Page 10 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 1: Introduction to Financial Management

This is so because at this price, the investors have an earning of 20%, something they expect from Notes
a company with this degree of risk.
The important issues relating to maximizing share prices are Economic Value Added (EVA) and
the focus on stakeholders.

Notes Economic Value Added (EVA) is a popular measure used by many firms to determine
whether an investment – proposed or existing – contribute positively to the owner's
wealth. EVA is calculated by subtracting, the cost of funds used to finance or investment
from its after-tax-operations profits. Investments with positive EVA increase shareholder
value as those with negative EVA reduce shareholders value.

Example: The EVA of an investment with after tax operations profits of 510,000 and
associated financing costs of 475,000 would be 35,000 (i.e. 410,000 – 375,000). Because this
EVA is positive, the investment is expected to increase owner's wealth and is, therefore,
acceptable.

What about Stakeholders?

Stakeholders are groups such as employees, customers, suppliers, creditors, owners and others
who have a direct economic link to the firm. A firm with a stakeholder focus, consciously avoids
actions that would prove detrimental to stakeholders. The goal is not to maximize stakeholder
well being but to preserve it. It is expected to provide long-run benefit to shareholders by
maintaining positive stakeholder relationships. Such relationship should minimize stakeholder
turnover, conflicts and litigation. Clearly, the firm can better achieve its goal of shareholder
wealth maximization by maintaining cooperation with other stakeholders rather than having
conflict with them.

Did u know? Besides the above basic objectives, the following are the other objectives of
financial management:
1. Building up reserves for growth and expansion.

2. Ensuring maximum operational efficiency by efficient and effective utilization of
finance.
3. Ensuring financial discipline in the management.

Role of Ethics

Ethics is standards of conduct or moral judgment. Today, the business community in general
and the financial community in particular are developing and enforcing ethical standards, purpose
being to motivate business and market participants to adhere to both the letter and the spirit of
laws and regulations concerned with business and professional practice. An effective ethics
programme is believed to enhance corporate value. An ethics programme can reduce potential
litigation and judgment costs, maintain a positive corporate image, and build shareholders'
confidence, and gain the loyalty, commitment and respect of the firms stakeholders. Such actions,
by maintaining and enhancing cash flow and reducing perceived risk, can positively affect the
firm's share prices. Ethical behaviour is, therefore, viewed as necessary for achieving the firm's
goal of owner wealth maximization.

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