Corporate Finance 1) Please explain why shareholder wealth is important XXXXXXXXXXWhy does finance focus on cash flows not net profits? 3) How would the following actions affect a firm’s current...

Answer 1:-
According to stockholders wealth maximization theory long term goal should always be
given prime importance as compared to short term goal. Management always tries to maximize
the shareholders wealth by using long term sustainable techniques and not short lived techniques
which can boost the prices for a short term period. Using techniques which will boost the price of
shares for short period will sometimes also leads to reduction in the value of the stock price and
loss of market reputation.
For example, if one action would probably increase the firms stock price from a cu
ent
level of $20 to $25 in six months, and then to $30 in five years, but another action would
probably keep the stock at $20 for several years but then increase it to $40 in five years.
In the present case if short term goal is kept in focus then price of the stock of the
company will reach at $25 within six month period and then at $30 after five years but if long
term goal is kept in focus then in such case the price of the stock of the company will remain at
$20 cu
ently but it will reach at $40 in five year period. From an investor point of view long
term goal is always beneficial whereas from a trader’s point of view short term goal is beneficial
ecause investors always holds security for a period of long term whereas trader holds securities
for a very short period of time and wealth maximization theory always focuses on the long term
investors. Therefore long term goals should be given prime importance.
Answer 2:-
Whenever a financing decision has to be taken we always evaluate the project on the
asis of cash flows and not net profits. In order to evaluate any financing decision we use capital
udgeting technique, Capital budgeting is done through various tools such as
eak even
analysis; net present value analysis, internal rate of return analysis, payback period analysis etc.
In order to use above mentioned we consider only cash flows and not the net profit, this
also shows that cash flows are more relevant than the net profit. The biggest reason why we use
cash flows instead of net profit is that cash flows are more realistic measure for any projects as
compared to the net profit, for example a project is yielding a good amount of net profit per year
ut will return the cash flow only at the end of the project which is 10 year later.
Thus if we will use the net profit for evaluation than we might accept the project but if we
use cash flow measure we would never accept the project and the major reason is time value of
money. Time value of money states that the value of money diminishes by time and later we
eceive the money the lesser is its value and vice versa. Net profit technique do not consider time
value of money and therefore only cash flow technique must be used for financing decisions.
Answer 3:-
a) Inventory is sold – In the present case firm’s cu
ent ratio will go up. Inventory is
always recorded in the books at its cost price, as selling price of a product is higher than its cost
price if a product is being sold than it might lead to increase in the cash or debtors in both the
cases cu
ent assets will increase marginally which leads to increase in the cu
ent ratio.
) The firm takes out a bank loan to pay its suppliers – In the present case cu
ent...