The Objective in Corporate Finance

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Aswath
 Damodaran
 

2

THE
 OBJECTIVE
 IN
 CORPORATE
  FINANCE
 
“If
 you
 don’t
 know
 where
 you
 are
 going,
 it
 does’nt
  maCer
 how
 you
 get
 there”
 

First
 Principles
 
3

Aswath
 Damodaran
 

3

The
 Classical
 Viewpoint
 
4

¨ 

¨ 

¨ 

¨ 

Van
 Horne:
 "In
 this
 book,
 we
 assume
 that
 the
 objecKve
 of
 the
  firm
 is
 to
 maximize
 its
 value
 to
 its
 stockholders"
  Brealey
 &
 Myers:
 "Success
 is
 usually
 judged
 by
 value:
  Shareholders
 are
 made
 beCer
 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
  objecKve
 of
 the
 firm
 is
 to
 maximize
 the
 wealth
 of
 its
  stockholders."
  Brigham
 and
 Gapenski:
 Throughout
 this
 book
 we
 operate
 on
  the
 assumpKon
 that
 the
 management's
 primary
 goal
 is
  stockholder
 wealth
 maximizaKon
 which
 translates
 into
  maximizing
 the
 price
 of
 the
 common
 stock.
 
4

Aswath
 Damodaran
 

The
 ObjecKve
 in
 Decision
 Making
 
5

¨ 

In
 tradiKonal
 corporate
 finance,
 the
 objecKve
 in
 decision
 making
 is
 to
  maximize
 the
 value
 of
 the
 firm.
 
  A
 narrower
 objecKve
 is
 to
 maximize
 stockholder
 wealth.
 When
 the
 stock
  is
 traded
 and
 markets
 are
 viewed
 to
 be
 efficient,
 the
 objecKve
 is
 to
  maximize
 the
 stock
 price.
 
Maximize firm value

Assets
Existing Investments Generate cashflows today Includes long lived (fixed) and short-lived(working capital) assets Expected Value that will be created by future investments Assets in Place Debt

¨ 

Maximize equity value

Liabilities

Maximize market estimate of equity value

Fixed Claim on cash flows Little or No role in management Fixed Maturity Tax Deductible

Growth Assets

Equity

Residual Claim on cash flows Significant Role in management Perpetual Lives

Aswath
 Damodaran
 

5

Maximizing
 Stock
 Prices
 is
 too
 “narrow”
 an
  objecKve:
 A
 preliminary
 response
 
6

¨ 

Maximizing
 stock
 price
 is
 not
 incompaKble
 with
  meeKng
 employee
 needs/objecKves.
 In
 parKcular:
 
¤  -­‐
 Employees
 are
 o\en
 stockholders
 in
 many
 firms
  ¤  -­‐
 Firms
 that
 maximize
 stock
 price
 generally
 are
 profitable
 

firms
 that
 can
 afford
 to
 treat
 employees
 well.
 

Maximizing
 stock
 price
 does
 not
 mean
 that
  customers
 are
 not
 criKcal
 to
 success.
 In
 most
  businesses,
 keeping
 customers
 happy
 is
 the
 route
 to
  stock
 price
 maximizaKon.
  ¨  Maximizing
 stock
 price
 does
 not
 imply
 that
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