13 mba 504: financial management and analysis
week 13 1. Read and summarize chapter 29 of your financial management and analysis text book in at least 500 words.
-Thinking about what you just read, what strategic and financial plan would you put in place to help bring down inflation in America? There is no right or wrong answer. Just answer from your opinion and from what you read in the chapter.
siness that maximizes its owners’ wealth allocates its resources
efficiently, resulting in an efficient allocation of resources for society
as a whole. Owners, employees, customers, and anyone else who has a
stake in the business enterprise are all better off when its managers
make decisions that maximize the value of the firm.
Just as there may be alternative routes to a destination, there may be
alternative ways to maximize owners’ wealth. A strategy is a sense of
how to reach an objective such as maximizing wealth. And just as some
routes may get you where you are going faster, some strategies may be
better than others.
Suppose a firm has decided it has an advantage over its competitors
in marketing and distributing its products in the global market. The
firm’s strategy may be to expand into European market, followed by an
expansion into the Asian market. Once the firm has its strategy, it needs
a plan, in particular the strategic plan, which is the set of actions the
firm intends to use to follow its strategy.
The investment opportunities that enable the firm to follow its strat-
egy comprise the firm’s investment strategy. The firm may pursue its
strategy of expanding into European and Asian markets by either estab-
lishing itself or acquiring businesses already in these markets. This is
where capital budgeting analysis comes in: We evaluate the possible
investment opportunities to see which ones, if any, provide a return
greater than necessary for the investment’s risk. And let’s not forget the
investment in working capital, the resources the firm needs to support
its day-to-day operations.
Suppose as a result of evaluating whether to establish or acquire
businesses, our firm decides it is better—in terms of maximizing the
value of the firm—to acquire selected European businesses. The next
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934 SELECTED TOPICS IN FINANCIAL MANAGEMENT
step is to figure out how it is going to pay for these acquisitions. The
financial managers must make sure that the firm has sufficient funds to
meet its operating needs, as well as its investment needs. This is where
the firm’s financing strategy enters the picture. Where should the funds
needed come from? What is the precise timing of the needs for funds?
To answer these questions, working capital management (in particular,
short-term financing) and the capital structure decision (the mix of long-
term sources of financing) enters the picture.
Strategy and Owners’ Wealth Maximization
Often firms conceptualize a strategy in terms of the consumers of the
firm’s goods and services. For example, you may have a strategy to
become the world’s leading producer of microcomputer chips by pro-
ducing the best quality chip or by producing chips at the lowest cost,
developing a cost (and price) advantage over your competitors. So your
focus is on product quality and cost. Is this strategy in conflict with
maximizing owners’ wealth? No.
To maximize owners’ wealth, we focus on the returns and risks of
future cash flows to the firm’s owners. And we look at a project’s net
present value when we make decisions regarding whether or not to
invest in it. A strategy of gaining a competitive or comparative advan-
tage is consistent with maximizing shareholder wealth. This is because
projects with positive net present value arise when the firm has a com-
petitive or comparative advantage over other firms.
Suppose a new piece of equipment is expected to generate a return
greater than what is expected for the project’s risk (its cost of capital).
But how can a firm create value simply by investing in a piece of equip-
ment? How can it maintain a competitive advantage? If investing in this
equipment can create value, wouldn’t the firm’s competitors also want
this equipment? Of course—if they could use it to create value, they
would surely be interested in it.
1 Lois Therrien, Patrick Oster, and Chuck Hawkins, “How Sweet It Isn’t At Nutra-
Sweet,” Business Week (December 14, 1992), p. 42.2 Monsanto sold its sweetener division in 2000.
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Strategy and Financial Planning 937
Now suppose that the firm’s competitors face no barriers to buying the
equipment and exploiting its benefits. What will happen? The firm and its
competitors will compete for the equipment, bidding up its price. When
does it all end? When the net present value of the equipment is zero.