Firm, Value & Wealth Creation

Topic 1b
Goals of the Firms:

Firm, Constraints, solutions & Wealth
Creation
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-1

Some key concepts to take them
forward…
 Economics(& business analysis) studies human behaviour as a relationship

between ends and scarce means

The Nature and Scope of CFM in
Managerial Decision-making
A. What is CFM or Managerial Economics ?
 Managerial economics is the use of economic analysis to
make business decisions involving the best use of an
organization's scarce economic resources.
 Joel Dean and William Baumol, highly respected
economists and industry consultants, defines
managerial economics as:
“the use of economic analysis in the formulation of
business policies ( both tactical or short-term and
strategic or long-term responses) ”……???
Tactical responses are basically through pricing, design and advertising; where as
strategic aspects include introduction of a new product or exploring a new market,
business acquisitions with an eye on capturing market share or enhancing
synergies etc.
Economic Analysis and Managerial Decision-making –
Managerial Decision Problems
Economic&
business
Analysis
Microeconomics Macroeconomics Interna. Eco
Interpretation
Application of Economic Theory and Tools of

Analysis to understand market scenario and solve
Managerial Decision Problems
CFM | Managerial Economics and
Other Business Studies
Marketing mgt. Finance & Risk mgt.
• Demand
• Capital Budgeting
• Price Elasticity
• Break-even Analysis
• Opportunity Cost
CFM | Managerial • Economic Profit /
Economic Value
Economics Added
Management
Managerial Accounting Sciences
• Relevant Cost • Assessment,
Business Strategy explanation and
• Incremental Cost forecasting
• Types of
Analysis Competition • Regression
• Opportunity Cost • Firm’s Structure – Analysis
conduct–
performance
analysis
C. What are the major issues before any economic
and business entity ?

 Firm’s revenues, profitability, competition,
product-pricing, inputs, factor-pricing and the
determinants there of.
 What are the major industrial and market movers.
 What causes ups and down in economic &
business activity at national markets and the
global scale.
 What are the risks and returns in the context of
operations of domestic corporates or Multinational
Enterprises (MNEs). 4-6
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e
D. Major Concerns
Perhaps as a manager you are interested in
understanding the issues which some times dominate
corporate world:
 How changes in policy instruments such as price, quality
and advertising of a firm are likely to affect the demand
for its product.
 How individual investors react to changes in the interest
rates or cost of capital or market prospects for companies?
 What does it mean when the US $ is strong against
INR or weak against Japanese ¥ ?

And its effect on the firm’s sales, profitability and
competitiveness. How you make use of the
E. Company-Industry-Economy Frame-work &
Conclusions
Studies on Corporate Performance have found that
changes in the value of business or stock prices can be
attributed to the following factors
Economy-wide factors : 30 – 35%
Industry factors : 15 – 20%
Company factors : 30 – 35%
Other influences : 15 – 20%

" When the rate of change on the
outside exceeds the rate of change
on the inside, the end is in sight “
 This quote from Jack Welch, formerly CEO of
General Electric, sums-up how firms need to
continuosly monitor the external economic &
business environment to prepare for the
future or become extinct.
 That is because issues of global competition,
economic environment, technological
advances, and population diversity, as well as
the need for professional and organizational
excellence, will become more pronounced,
maintains Edward Barlow, President of
Creating the Future, Inc….Best of Luck.

Case Example : What is a Decision Problem?
Decision Problem : Toyota Motors
Consider Toyota Motors operations in India. Toyota faces

increasing demand for its India manufactured vehicles. It
identifies two possible strategies : S1 and S2 to meet the
growing demand for its LCVs. Strategy S1 represents an
internal expansion of production capacity. Strategy S2
represents the purchase of a surplus plant now owned by
TELCO. The objective of Toyota’s managers is to
maximize the today’s value (present value) of expected
future returns (profits) from the capacity expansion.

