Investment decision rule

It only has to care about maximizing firm value when

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Unformatted text preview: You can borrow and lend money from the capital markets so as to satisfy your consumption preference. In the same way, if you have capital markets where you can borrow and lend freely whenever you want, the firm doesn’t have to worry about choosing an investment level to satisfy each of its investor’s consumption preference. It only has to care about maximizing firm value. When firm value is maximized you will have the maximum amount of wealth available to investors and investors can adjust their consumption patterns by visiting capital markets. 7. This is Fisher’s Separation Theorem: Firm’s investment decision is separated from investors’ (owners’) consumption decisions. 8. Then how does firm maximize firm value? In other words, what should be their investment strategy to maximize its firm value? Answer: The firm only needs to invest up to the point where its investment possibilities curve is tangent to the capital market line. In other...
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