PRINCIPLES OF FINANCE
The financial manager of every business is faced with many tough decisions in today’s economy. These decisions involve making choices that will affect the financial welfare of their company and shareholders. Many managers find market prices to be most useful as a means of measuring the value of the options they may be considering for investing or choosing projects and how to pay for them in a competitive market.
Let me explain by first telling you what a market price is. A market price is the current price at which an asset or service can be bought or sold according to Investopedia Financial Dictionary online. So a market price can be used to evaluate the cost and benefits of a decision in terms of cash today. (Berk, DeMarzo, Harford, (2009). By having that information available, the financial manager can make informed decisions as to which investments and which projects will increase the value of his firm.
The Valuation Principle is helpful to financial managers because, it seeks to increase Shareholder’s wealth. The Valuation Principle states that when the value of the investments or project (benefit) exceed the value of the cost, the financial manager should choose this option because, the decision will make a profit and increase the firms value. “Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability, and in litigation.” (http://en.wikipedia.org/wiki/Valuation_(finance)
Net Present Value rule relates to cost-benefit analysis because they both examine, compare, and quantify the cost and benefits of the investment that’s being considered. The Net Present Value does so by examining the ins and outs of cash flows at a discount rate. If those inflows are greater than the outflows (or...