effects of these projects. Choose a ¡nancing mix that minimizes the hurdle rate and matches the assets being ¡nanced. If there are not enough investments that earn the hurdle rate, return the cash to the owners of the ¡rm (if public, these would be stockholders). • The form of returns - dividends and stock buybacks - will depend upon the stockholders ’ characteristics . Objective: Maximize the Value of the Firm Aswath Damodaran 4 The Classical Viewpoint Van Horne : "In this book, we assume that the objective of the Frm is to maximize its value to its stockholders " Brealey & Myers : "Success is usually judged by value: Shareholders are made better off by any decision which increases the value of their stake in the Frm ... The secret of success in Fnancial management is to increase value." Copeland & Weston : The most important theme is that the objective of the Frm is to maximize the wealth of its stockholders ." Brigham and Gapenski : Throughout this book we operate on the assumption that the management's primary goal is stockholder wealth maximization which translates into maximizing the price of the common stock . Aswath Damodaran 5 The Objective in Decision Making In traditional corporate fnance, the objective in decision making is to maximize the value oF the frm . A narrower objective is to maximize stockholder wealth . When the stock is traded and markets are viewed to be eFfcient, the objective is to maximize the stock price . Assets Liabilities Assets in Place Debt Equity Fixed Claim on cash flows Little or No role in management Fixed Maturity Tax Deductible Residual Claim on cash flows Significant Role in management Perpetual Lives Growth Assets Existing Investments Generate cashflows today Includes long lived (fixed) and short-lived(working capital) assets Expected Value that will be created by future investments Maximize frm value Maximize equity value Maximize market estimate oF equity value Aswath Damodaran 6 Maximizing Stock Prices is too “narrow” an objective: A preliminary response Maximizing stock price is not incompatible with meeting employee needs/objectives . In particular: •- Employees are often stockholders in many Frms •- ¡irms that maximize stock price generally are Frms that have treated...
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mbo - Aswath Damodaran 1 Packet 1: Corporate Finance...

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