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Busines Valuation Notes T:F

Busines Valuation Notes T:F - A firm operating at points A...

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A firm operating at points A or B is maximizing shareholder value. FALSE Operating at point B maximizes profits because it maximizes market share. FALSE As institutional capitalism becomes more relevant, the movement from C to A or B is less likely to occur than from either B or A toward C. TRUE In moving from A to C, more is added to marginal revenue than to marginal cost, increasing profits to their maximum level. TRUE A and B are less representative of robber baron capitalism than institutional capitalism. FALSE Mistaken Alternatives to Sound Capital Budgeting : There are three main mistakes: Expansion on the assumption that profits will improve: In reality, many management teams follow a mistaken alternative that might best be described as "the field of dreams." If you expand, profits and improved cash flows will come. This strategy has led to the demise (or near demise) of many midsize regional firms desirous of expanding into other markets. Failure to fully implement rational capital budgeting techniques: The second mistake that can occur is that in spite of following rational capital budgeting techniques to maximize shareholder value (expected rate of return on investment exceeds the cost to undertake the investment), the recommended actions prescribed in the decision-making process are simply not followed. For example, the decision is made to go to just-in- time inventory methodology , and the estimated impact on cash flow is calculated on the basis of that conversion. At the operating level, while formally adopting the principles and signing on to adhere to the stricture of just-in-time, management, due to mistrust or fear of failure, opts instead to accumulate safety stock off-line. What eventually transpires? The impact of short-circuiting the just-in-time process results in lower levels of cash flows and poorer than expected performance. In a publicly held company, this is manifested in a lower stock price. Growth for the sake of growth: Recent history is replete with retail establishments attempting to grow for the sake of growth. This is another example of the field of dreams. A company currently has poor performance but is under the impression that expansion will increase cash flows and improved profits will result. In decisions made in a manufacturing environment (just-in-time, Kanban , etc.), oftentimes much of the expected improvement in earnings in cash flows does not materialize because management does not follow through with the discipline required for implementation.
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