Objectives in Corporate Finance
The Objective in Corporate Finance
“If you don’t know where you are going, it does not matter how you get there”
Aswath Damodaran
Stern School of Business
Aswath Damodaran
2
First Principles
Invest in projects that yield a return greater than the minimum acceptable hurdle rate.
• The hurdle rate should be higher for riskier projects and reflect the financing mix used - owners’ funds (equity) or borrowed money (debt) • Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects.
Choose a financing mix that minimizes the hurdle rate and matches the assets being financed. If there are not enough investments that earn the hurdle rate, return the cash to the owners of the firm (if public, these would be stockholders).
• The form of returns - dividends and stock buybacks - will depend upon the stockholders’ characteristics.
Objective: Maximize the Value of the Firm
Aswath Damodaran
3
The Classical Viewpoint
Van Horne: "In this book, we assume that the objective of the firm is to maximize its value to its stockholders" Brealey & Myers: "Success is usually judged by value: Shareholders are made better off by any decision which increases the value of their stake in the firm... The secret of success in financial management is to increase value." Copeland & Weston: The most important theme is that the objective of the firm is to maximize the wealth of its stockholders." Brigham and Gapenski: Throughout this book we operate on the assumption that the management's primary goal is stockholder wealth maximization which translates into maximizing the price of the common stock.
Aswath Damodaran
4
The Objective in Decision Making
In traditional corporate finance, the objective in decision making is to maximize the value of the firm. A narrower objective is to maximize stockholder wealth. When the
“If you don’t know where you are going, it does not matter how you get there”
Aswath Damodaran
Stern School of Business
Aswath Damodaran
2
First Principles
Invest in projects that yield a return greater than the minimum acceptable hurdle rate.
• The hurdle rate should be higher for riskier projects and reflect the financing mix used - owners’ funds (equity) or borrowed money (debt) • Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects.
Choose a financing mix that minimizes the hurdle rate and matches the assets being financed. If there are not enough investments that earn the hurdle rate, return the cash to the owners of the firm (if public, these would be stockholders).
• The form of returns - dividends and stock buybacks - will depend upon the stockholders’ characteristics.
Objective: Maximize the Value of the Firm
Aswath Damodaran
3
The Classical Viewpoint
Van Horne: "In this book, we assume that the objective of the firm is to maximize its value to its stockholders" Brealey & Myers: "Success is usually judged by value: Shareholders are made better off by any decision which increases the value of their stake in the firm... The secret of success in financial management is to increase value." Copeland & Weston: The most important theme is that the objective of the firm is to maximize the wealth of its stockholders." Brigham and Gapenski: Throughout this book we operate on the assumption that the management's primary goal is stockholder wealth maximization which translates into maximizing the price of the common stock.
Aswath Damodaran
4
The Objective in Decision Making
In traditional corporate finance, the objective in decision making is to maximize the value of the firm. A narrower objective is to maximize stockholder wealth. When the