Finance debt and shareholders equity. Asset management decision

Finance is the art of playing with money. It is
the management of money, especially by governments or large companies. It is
the major branch of its mother subject Economics. Basically, finance is a
combination of:

·      
Economics

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·      
Accounting

·      
Mathematics

·      
Statistics

Finance
can be divided into three distinct categories and they are:

·      
Public
finance

·      
Corporate
finance

·      
Personal
finance

Public finance is the study of the role of the
government in the economy. It deals with the tax systems, government
expenditures, budget procedures and other government concerns.

Corporate finance is the area of finance dealing with the
sources of funding and the capital structures of corporations. It involves
managing assets, liabilities, revenues and debt for a business.

Personal finance defines all financial decisions and
activities of an individual or household.

Corporate
finance is concerned with the acquisition (investment decision), financing
(financing decision), management of assets (asset management decision) with
some overall goal on mind.

Investment decision includes capital investment decision or
capital budgeting decision. It mainly deals with the fixed assets.

Financing decision makes the budget structure. Their main
goal is to maximize shareholder value. It allocates the capital from long term
debt and shareholders equity.

Asset management decision mainly deals with the working capital.
Working capital is the difference between current assets and current liability.

Financial
manager performs some functions, the first thing that they do is they raise
money from investors, then they invest the cash in the business and generate
cash from operations. From the money that is generated from operations they
give cash to for services or operational compensations they also pay tax to the
government then they again reinvest the left-out cash and return it to the
investors.

The goal of the firm is the maximization of shareholders
wealth. It is the concept of increasing the value of a business in order to
increase the value of the shares held by stockholders. It is a superior goal
compared to the profit maximization as it takes broader arena into consideration.

Strength
of shareholder wealth maximization:

·      
Takes
account of current and future profits and EPS.

·      
Share
price serves as a barometer for business performance.

Profit maximization means maximizing a firm’s earnings after
taxes. Problems of profit maximization:

 

·      
Could
increase current profits while harming firm

·      
It
ignores changes in the risk level of firm

Earnings per share
maximization means
maximizing earnings after taxes divided by shares outstanding. The problem of
earnings per share maximization is:

·      
Does
not specify timing or duration of expected returns

·      
Ignores
changes in the risk level of the firm

·      
Calls
for a zero-payout dividend policy

Agency theory: it is a principle agent problem. Its
main concern is the conflict between the managers and shareholders of the firm.
Managers are the one who are hired for managing the operational activities of
the firm. Wealth maximization is always preferable for a firm in the long run
but the managers are more interested in making more profit so that they can earn
more money. They do not think about the long term benefit of the firm and the
shareholders interests.

 

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