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What is the difference between shareholder wealth maximization and profit maximization? Can a company achieve both at the same time? Can a company still be successful in the long term with one and not the other? Do you know of any companies that use both?

[CaptainForest]

Wow, so many questions in just one post.

What is the difference between shareholder wealth maximization and profit maximization?

Shareholder wealth is the market value of the firm's common stock. Shareholder wealth is calculated as the number of common shares outstanding times the market price per share (the price at which the firm's common stock trades for in the marketplace such as the New York Stock Exchange).

Profit maximization typically is defined as a more static concept than shareholder wealth maximization. The profit maximization objective does not normally consider the time dimension or the risk dimension in the measurement of profits. Additionally, the definition of profit is ambiguous and subject to accounting manipulation. In contrast, the shareholder wealth maximization objective provides a convenient framework for evaluating both the timing and the risks associated with various investment and financing strategies and relies on cash flows as a measure of returns

Can a company achieve both at the same time?

Yes.

Consider why shareholder wealth is a preferred objective to profit maximization. The goal of shareholder wealth maximization is a long-term goal. Shareholder wealth is a function of all the future returns to the shareholders. Hence, in making decisions that maximize shareholder wealth, management must consider the long-run impact on the firm and not just focus on short-run (i.e. current period) effects. For example, a firm could increase short-run earnings and dividends by eliminating all research and development expenditures. However, this decision would reduce long-run earnings and dividends, and hence shareholder wealth, because the firm would be unable to develop new products to produce and sell.

Can a company still be successful in the long term with one and not the other?

Yes.

Do you know of any companies that use both?

Not off the top of my head.

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Thank you for all your help Captain Forest

[CaptainForest]

Your welcome

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Captain Forest do you have any comments on these questions?

When conducting financial statement analysis, it is important to look for circumstances when positive net income doesn’t necessarily translate into a positive cash flow. Explain how a company can post positive profits, but negative cash flow. If possible, provide a specific example of a company who has done this.

Chose one public traded company and down load their annual report or 10(k) filing. Run 2-3 key ratios to assess their financial condition. Discuss strengths and weaknesses including what you believe are driving these strengths and weaknesses.

[CaptainForest]

When conducting financial statement analysis, it is important to look for circumstances when positive net income doesn’t necessarily translate into a positive cash flow. Explain how a company can post positive profits, but negative cash flow. If possible, provide a specific example of a company who has done this.

How can this happen you ask?

If I make all my sales on credit, I can have a positive Net Income (Sales 100M – Expenses 10M = NI of 90M).

However, my Cash Flow is -10M since I have not received any more to pay for my expenses.

I am not familiar off hand with any company. But all you have to do is to check the financial statements of a company. On their Income Statement, they will have a positive Net Income and on their Statement of Cash Flows, they will have a negative cash flow.

To access all of the financial reports for all publicly traded companies in Canada is: http://www.sedar.com/

Chose one public traded company and down load their annual report or 10(k) filing. Run 2-3 key ratios to assess their financial condition. Discuss strengths and weaknesses including what you believe are driving these strengths and weaknesses.

Try http://www.sedar.com/ for Canadian publicly traded companies.

Some ratios you can use could be current ratio, inventory turnover and debt-to-equity ratio.

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Where a public company which employs high financial leverage. Determine, over time, whether they are successful or not. Discuss why or why they are not successful in employing this leverage.


Discuss specific ways a financial manager can improve both their gross margin and contributions margins to improve shareholder wealth.