This decision problem can be summarized as follows :
Objective function : Maximize ( present value) profit (S1,

S2)
In this, the following decision-rule can be created.
Decision Rule : Choose strategy S1 if profit (S1) > profit

(S2).
Choose strategy S2 if profit (S1) < Profit (S2)

A. What we assume or see normal behavior of a
rational future manager or entrepreneur like
you, a business entity or CEO?
For our analysis the premise is that:

- we have an owner manager/ entrepreneur or
CEO,
- who has a business to manage,
- with the primary and only objective to maximize
economic profit.

B. What is a Firm? - Remarks
Switchinggears: “Theory of the Firm”
Embarking on an analysis of the firm.
Note:
- There are lots of different types of firms.
- There are lots of ways to organize
entrepreneurial activity.
- There are lots of firm objectives.

…. What’s a Business?
 A business is an organization producing goods or services, also called a
firm.
 A business, or firm, is assumed to maximize its profits.
 Examples of businesses: Reliance Industries, Kalyani Steel, Wipro,
General Motors, Microsoft, the Campus Stores, Prayatna & Frost& Fun (a
business within IMT).
 Examples of organizations that are not businesses in this sense: University
system as a whole, Department of Defense, Health, fire protection, public
amenities like public parks, etc.
 Organizations that produce goods and services but are legally prohibited
from using the profit motive are excluded from our formal model of a firm.

C. What’s a Market?
A collection of buyers and sellers organized for the
purpose of exchanging goods and services for money or
in kind(even in todays modern times).
 Markets can be global, national, regional, or local
depending upon the item being bought and sold.
 Company bartering its products..!?

 You have seen, Toyota Brazil

…. What’s a Market?
 Company bartering its products..!?

 You have seen, Toyota Brazil.
 https://www.msn.com/en-in/autos/news/toyota-brazil-now-accepting-corn-soyabean-in-exchange-of-selected-car-models/ar-AAN2JQr
 https://www.overdrive.in/news-cars-auto/toyota-brazil-will-now-barter-a-suv-or-a-pickup-in-exchange-of-soybeans-or-maize/

Discussion Objectives
 To understand the context and constraints under which firms create
Value – Is it ‘constrained optimization’?
 To appreciate the reasons for the very existence of the firm – Why does
a firm exists?.
 To examine the goals of the firm; and nature and role of profits in
today’s free-enterprise market economy.
 To examine the conflict (of interests) between agent(CEO, who
controls, manages) vs. principal(Investors or owners) i.e. agency
problem and wealth creation; and possible remedies in modern Free
Enterprise Economies.
 To introduce Firm and Value: PV, Discount Factor, FV and NPV and to
assess the feasibility of an investment or project – to invest or not ?.

 To introduce firm value and its international context: To integrate PV, Discount
Rate and Discount Factor into valuation model for an enterprise. Extending the
model from a purely domestic firm to a global enterprise to reflect upon the
globalization of production, marketing& distribution and investments in today’s
world. -- It is all about TIME & MONEY !
 Numerical Exercise: Investment in Office Building.
 Case Applications:
 Case-let 1: Amcott Loses $ 3.5 Million; Manager Fired
 Case-let 2: Indian-origin Tech Entrepreneur Arrested in the US over Alleged $45 Million Investment
Fraud, Shweta S, MSN.COM / 2 Jun ’22(course docket);
 2. Hathaway Berkshire – Wealth Maximization
 3. Facebook's CEO Zuckerberg under fire as shareholders are urged to remove him as tech giant’s Board
Chair, 8th May ’19, Fox News.
 4. Uber Chief Travis Kalanick to take indefinite leave

 Video: 1. Warren Buffett - How He Became a Billionaire
 http://www.youtube.com/watch?
v=v_96Mnm0jtk&feature=related
 2. Warren Buffett Speaks to UGA Students
 http://www.youtube.com/watch?v=2a9Lx9J8uSs&feature=related
 Concluding remarks.

1b-1. The context and constraints under
which firms create Value – Is it a
‘constrained optimization’?

