Unformatted text preview: ead to an increase in the
value of the stock.
This is because investors generally prefer more wealth
to less. Thus, the financial goal of the firm is to
maximize shareholder wealth as reflected in the
market price of the stock.
The term shareholders refers to the firm’s current
owners or stockholders.
34 In practice, this goal means that the financial manager
can best serve business owners by identifying goods
and services that add value to the firm because the
marketplace desires and values the firm’s offerings.
This single-valued objective serves as a prerequisite
for rational behavior within an organization. In fact,
maximizing shareholder wealth has become the
premier business mantra.
Shareholder wealth maximization rests on several
assumptions. The corporate objective function
assumes that managers operate in the best interests
of stockholders, not themselves, and do not attempt to
expropriate wealth from lenders to benefit
stockholders. Shareholder wealth maximization also assumes that
managers do not take actions to deceive financial
markets in order to boost the price of the firm’s stock.
Another assumption is that managers act in a socially
responsible manner and do not create unreasonable
costs to society in pursuit of shareholder wealth
This implies that the financial manager should not take
illegal or unethical actions to increase the value of the
Given these assumptions, shareholder wealth
maximization is consistent with the best interests of
stakeholders and society in the long run.
36 Accounting profit is the difference between revenues and
usually only explicit costs, recorded according to accounting
An explicit cost is a direct payment made to others in the
course of running a business such as wage, rent and
materials. Accounting costs generally do not include implicit
costs, which are the returns the employed resource would have
earned in its next best use.
Implicit costs include opportunity costs associated with a
firm’s equity, costs of assets used in production, and ownerfirm’s
For example, the opportunity cost of equity capital is the implied
rate of return that investors could earn by investing these funds
37 Economic profit is the difference between revenues and
total costs (explicit and implicit costs, including the normal
rate of return on capital).
Normal profit is the minimum rate of return that investors are
willing to accept for taking the risks of investment. By earning
revenues in excess of its total costs, the firm has an economic
When revenues equal total costs, economic profit is zero. This
does not mean, however, that investors are receiving no
returns. Instead, investors are get...
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