2.3 FINANCIAL MANAGEMENT 1.
Design an appropriate capital structure which yield more profitability for a service industry . Illustrate your answer with the help of EBIT-EPS analysis.
2. a) As a financial consultant, will you advice your client to have term deposits in a commercial bank which pay 8% interest compounded semi-annually or 8% interest compounded annually? Why? b) ´The finance manager should take account of the time value of money in order to take a correct and objective financial decisionµ . Elucidate the statement with the help of suitable illustrations . 3.
Comment
upon the statement ´The goal of capital management is the maximization of long-run earning to present shareholders .µ
4. ´The recommendation of the Tandon Committee is to frame Guidelines for followup of bank credit .µ Do you agree? Explain.
Answers managementt is the maximization of long-run earning to present shareholders.´ 3) ³The goal of capital managemen Shareholder value is a business term, sometimes phrased as shareholder value maximization or as
the shareholder value model , which implies that the ultimate measure of a company's success is the extent to which it enriches shareholders. It became popular during the 1980s, and is particularly associated with former CEO of General of General Electric, Electric, Jack Welch. Welch. The term used in several ways:
To refer to the market capitalization of a company (rarely used)
To refer to the concept that the primary goal for a company is to increase the wealth of its shareholders (owners) by paying dividends and/or causing the stock price to increase
To refer to the more specific concept that planned actions by management and the returns to shareholders should outperform certain bench-marks such as the cost of capitalconcept. capitalconcept. In essence, the idea that shareholders' money should be used to earn a higher return than they could earn themselves by investing in other assets having the same amount of risk of risk . The term in this sense was introduced by Alfred Rappaport in 1986.
Definition For a publicly traded company, Shareholder Value (SV) is the part of its capitalization that is equity as opposed to long-term debt debt.. In the case of only one type of stock of stock , this would roughly be the number of outstanding shares times current shareprice. Things like dividends augment shareholder value while issuing of shares (stock ( stock options)) lower it. This shareholder value added should be compared to average/required increase in value, options making reference to the cost of capital. capital. For a privately held company, the value of the firm after debt must be estimated using one of several valuation methods, s.a. discounted cash flow or others.
History On August 12, 1981, Jack Welch made a speech at The Pierre in New York City called µGrowing fast in a slowgrowth economy¶. [1] This is often acknowledged as the "dawn" of the obsession with shareholder value. Welch's stated aim was to be th e biggest or second biggest market player, and to return maximum value to stockholders. In March 2009, Welch criticized parts of the application of this concept, calling a focus on shareholder quarterly profit and share price gains "the dumbest idea in the world".[2] Welch then elaborated on this, claiming that the quotes were taken out of context.[3]
Maximizing shareholder value This management principle, also known under value based management , states that management should first and foremost consider the interests of shareholders in its business decisions. (Although the legal premise of a publicly traded company is that the executives are obligated to maximize the company's profit, [4] this does not imply that executives are legally obligated to maximize share holder value.) The concept of maximizing shareholder value is u sually highlighted in opposition to alleged examples of CEO's and other management actions which enrich t hemselves at the expense of shareholders. Examples of this include acquisitions which are dilutive to shareholders, that is, they may cause the combined company to have twice the profits for example but t hese might have to be split amongst three times the shareholders. As shareholder value is difficult to influence directly by any manager, it is usually broken down in components, so called value drivers. A widely used model comprises 7 drivers of shareholder value,[5] giving some guidance to managers:
Revenue
Operating Margin
Cash Tax Rate
Incremental Capital Expenditure
Investment in Working Capital
Cost of Capital
Competitive Advantage Period
Looking at some of these elements also makes it clear that short term profit maximization does not necessarily increase shareholder value. Most notably, the competitive advantage period takes care of this: if a business sells sub-standard products to reduce cost and make a quick profit, it damages its reputation and therefore destroys competitive advantage in the future. The same holds true for businesses that neglect research or investment in motivated and well-trained employees. Shareholders, analysts and the media will usually find out about these issues and therefore reduce the price they are prepared to pay for shares of this business. This more detailed concept therefore gets rid of some of the issues (though not all of them) typically associated with criticism of t he shareholder value model.
Based
on these seven components, all functions of a business plan and show how they influence shareholder
value. A prominent tool for any department or function to prove its value are so called shareholder value maps that link their activities to one or several of these seven components. So, one can find "HR shareholder value maps", "R&D shareholder value maps", and so on.
Criticism See also: Corporate social responsibility The sole concentration on shareholder value has been widely criticized,[6] particularly after the late-2000s financial crisis. While a focus on shareholder value can benefit the owners of a corporation financially, it does not provide a clear measure of social issues like employment, environmental issues, or ethical business practices. A management decision can maximize shareholder value whil e lowering the welfare of third parties. It can also disadvantage other stakeholders such as customers. For example, a company may, in the interests of enhancing shareholder value, cease to provide support for old, or even relatively new, products. Additionally, short term focus on shareholder value can be detrimental to long term shareholder value; the expense of gimmicks that briefly boost a st ocks value can have negative impacts on its l ong term value.
Alternative: stakeholder value The intrinsic or extrinsic worth of a business measured by a combination of financial success, usefulness to society, and satisfaction of employees, the priorities determined by the makeup of the individuals and entities that together own the shares and di rect the company. This is sometimes referred to as st akeholder value. However, this concept is difficult to implement in practice because of the difficulty of determining equivalent measures for usefulness to society and satisfaction of employees. For instance, how much additi onal "usefulness to society" should shareholders expect if they were to give up $100 million in shareholder return? In response to this criticism, defenders of the stakeholder value concept argue that employee satisfaction and usefulness to society will ultimately translate int o shareholder value
