FMF9
Syllabus A. Financial Management Function A2. Financial objectives and corporate strategy

Financial objectives and corporate strategy 1 / 1

Shareholder wealth maximisation (share price)

Maximisation of shareholder wealth is measured by the share price (if the company is listed of course).  This is because the share price is simply the value of all future dividends coming to the shareholders.

However, sometimes a business reports a profit increase and the share price falls due to the manner in which they made the profit. This suggests that that profit is not sufficient as a business objective

Share price could also rise and fall due to potential investment decisions or the fact that a new loan is being taken out or that dividends are to be increased or lowered

Corporate Strategies

Clearly corporate strategies are wider than purely financial, they look at the business as a whole. Once these are set appropriate financial objectives can then be set and measured

Examples include:

  • Return on investment
    Market share
    Growth
    Customer satisfaction
    Quality

Financial Objectives

Examples include:

  1. Profit Maximisation

    Focusing on profits could mean undue risk and short termism. 

    Also there is the problem that profits can be manipulated using financial accounting, unlike cash. 

    So maybe profit maximisation focuses on financial profit too much and not enough on cash generation.

  2. Earnings Per Share Growth

    This still uses earnings (profits) rather than cash unfortunately.

    EPS looks at the amount of profits made in the year for each individual share. 

    Remember it is the ORDINARY shareholders who are interested in EPS. Therefore EPS is:

    (Profit after tax - preference dividends) / Weighted average Ordinary shares

Illustration

  • What is the EPS in each year?

  Last year Current year
Profits before interest and tax 22,300 23,726
Interest 3,000 3,000
Tax 5,790 6,218
Profits after tax 13,510 14,508
Preference dividends 200 200
Number of ordinary shares issued 100,000 100,000

Solution

  • Last year:

    Earnings (13,510 - 200) = 13,310
    EPS = Earnings 13,310 / Shares 100,000 = 13.31p

  • Current year

    Earnings (14,508 - 200) = 14,308
    EPS = Earnings 14,308 / Shares 100,000 = 14.31p