Market Prices Are Useful to a Financial

¶ … Market Prices Are Useful to a Financial Manager

The objective of financial managers are to maximize the value of the firm. This in, other words, is called raising its market value for all stakeholders concerned. It is in this way that financial managers are concerned about the market price of a share of stock (i.e. how much that stock costs in the market). Market price is the measure of the owner's economic well-being. Investors who buy stocks would be willing to pay for the share in the company exactly what they believe it to be today (i.e. future dividends are as calculation of present value). To that end, therefore, financial managers attempt to maximize the present value of the stock Fama, 1976).

Discuss how the Valuation Principle helps a financial manager make decisions.

Financial managers must often make decisions regarding the benefits and costs associated with an investment. That is when valuation principles -- or valuation assessments -- come into account; determining what an investment is worth today and comparing it to the cost of the investment. Valuation Principles are premised on determining the expected future cash flows of the company and the discount rate (i.e. The rate that the investors require or demand) of the company. The discount rate is more popularly known as the required rate of return. The more uncertain the future cash flows the higher the required rate of return.

3. Describe how the Net Present Value is related to cost-benefit analysis.

The net present value (NPV) is described as the sum of the present values of the individual's cash flow or market value of the company. In the future, when investors will depend upon rate of return, the company's NPV is simply the present value of its cash flows minus its purchase price (which is its present value). NPV is a significant tool in making a valuation assessment of the company since it measures the shortfalls or excess of cash flows in present value terms once financial charges are met.

Cost benefit analysis gives financial managers a survey of the costs, benefits, and risks of the company or project. It determines the benefits and savings that are expected from the firm and compares them with the current costs. It is in this way that cost benefit analysis is related to the NPV of the company, since determination of the former gives the financial manager, stockholders and all concerned with the firm, investment, or project's success some approximation of the latter (Khan, 1993).

4. Explain how an interest rate is just a price.

The interest rate is the added fee paid for the use of borrowed money, or money earned by deposited funds. Interest, in economics, is considered the price of credit since it is considered compensation to the lender for 'credit risk' (i.e. Risk of principal loss), and for forgoing other useful investments (cost opportunities) that could have been made with the money. The money, instead of being used by the lender directly, is advance to the borrower who pays a minimal fee for this benefit (Kellison, 1970).