The Primary Objective of the Corporation: Value Maximization

• • • Maximizing the value of the firm should be the primary objective of the corporations.
    • The market price is the stock price that we observe in the financial markets.
    • If the market price reflects all relevant information, then the observed price is also the fundamental, or intrinsic, price.
    • The same actions that maximize fundamental stock prices usually benefit society. Reasons include:
      • To a large extent, the owners of stock are society.
      • Consumers benefit because stock price maximization requires efficient, low-cost businesses that produce high-quality goods and services at the lowest possible cost.
      • Employees benefit because companies that successfully increase stock prices also grow and add more employees, thus benefiting society.
    • Free cash flows (FCF) are the cash flows that are available for distribution to all of a firms investors (stockholders and creditors) after the firm pays expenses, pays taxes, and makes the necessary investments to support growth.
      • Three factors primarily determine free cash flows: (1) sales revenues, (2) operating costs and taxes, and (3) required investments in operating capital.
      • FCF =sales revenues - operating costs - operating taxes - required investments in operating capital
    • Managers can enhance their firms values (and stock prices) by increasing the size of the expected free cash flows, by speeding up their receipt, and by reducing their risk.
    • The weighted average cost of capital (WACC) is the average return required by all of the firms investors (stockholders and creditors). It is affected by the firms capital structure (the firms relative amounts of debt and equity financing), interest rates, the firms risk, the markets overall attitude toward risk.
    • The relationship between a firms fundamental value, its free cash flows, and its cost of capital is defined by the following equation

Instructions:

• Discussion prompt, resource or idea/example