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Sydney Ruzicka 1/27/17

Managerial Finance Homework 1

1. If a companys board of directors wants management to maximize shareholder


wealth, the CEOs compensation should depend on how well the firm performs as
opposed to being set as a fixed dollar amount. Performance should be measured by the
growth rate in the stocks intrinsic value. It is easier to measure performance based on the
growth rate in reported profits rather than intrinsic value only because intrinsic value is
not observable. Intrinsic stock value is the better performance measure because it shows
growth as a company in terms of value and what is actually going on in the company
itself, not just in terms of stock prices. The stock price used in reported profits should be
an average over time and not on a specific date.

2. Stockholder wealth maximization should be thought of as a long-term goal. If one


action increases a firms stock price from a current level of $20 to $25 in 6 months and
then to $30 in 5 years, but another action keeps the stock at $20 for several years but then
increases it to $40 in 5 years, the better option would be the one that increases it to $40 in
5 years. Shareholder wealth maximization means that firms managers are working on
behalf of the shareholders, and that they were hired to pursue policies that enhance
shareholder value.

3. SCCs stockholders might have mixed feelings about some of the announcements
that were made. Even if the stock price isnt directly affected, stockholders might feel
that the company contributing $1.5 million to the symphony orchestra wasnt the best use
of the money that they put into the company. Especially because there are really no
foreseeable benefits to them doing so. The $500 million that is going towards opening a
new plant and expanding operations in China might be a good thing in the long run and
turnover a bigger profit for shareholders, however in until that happens they might not be
too happy about it because it is going to depress the profits being made as well as the
stock price for at least four years. When the SCCs emergency funds are switched over
from Treasury bonds to common stocks, the stock price will go up so shareholders will
view this as a good action.

4. The large investment that Edmund Enterprises made in their technology will
lower the companys earnings per share this year. However, because the upgraded
technology is expected to reduce future costs significantly in the long run (and we know
this) the intrinsic value will go up. The stock price will most likely go down for the time
being because of the large investment that was made without having much of an effect at
first.