(a) The theory of company finance is based on the assumption that the objective of management is to maximize the market value of a company. To be able to do this, we need to be able to put values on a company and its shares.
Briefly explain three methods that can be used to value a company.
(b) Describe four non-financial objectives that a company might pursue that have the effect of limiting the achievement of the financial objectives.
(c) List three advantages to the management of a company for knowing who their shareholders are.
(a) Methods of valuation
(i) Balance sheet valuation, with assets valued on a going concern basis.
Investors look at a company‟s balance sheet and if retained profits rise every year, the company will be a profitable one. Balance sheet values are not a measure of the market value but retained profits may give an indication of what the company could pay as dividends to the shareholders.
(ii) The valuation of a company on a break-up basis. This method is only of interest when the business is threatened with liquidation or when its management is thinking about selling off individual assets (other than a complete business) to raise cash.
(iii) Market values. This is the value at which buyers and sellers will trade stocks and shares in a company. This is the method of valuation that is relevant to the financial objective of a company. When a company has its shares traded on a recognized stock exchange, the market value of a company will be measured the price at which the shares are currently trading. Shares of unlisted companies are difficult to value even though the financial objective of such companies is to maximize the market value of the company.
(b) Welfare of employees. A company might try to provide good wages and salaries, comfortable and safe working conditions, good training and career development etc.
Welfare of management. Managers will often take decisions to improve their own circumstances. Their decisions have the effect of incurring expenditure and reducing profits.
Welfare of society as a whole. Many companies participate in social and environmental activities which are meant to improve the social welfare of the society as a whole. Such activities incur costs.
Fulfillment of responsibilities towards customers and suppliers.
– Customers will need to be provided with products and services of the standard of quality that they demand. They will also expect the company to be honest and fair in its dealing with them.
– The company needs to maintain relationships with suppliers.
Business ethics e.g no tax evasion, no bribery, fair employment practices and policies.
(c) Management might learn about the shareholders preference for either high dividends or high retained earnings for profits and capital gain.
Recent share price movements can be explained changes in share holdings.
Enables them to know their attitudes towards risks and gearing.