3 - WealthMaximisation 1. Keydefinitions:

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Wealth Maximisation 1. Key definitions: Accounting Rate of Return:  Investment’s average accounting profits  each year average book value of assets invested each year 2. Key knowledge: NPV rules: o NPV uses cash flows o NPV uses all the cash flows of the project o NPV discounts the cash flows properly Minimum Acceptance Criteria: Accept if NPV > 0 Ranking Criteria: Choose the highest NPV  (Irving) Fisher’s separation theorem If capital markets for borrowing and lending are  well-functioning, Companies can make their investment decisions  independently of individual shareholders’  consumption decisions,  by using the NPV rule Perfect capital market  (PCM) There are no transactions costs or other ‘frictions’ to  accessing capital markets, either by firms or investors   the  interest rate on borrowing equals the interest rate on investing. Markets are competitive in the sense that access is free and  equal, and no participants have the power to influence prices. All participants have the same information about prices  and security/firm characteristics. Other stakeholders in the firm face competitive prices. There are no distorting taxes. PCM   maximising share price makes shareholders better  off… … because shareholders can sell or buy shares and other  securities,  or borrow and lend to get their desired consumption – saving  pattern PCM   market interest rates and returns gives the opportunity  costs of transferring wealth across different periods …
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… if firms use market interest rates and returns to calculate NPVs  they make the same tradeoffs as investors Fisher’s separation theorem:   With PCMs, the firm’s optimal investment decision  depends only on estimated cash flows from the investment and 
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This note was uploaded on 02/25/2012 for the course CHEM 4385 taught by Professor Staff during the Fall '11 term at Texas State.

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3 - WealthMaximisation 1. Keydefinitions:

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