Economic& Business Decisions
CONSTRAINTS GOALS & OBJECTIVES
INFORMATION
 Constraints - limitations of time, resources, money, production capacity, regulatory climate,
etc.
 Information - forecasting, causal relationships, expectations, possible retaliation by rivals, etc.
 Policy changes at home(Modi’s Budget 2022) & abroad (President Joe Baden;
geopolitical conflicts- Ukraine-Russia war): Automobile regulations; Sanctions,
Trade wars uncertainty for Managers, says Mckinsey

1b-2. The Firm - Why does an enterprise or
firm Exist?

1b-2. The Firm - Why does a firm Exist?
Why does a firm exist? – Why Entrepreneurship and running an Enterprise is not every one’s cup of tea..? Is it risk-taking behavior?
Think, why PricewaterhouseCoopers(PWC) exists? Tata & Reliance industries exists..?
 a. Ability to think differently & pioneer an idea.
 b.Financial feasibility& ability to take risk and organize . Resources- like land, human capital & physical capital.
 C. To minimize the Frequency of Transactions and Costs – dealing with clients, suppliers, lenders and regulators.Transactions costs, Ronald H Coase “ The nature of the
firm”(1937) ; Nobel Prize in 1991. He suggested that a company compares costs of organizing an activity internally vis-a-vis the costs of using the market system for its business
transactions, say procuring a component.

1b-2. The Firm - Why does a firm Exist?
 PricewaterhouseCoopers(PWC) is a multinational professional services
network with headquarters in London, United Kingdom.
 PwC ranks as the second largest professional services firm in the world
and is one of the Big Four auditors, along with Deloitte, EY and
KPMG.
 The Big Four are the world’s largest consulting firms, accounting for
nearly 40% of the industry's $150 billion global market. PwC, Deloitte,
EY and KPMG are followed by US strategy giants McKinsey &
Company and The Boston Consulting Group.

Why does a firm exist?
– Why Entrepreneurship and Enterprise is not every one’s cup of tea..?
• The trade-off between external transaction costs and the

cost of internal operations – Why does a firm perform
certain functions internally and others through the market?
• E.g.: Why cant IMT-N own and run Food Court or

Xerox Centre?
• D. To manage Uncertainty & RISK-MANAGEMENT

well.

1b-3 .The Goal of the Firm &
Role of Profits in a Market
Economy
 Throughout the text we will assume that the goal of the
firm is to maximize profits.
- profit-maximization assumption
 What is profit - in your business venture?
- Total Revenue(TR) minus Total Cost(TC)

- TR(P*Q) – TC(human capital, materials, physical
capital like building, financial capital(10%) and how
about your risk taking entrepreneurial efforts
used(?)).
1b-4: Nature and Function of Profits: Profit
Maximization
profit = total revenue - total cost
total revenue: product markets

- determined by the level and nature of competition
in your market
total cost: resource markets
- costs are determined by factor market prices and
the firm’s technology or production function

Economic Profits
 Economic profits are the difference between total
revenue and total costs.
 Economic total costs include the opportunity costs
of all inputs to the production process–in particular,
the opportunity costs of the owner’s time and
physical capital (equipment and space).
 Whenever we talk about profit we mean Economic
Profit, now on.

Accounting or Business Profits
 Accounting profits are defined as total sales
revenue (the same as total revenue in the economic
profits definition) minus operating costs (costs of
goods sold + administrative and sales costs for
those who know some accounting).
 Accounting Profits = Sales Revenue - Accounting
or explicit Costs

1b-5: The Goal of the Firm
•Other goals that the firm might pursue:

- Economic Objectives
• market share
• profit margin
• return on investment
• technological advancement
• customer satisfaction
• Shareholder value

The Goal of the Firm
•Other goals that the firm might pursue:

- Non-economic Objectives
• workplace environment
• product quality
• Service to community
• Impact on Environment
Triple-bottom line(TBA) Approach
- Profits; People; and Planet

Goals of the Firm: Triple-bottom line(TBA) Approach
Use of Child Labor - A major concern for corporates
E.g. IKEA Netherlands was in a serious mess when its Indian woolen
rug suppliers used child labor.

