Assignment # 1
Why are market prices useful to a financial manager?
A competitive market is one which a good can be bought and sold at the same price. We can use prices from competitive markets to determine the cash value of a good. Whenever a good trades in a competitive market, the price determines the value of the good. Financial Managers must be able to evaluate costs and benefits in order to make the appropriate decisions that benefit the company. Once we use the market prices to evaluate the cost and benefits of a decision in terms of cash today, it is then a simple matter to determine the best decision for the company. The best decisions make the company and its investors wealthier, because the value of its benefits exceeds the value of its cost. In a competitive market the value of a good is set by its price, and any personal opinion or preference is irrelevant when determining value. How does the Valuation Principle help a financial manager make decisions?
According to our text, the valuation principle is an analysis between the value of the benefits and the value of its costs. It is the foundation of financial decision making and it provides a basis for making decisions within a company. Understanding the valuation principle is very useful in assisting a financial manager in the company’s overall well being. The valuation principle also utilizes the market prices as well. The value of a commodity or an asset to the firm or its investors is determined by its competitive market price. The benefits and costs of a decision should be evaluated using those market prices. When the value of the benefits exceeds the value of the costs, the decision will increase the market value of the firm. Describe how the Net Present Value is related to cost-benefit analysis.
The Net Present Value is the base of the cost-benefit analysis, the reason for this is that the NPV is the difference between costs and benefits, and this NVP is what determine the outcome...
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