Objectives of Firm

OBJECTIVES OF A FIRM
OBJECTIVES OF A FIRM
Profit Maximisation
Increase in market share Growth Increase in revenue Building Brand Image Globalisation of Business
Whats the objective of the firm?

The objective of the firm is to maximize the value of the firm.
Value of the firm is the true measure of business success (of course, from a for-profit perspective.)
Two questions:
1. How is the value of the firm defined and measured? 2. How do managers go about adding value to the firm?
Continue
The profit-maxing assumption can be interpreted in two ways:
1. Maximisation of profit in the short-run i.e. the firm has a given set of plant and equipment and makes as much profit as it can with that 2. Long-run profit maximisation i.e. maximise the wealth of the shareholders Shareholder wealth is maximised by selecting the most profitable set of plant and equipment and then operating it in the most profitable way. BUT THERE MAY BE EXCEPTIONS - making maximum short term profit might trigger entry or government intervention
Profit Maximisation
Profit maximization is the traditional approach and
the primary objective of a business. It implies that every decision relating to business is evaluated in the light of profits. All the decision with respect to new projects, acquisition of assets, raising capital, distributing dividends etc are studied for their impact on profits and profitability.
Continue..
A Useful Map
Profit = Total Rev - Total Cost = P . Qd - AC . Qs
Conditions of Profit Maximisation

There are two set of conditions: 1. The Necessary or First Order Condition 2. The Supplementary or Second Order Condition The First Order condition requires that MC shall be equal to MR. MR = MC It implies that first derivative of TR Function must be equal to the first derivative of TC or their difference must be equal to zero.
Continue..
The Second Order Condition requires that the
difference between second derivative of TR Function & Second derivative of TC Function must be less than zero. The sum of the second derivative of two functions must be negative.
Limitations of Profit Maximisation

Profit maximization is criticized for some of its limitations which are discussed below: Haziness of the concept Profit: The term Profit is a vague term. It is because different mindset will have different perception about profit. For e.g. profits can be the net profit, gross profit, before tax profit, or the rate of profit etc. There is no clear defined profit maximization rule about the profits. Ignores Time Value of Money: The profit maximization formula simply suggests higher the profit better is the proposal. Another important dictum of finance says a dollar today is not equal to a dollar a year later. So, the time value of money is completely ignored.
Continue..
Ignores the Risk: A decision solely based on profit
maximization model would take decision in favor of profits. In the pursuit of profits, the risk involved is ignored which may prove unaffordable at times simply because higher risks directly questions the survival of a business. Ignores Quality: The most problematic aspect of profit maximization as an objective is that it ignores the intangible benefits such as quality, image, technological advancements etc. The contribution of intangible assets in generating value for a business is not worth ignoring. They indirectly create assets for the organization.
Wealth Maximisation
In wealth maximization, major emphasizes is on cash
flows rather than profit. So, to evaluate various alternatives for decision making, cash flows are taken under consideration. For e.g. to measure the worth of a project, criteria like: present value of its cash inflow present value of cash outflows (net present value) is taken. This approach considers cash flows rather than profits into consideration and also use discounting technique to find out worth of a project. Thus, maximization of wealth approach believes that money has time value.
Continue..
value of business is said to be a function of two factors
- earnings per share and capitalization rate. And it can be measured by adopting following relation: Value of business = EPS / Capitalization rate At times, wealth maximization may create conflict, known as agency problem. This describes conflict between the owners and managers of firm.
Continue..
As, managers are the agents appointed by owners, a
strategic investor or the owner of the firm would be majorly concerned about the longer term performance of the business that can lead to maximization of shareholders wealth. Whereas, a manager might focus on taking such decisions that can bring quick result, so that he/she can get credit for good performance. However, in course of fulfilling the same, a manager might opt for risky decisions which can put on stake the owners objectives.
Continue..
Hence, a manager should align his/her objective to broad objective of organization and achieve a tradeoff between risk and return while making decision; keeping in mind the ultimate goal of financial management i.e. to maximize the wealth of its current shareholders.
The Firm and Its Economic Problem

The Firms Constraints The firms profit is limited by three features of the environment: Technology constraints Information constraints Market constraints

Technology Constraints Technology is any method of producing a good or service. Technology advances over time. Using the available technology, the firm can produce more only if it hires more resources, which will increase its costs and limit the profit of additional output.

Information Constraints A firm never possesses complete information about either the present or the future. It is constrained by limited information about the quality and effort of its work force, current and future buying plans of its customers, and the plans of its competitors. The cost of coping with limited information limits profit.

Market Constraints What a firm can sell and the price it can obtain are constrained by its customers willingness to pay and by the prices and marketing efforts of other firms. The resources that a firm can buy and the prices it must pay for them are limited by the willingness of people to work for and invest in the firm. The expenditures a firm incurs to overcome these market constraints will limit the profit the firm can make.
The Principle of Opportunity Cost

Costs are opportunities sacrificed. To be precise,
the opportunity cost of a choice or decision is measured by the highest valued alternative that will be given up. Cost is not always the monetary expense Cost is often implicit rather than explicit
19
Significance of the Opportunity Cost Concept

Accounting profits = Net revenue Accounting costs
(dollar costs of goods and services) Reported on the firms income statement Economic profits = Net revenue Opportunities Costs Economic profits and opportunity costs are critical to decision making
20

Objectives of Firm

Uploaded by

Copyright:

Available Formats

Objectives of Firm

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Objectives of Firm

Uploaded by

Copyright:

Available Formats

OBJECTIVES OF A FIRM

Whats the objective of the firm?

Conditions of Profit Maximisation

Limitations of Profit Maximisation

The Firm and Its Economic Problem

The Firm and Its Economic Problem

The Firm and Its Economic Problem

The Firm and Its Economic Problem

The Principle of Opportunity Cost

Significance of the Opportunity Cost Concept

You might also like