FINANCIAL MANAGEMENT SESSION - 2

GOALS OF A FIRM
GOAL FINANCIAL GOAL

1.PROFIT MAXIMISATION 2.WEALTH MAXIMISATION

PROFIT MAXIMISATION

GOODS AND SERVICES

Market EconomyGovt Controlled

Economy

Market Economy - profits

Goods desired by society

Demand Supply mechanism - huge profits achieve price equilibrium.

Goods not desired by society

Low prices Huge losses Product out of the market huge losses

ECONOMIC THEORY
PROFITABLE FIRM WILL ADOPT THIS THEORY

MAXIMUM OUTPUT GIVEN INPUT MINIMUM INPUT GIVEN OUTPUT

OBJECTIONS TO PROFIT MAXIMISATION

Form of organisation ancient /modern Market economy wasteful goods Inequality of income and wealth It is vague It ignores timing of returns/uncertainity of

returns It ignores risk

DEFINITION OF PROFIT
Short or long PBT or PAT Total profits or profits per share Total operating profit/ profit accruing to share

holders

Max profit after Tax

Case: A company has 10,000 shares PAT = RS. 50,000/EPS = Rs.5

Invest in additional 10,000 shares @Rs.50 Rs.5,00,000 invested for a return of 5% Additional revenue of Rs. 25,000/PAT Increased to Rs.75,000/EPS = Rs. 3.75

INFERENCE
The addition in profits does not necessarily

mean addition in earnings for the share holders so maximising PAT is not doing any good in return if profitability is the only goal of a firm.

MAXIMISING EPS
EPS Is not the only factor that influences the

market price of a share. So only measures adopted to increase EPS is not going to satisfy the financial goal of the company.

WEALTH MAXIMISATION
Share holders wealth maximisation means

maximising the net present value of a course of action to shareholders.

One way to decide if an investment or project

is worthwhile is to calculate something called NPV.

Benefit of Investment proposals based on Npv

Share holders wealth Maximisation

Market price valuation approach

Various factors influence the market price of a company

Risk return trade off

Return = risk free rate + risk premium Risk free rate = rate of default return Risk premium = the return expected for the

risk taken.

The risk return trade off.

Financial Decisions & Risk-Return trade off

Market value of the firm

Capital budgeting Capital Structure Dividend Working Capital Risk Return

Principle of Finance
Investors -Shareholders -Lenders Provides initial cash to finance The business proposal

Generates cash return

Organization of finance functions

Chief Finance Officer Treasurer Credit Manager Fund Raising Manager Controller Financial Accounting Manager Tax Manager Cost Accounting Manager Data Processing Manager Internal Auditor

Cash Manager Capital Budgeting Manager

Portfolio Manager