Triple-bottom line(TBA) Approach
Unflinching frugality of IKEA founder Ingvar Kamprad, the
enigmatic force behind affordable flat-pack furniture, Euro 40 billion
empire
Ingvar Kamprad Sustainable Resource Use
 The king of flat-pack: Best
known for his seclusive,
penny-pinching personal life,
IKEA founder Ingvar
Kamprad's creativity and
obsession with curtailing
waste greatly influenced the
home furnishing giant’s wide-
ranging sustainability efforts.
(Photo: Inter IKEA Group)

QUICK Quiz(10 minutes): Check-point
 A. Explain how IKEA’s Ingvar Kamprad, Reliance’s
Dhirubai Ambani, Nyka’s Phalguni and other entrepreneurs
affect the PPF curve? And how?
 B. Explain in brief how micro analysis of decision-making
at CEO’s / firm’s level is closely connected with Macro big
picure? How your actions are sharpened to the imminent
reality of US$ 10 Trillion economy(vs. current apprx. US$
3.5 Trillion)? What steps you take in finance, marketing and
operations?
 C. Do you see any logical connection between A& B above?
Yes or no? Explain why?.


Dhirubai Ambani, Nyka’s Phalguni and other
entrepreneurs affect the PPF curve? And how?
 B. Can you comprehend(?) the policy statement when
World Bank says: India Inc., can be a US$ 10 Trillion
economy(vs. current apprx. US$ 3.5 Trillion) without
spending an additional single penny.
 C. Do you see any logical connection between A& B
above? Yes or no? Explain why?.

Dhirubai Ambani, Nyka’s Phalguni and other entrepreneurs
affect the PPF curve? And how?
 B. Can you comprehend(?) the McKinsey observation:
that India needs to invest 40% its GDP in physical capital
to grow at 10-12%, just to accommodate increasing inflow
of workforce into job market. But we are able to do it only
32%(28% domestic+4-5% FDI). What are the implications
to India’s PPF?
 C. Do you see any logical connection between A& B
above? Yes or no? Explain why?.

….Sustainable solutions
 Bengaluru startup TrashCon is reinventing waste
management | Channeliam.com
https://www.youtube.com/watch?v=cXtFJMsO5lM
 TrashCon with United Nations Dy Secretary-
General,6,059 views,Sep 16, 2019
https://www.youtube.com/watch?v=F9Wky4x0Ks8

NOTES
 IKEA is a Swedish-founded multinational group that designs and sells ready-to-assemble

furniture, kitchen appliances and home products, among other useful goods and occasionally
home services. It has been the world's largest furniture retailer since at least 2008.
 It was founded in Sweden in 1943 by 17-year-old carpenter Ingvar Kamprad, who was
listed by Forbes in 2015 as one of the ten richest people in the world, worth more than
$40 billion.
 The company's name is an acronym that consists of Kamprad's initials with those of
Elmtaryd, and Agunnaryd.

 NOTES
The Goal of the

Firm
 Triple bottom line (TBL) is a concept which seeks to broaden the focus on the financial
bottom line by businesses to include social and environmental responsibilities. A triple
bottom line measures a company's degree of social responsibility, its economic value, and its
environmental impact.
 TBL framework allows companies to evaluate their performance in a broader perspective to
create greater business value.

 NOTES
The Goal
 Profits?;
ofOrthe
People? Planet?
Firm
 SOCIAL/ PEAPLE: Nestlé's Maggi Noodles crisis in 2015 emerged as one of the biggest public relation hurdles for Nestle India, which
came under fire after laboratory tests found the popular two-minute instant noodles were unsafe and hazardous for human consumption.
 PLANET: Vedanta's (Sterlite Copper)controversial 400,000 tonnes per annum copper smelter in city of Tuticorin has been shut since
May 2018, a week after the deadly protests that sought the plant's closure for apparent pollution.

