ST.

VINCENT COLLEGE OF CABUYAO

Brgy. Mamatid, City of Cabuyao
Laguna 4025

Assignment #2 – Chapter 2 Relationship of Financial Objectives to Organizational Strategy and other Organization Objectives
I. Questions
1. Suppose you were the financial manager of a non-for-profit business (a not-for-profit hospital). What kinds of goals
do you think would be appropriate?

Non-profit organizations frequently pursue social or missions, so many different goals are conceivable. One
goal that is often cited is providing whatever goods and services are offered at the lowest possible cost to society.
A better approach might be to observe that even a not-for-profit business has equity thus, an appropriate goal is to
maximize the value of the equity next to promoting a welfare for less fortunate or in-need.

2. Evaluate the following statement: Managers should not focus on the current stock value because doing so will lead
to an overemphasis on short-term profits at the expense of long term profits.

The current stock value presumes the potential, risk, timing and benefits of all future cash flows, both short-
term and long-term. If this what I said is correct, then the statement is false.

3. If a company’s board of directors wants management to maximize shareholder’s wealth, should the CEO’s
compensation be set as fixed amount or should the compensation depend on how well the firm performs? If it is to
be based on performance, how should the performance be measured? Would it be easier to measure performance
by the growth rate in reported profits or the growth rate in the stock’s intrinsic value? Which would be better
performance measure? Why?

Board of directors should compensate the CEO based on his performance as he would be goal-driven and
motivated to continue working hard because he might be rewarded for making the price per share higher. If the
intrinsic value could be measured in an objective and possible manner, then performance pay could be based on
changes in intrinsic value. However, it is easier to measure the growth rate in reported profits than the intrinsic
value as it has already shown data, although reported profits can be manipulated through aggressive accounting
procedures or fraud and intrinsic value cannot be manipulated. Since intrinsic value is not observable,
compensation must be based on the stock’s market price—but the price used should be an average over time rather
than on a specific date

4. Should stockholders’ wealth maximization be thought of as a long-term or short-term goal? For example, if one
action increases a firm’s stock price from a current level of P1,000 to P2,000 in 6 months and then to P3,000 in 5
years but another action keeps the stock at P1,000 for several years but then increase to P4,000 in 5 years, which
action would be better? Think of some specific corporate actions that have these general tendencies.

Stockholder wealth maximization is a long-term goal. Companies, and consequently the stockholders,
prosper by management making decisions that will produce long-term earnings increases.
 A prime example is the auto industry, which has been accused of continuing to build large “gas guzzler” automobiles
because they had higher profit margins rather than retooling for smaller, more fuel-efficient models.

5. What are some actions that stockholders can take to ensure that management’s and stockholder’s interests are
aligned?

To keep the stockholder and management aligned, motivational tools that will aid in aligning stockholders’
and management’s interests include: : (1) reasonable compensation packages, (2) direct intervention by
shareholders, including firing managers who don’t perform well, and (3) the threat of takeover.
compensation package should be sufficient to attract and retain able managers but not go beyond what is needed.
Stockholders can intervene directly with managers to make them feel involved and informed.

6. The president of Southern Tagalog Corporation (STC) made this statement in the company’s annual report: “STCs
primary goal is to increase the value of our common stockholder’s equity”. Later in the report, the following
announcements were made:

a. The company contributed P1.5 million to the symphony orchestra.

This could be taken negatively by stockholders as this could decrease stock price if competing firms are not
making similar contributions.

b. The company is spending P500 million to open a new plant and expand operations. No profits will be produced
by the operations for 4 years, so earnings will be depressed during this period versus what they would have
been had the decision been made not to expand.
Assuming that correct budgeting analysis has made, the decision should be agreed to because the
situation is an investing event which creates future cash flows.

c. The company holds about half of its assets in the form of government treasury bonds, and it keeps this fund
available for use in emergencies. In the future, though, STC plans to shift its emergency funds from treasury
bonds to common stocks.

Treasury bonds are a lot safe than common stocks, since stock returns are not guaranteed, and the firm’s
stock price might fall when emergency arises and funds are used at that moment.
Discuss how STC’s stockholders might view each of these actions and how the actions might affect the stock price.
7. Miguel Enterprise recently made a large investment to upgrade its technology. While these improvements won’t
have much effort on performance in the short run, they are expected to reduce future costs significantly. What effect
will this investment have on Miguel Enterprises’ earnings per share this year? What effect might this investment
have on the company’s intrinsic value and stock price?

Earnings per share in the current year will decline due to the cost of the investment made in the current year
and no significant and visible performance impact and benefit in the short run. However, the company’s stock price
should increase due to the significant cost savings expected in the future which is a good way to earn more.

II. Multiple Choice Questions

1. Which of the following statement is true?
 a. The higher the profit of the firm, the higher the value of the firm is assured of receiving in the market.
b. Social responsibility and profit maximization are synonymous.
c. Maximizing the earnings of the firm is the primary goal of financial management.
d. There are some serious problems with the financial goal of maximizing the earnings of the firm.
2. Corporate social responsibility is
a. Effectively enforced through the controls envisioned by classical economics.
b. The obligation to shareholders to earn a profit.
c. The duty to embrace service to the public interest.
d. The obligation to serve long-term organizational interests.
3. A common argument against corporate involvement in socially responsible behavior is that
a. It encourages government intrusion in decision making.
b. As a legal person, a corporation is accountable for its conduct.
c. It creates goodwill.
d. In a competitive market, such behavior incurs costs that place the company at a disadvantage.
4. Which of the following statements is false?
a. Because socially desirable goals can impede profitability in many instances, managers should not try to operate
under the assumption of wealth maximization.
b. As finance emerged as a new field, much emphasis was placed on mergers and acquisitions.
c. Timing is particularly important consideration in financial decisions.
d. During the 1930s, the government assumed a much greater role in regulating the securities industry.
5. Which of the following statements is false?
a. In the mid-1950s, finance began to change to a more analytical decision oriented approach.
b. Recently, the emphasis of financial management has been on the relationships between risk and returns.
c. Inflation has led to phantom profits and undervalued assets.
d. For as long as satisfactory level of profit is earned, the financial manager need not be concerned with unethical
behavior.