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• How should the firm obtain needed short-term financing?
29 In summary, some of the more important concerns of
financial management can be distilled into three
1 What long-term investments should the firm
undertake? (Investment decisions)
2 How should the firm raise money to fund these
investments? (Financing decisions)
3 How should the firm manage its short-term assets and
liabilities? (Working capital management decisions)
These decisions affect a firm’s success and ultimately
the overall economy. For example, misallocation of
resources can affect a company’s prospects of survival
and growth and can be detrimental to the economy as a
whole. At the heart of most financial decisions is the concern
about two specific factors: risk and return.
An underlying assumption of finance is that investors
should demand compensation for bearing risk. According
to the concept of risk aversion, investors should expect
a higher return for taking on higher levels of risk.
Although considerable debate exists over the precise
model for estimating risk and return, few contest the notion
of a risk–return tradeoff.
When making financial decisions, managers should
assess the potential risk and rewards associated with
In fact, the foundation for maximizing shareholder wealth
lies in understanding tradeoffs between risk and return.
31 To make effective decisions, the financial manager needs
a clear objective or goal to serve as a standard for
evaluating performance and deciding between alternative
courses of actions. Without such a criterion, the financial
manager would be unable to keep score –that is, to
measure better from worse. Although much division of opinion exists on the goal of
financial management, two leading contenders are
stakeholder theory and value (wealth) maximization.
stakeholder Stakeholder theory is the main contender to value
maximization as the corporate goal.
maximization Stakeholder theory asserts that managers should make
decisions that take into account the interests of all of a
3 Such stakeholders include not only financial
claimholders but also employees, managers,
customers, suppliers, local communities, and the
The major problem with stakeholder theory is that it
involves multiple objectives.
Telling the financial manager to maximize multiple
objectives, some of which may be conflicting, would
leave that manager with no way to make a reasoned
That is, corporate managers cannot effectively serve
many masters. Purposeful behavior requires the
existence of a single-valued objective function.
33 Value or Wealth Maximization- Most corporate
financial theorists agree that the primary corporate
goal is to maximize long-term firm value or wealth. From the stockholders’ perspective, a good
management decision would l...
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