 NOTES
The Goal of the

 Profits?;
Firm
 People? ;
 Planet?; and
 ………….!?
 TATA’s TANISHQ WITHRAWN AD – EKATVAM (Unity)

Commercial.
 https://www.youtube.com/watch?v=jnfxtq7DWwg

From carrying firewood to winning silver at Olympics,
Mirabai Chanu scripts history in Tokyo, 2021
 Just be humble, sincere, keep working smart and most importantly

believe in your abilities…

1b-4 . Agency Problems and Wealth
Creation:
PRINCIPAL-AGENT PROBLEM
How to align Agents(CEOs)
interests vs. Principal(investor)’s
Interests?

Agency Problems: Principal vs.
Agent
Modern corporations allow managers / CEOs
to have no, or limited, ownership participation
in the profitability of the firm.
Shareholders may want profits, but managers
may wish to relax and weigh more short-term
gains.
The shareholders are principals, whereas the
managers are agents.
- Conflicting motivations between these groups
are called agency problems.
The Principal-Agent Problem
- Shareholders (principals) want profit
- Managers (agents) want leisure & security
- The Fall-out and costs associated with such

Problems
- Low profitability, share price decline and Value
destruction
Examples
- Recent period Mittal Steel’s hostile take-over bid for
Arcelor; Elon Musk’s bid for Twitter

Solutions to Agency Problems
 INTERNAL SOLUTIONS:
 (a)Compensation as incentive
 (b)Extending to all workers the provision of equity stock options(ESOPS),
bonuses, and grants of stock
- Help make Board, CEOs, other management team act as owners or entrepreneurs of
firm
 Incentives for Managers to help sustain the company, because that
improves the value of stock options and bonuses.
 Vieroots Wellness Solutions offering positions with the title ‘Entrepreneur’
 Actor Sunil Shetty invests in Vieroots Wellness Solutions
 https://www.youtube.com/watch?v=TSmsnFVHcSM

 INTERNAL SOLUTIONS:
 C. Efforts to monitor management actions such as internal

audits and accounting oversight(overseeing) boards.
 Ex. Satyam Computers; Enron(The crooked ‘E’)&
Anderson; latest being Infrastructure Leasing & Financial
Services(IL&FS) and Deloite&KPMG.

Solutions to Agency Problems…
 External Solutions:
a. Hostile Take-over. See the notes that
follow.
Examples:
Mittal-Arcellor.
Elon Musk’s bid to takeover Twitter.

NOTES
 Hostile takeovers
 A hostile takeover allows a suitor(company trying to takeover) to bypass a target
company's management unwilling to agree to a merger or takeover. A takeover is
considered "hostile" if the target company's board rejects the offer, but the bidder
continues to pursue it, or the bidder makes the offer without informing the target
company's board beforehand.
 A hostile takeover can be conducted in several ways. A tender offer can be made
where the acquiring company makes a public offer at a fixed price above the current
market price. An acquiring company can also engage in a proxy fight, whereby it tries
to persuade enough shareholders, usually a simple majority, to replace the
management with a new one which will approve the takeover. Another method
involves quietly purchasing enough stock on the open market, known as a creeping
tender offer, to effect a change in management. In all of these ways, management
resists the acquisition but it is carried out anyway.

 b. Whistle blowers: Include individuals & voluntary

organizations.
 Examples:
 UBER’s Travis Kalanick vs. Ms. Fowler, ex-employee
of UBER;
 NGOs, Color of Change & Majority Action vs. FB’s
Mark Zuckerberg

 Enforcement Directorate(ED) summons Infrastructure Leasing & Financial

Services(IL&FS)’ auditors, Deloitte& KPMG in IL&FS money laundering
case.
 The corporate affairs ministry on Monday filed fresh applications at National

Company Law Tribunal(NCLT) to expel Deloitte Haskins & Sells and BSR
Associates, an arm of KPMG -- who are the auditors of IL&FS.

