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mgtobj - The Objective in Corporate Finance If you dont...

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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
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Aswath Damodaran 3 First Principles
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Aswath Damodaran 4 The Classical Viewpoint Van Horne : "In this book, we assume that the objective of the firm 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 firm ... The secret of success in financial management is to increase value." Copeland & Weston : The most important theme is that the objective of the firm 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 .
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Aswath Damodaran 5 The Objective in Decision Making In traditional corporate finance, the objective in decision making is to maximize the value of the firm . A narrower objective is to maximize stockholder wealth . When the stock is traded and markets are viewed to be efficient, 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 firm value Maximize equity value Maximize market estimate of equity value
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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 firms - Firms that maximize stock price generally are profitable firms that can afford to treat employees well. Maximizing stock price does not mean that customers are not critical to success . In most businesses, keeping customers happy is the route to stock price maximization. Maximizing stock price does not imply that a company has to be a social outlaw .
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Aswath Damodaran 7 Why traditional corporate financial theory focuses on maximizing stockholder wealth. Stock price is easily observable and constantly updated (unlike other measures of performance, which may not be as easily observable, and certainly not updated as frequently). If investors are rational (are they?), stock prices reflect the wisdom of decisions, short term and long term, instantaneously.
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