2b-5 Firm and Its Value
PV, Discount Factor, FV and NPV and

to assess the feasibility of investing your
own money or an investment or project
by your organization

2b-5 Firm and Its Value
“ Time is Money ”
First Principles of Business Finance:
1.A dollar(or rupee) today is worth more than a dollar(or rupee) tomorrow.
2.A safe dollar(or INR) is more valuable than an unsafe one.
3.When company management realizes that it is unlikely that it can create a positive NPV on any
investment project, it is always far-sighted and ethical to return the money to the investors and lenders.
Else, you have situations like…Kingfisher Airlines, IL& FS, Satyam Computers,
Enron…

Maximizing the Wealth
of Stockholders, why ?
 Whether today’s modern corporations are satisficing – i.e.
fulfilling or strive for some satisfactory goals such as sales,
profits, growth, market share – or value maximizing?
 Views the firm from the perspective of a stream of earnings
over time, i.e., a cash flow.
 Must include the concept of the “time value of money.”
- 1st Principles: INR / Dollars earned in the future are

worth less than Rupees / dollars earned today.

of Stockholders
Future cash flows must be “discounted” to
the present.
The discount rate is affected by risk.
Two major types of risk:
•Business or Market Risk

•Financial Risk

of Stockholders
Business risk involves variation in returns due to
the ups and downs of the economy
(macroeconomic and policy factors, Covid-
19)and hence market demand, the industry, and
the firm’s profitability.
All firms face business risk to varying degrees
( Quick quiz: name this type of risk manager!?)
…….look at industries and sectors, keep a watch.

of Stockholders
 Financial Risk concerns the variation in returns that is
induced by leverage.
 Leverage is the proportion of a company financed by
debt.
 The higher the leverage, the greater the potential
fluctuations in stockholder earnings –due to the fact that
the firm has always to repay the debt liability, which
is not the case when the stock is subjected to
depreciation in value.
 Hence, Financial risk is directly related to the degree of
leverage, borrowing.

Maximizing the Wealth of Stockholders
Objectives of the Firm
 Profit maximization
 Shareholder wealth
The value of the firm =V0 (shares outstanding), is the present

value of expected future profits or cash flows or
dividends(D), discounted at the shareholders required rate of
return, ke, ignoring taxes. 
V0 (shares outstanding) = t /(1+ke) t
t-1

of Stockholders
The present price of a firm’s stock should
reflect the discounted value of the expected
future cash flows.
P  (1D1k )  (1Dk2 ) 2  (1Dk3 )3    Dn

(1 k ) n
where P  present price of stock

D  dividends received per year
k  discount rate
n  life of firm in years
Figure 4.1 Value maximization ? The Decision-Making
Process – Infosys and Tata Group during 1990s and
2000s and Beyond…

1. Time value of money…
Here we can invoke a first basic financial principle: A
dollar today is worth more than a dollar tomorrow .
Because…… of interest costs.
The use of money has a cost or value just as other
commodities do. Interest is that cost. As time elapse there
is cost to using money. The sooner money is received the
more valuable it is because it can be invested and re-
invested to earn an interest.

Notes: Time value of money
 The time value of money is the value of money figuring in a given amount of interest
earned over a given amount of time. The time value of money is the central concept in
finance theory.
 For example, $100 of today's money invested for one year and earning 5% interest will be
worth $105 after one year. Therefore, $100 paid now or $105 paid exactly one year from
now both have the same value to the recipient who assumes 5% interest; using time value
of money terminology, $100 invested for one year at 5% interest has a future value of $105.
This notion dates at least to Martín de Azpilcueta (1491–1586) of the School of Salamanca.
 The method also allows the valuation of a likely stream of income in the future, in such a
way that the annual incomes are discounted and then added together, thus providing a
lump-sum "present value" of the entire income stream.
 All of the standard calculations for time value of money derive from the most basic
algebraic expression for the present value of a future sum, "discounted" to the present by an
amount equal to the time value of money. For example, a sum of FV to be received in one
year is discounted (at the rate of interest r) to give a sum of PV at present: PV = FV − r·PV
= FV/(1+r).

B. Present Value and Future Value
Future Value
Amount to which an
investment will grow
after earning interest
Present Value
Value today of a
future cash flow.

Discount Factors and Rates
Discount Rate i - the DISCOUNT RATE - the rate of
return that could be earned on an
Interest rate used investment in the financial markets with a
to compute similar risk.
present values of
future cash flows.
We know that why today’s dollar is more
valuable than tomorrow’s dollar. Then the Discount Factor
present value of a delayed pay-off may be
found by multiplying the pay-off by a Present value of
DISCOUNT FACTOR which is less than
1 ( if the discount factor is more than 1, a a $.1 future
dollar today would be worth less than a payment.
dollar tomorrow, an absurd result you do
not agree with !! ).
Notes:
The term discount rate has two meanings:

 the same as interest rate; the term "discount" does not refer to the
meaning of the word, but to the purpose of using the quantity, such
as computations of present value, e.g. net present value or
discounted cash flow

Future value
 Suppose you invest $100 at 10% for one year. How much
will you have at the end of one year?
0 1 year
 |---------------------------------------|
 $100 $110
 PV
 Interest Rate (10%)
 FV = (100) (1+ 0.1) = $110

Present Value
 Similarly, if you are receiving $100 one year from today, how much is
it worth today?
 0 1 year
 |---------------------------------------------------|
 $90.91 $100
 PV = (100)/(1.10) = 90.91; Discount Rate (10%) FV

 ; Discount rate is opportunity cost of capital.
 Present Value(PV) = Discount factor x C1
 Then what is an NPV?

Future Values
Future Value of $.100 = FV ; and r is

expected pay-off at period t
FV  Rs.100  (1  r )t

Future Values
t
FV  Rs.100  (1  r )
Example - FV
What is the future value of Rs.400,000 if interest is
calculated annually at a rate of 5% for one year?
1
FV  Rs.400, 000  (1  .05)  Rs.420, 000

Present Value
Why a dollar today worth more than a dollar
tomorrow?
A $ today worth more than a $ tomorrow, because the

dollar today can be invested to start earning interest
immediately. This is the first basic guiding principle of
business finance.
 Thus the present value of a delayed pay-off may be found
by multiplying the pay-off by a discount factor which is less
than one(remember if the discount factor were more than 1,
a dollar today would be worth less than a dollar tomorrow).
Suppose, C1 denotes the expected pay-off at period 1(one
year hence), then

This discount factor is the value today of $1 received in
future. It is usually expressed as the reciprocal of 1plus a
rate of return.
Present Value = PV
PV = discount factor  C1
Present Value
Discount Factor = DF = PV of Rs.1
DF  1
(1 r ) t
Discount Factors can be used to compute the present value of

any cash flow.

Valuation of Assets using NPV:
Exercise 1 : Valuing an Office Building.
(Note that figures are in thousands of units ‘000’ and in US $ )
Step 1: Estimated cash flows

Cost of building = C0 = 370(initial outgo)
Sale price in Year 1, end of year = C 1 = 420(FV)
Step 2: Estimate opportunity cost of capital

If equally risky investments in the capital market
offer a return of 5%, then
Cost of capital = r = 5%

Valuation Model for an Enterprise
Domestic Model- Present Value(PV)
n
E CF$, t 
Value = 
t =1 1  k t
E (CF$,t ) = expected cash flows to
be received at the end of period t in $
or Rs.
n = the number of periods into
the future in which cash flows are
received
k Finance,=South-Western
Kirt C. Butler, Multinational theCollege
required
Publishing, rate
3e of return 4-74
Valuation Model for an Enterprise
Additionalinsight regarding the

achievement of shareholder wealth-
maximization goal can be gained by
decomposing the profit concept.

Figure 4.2 Determinants of Firm Value – The Integrative nature of
wealth maximization model.
& inflation expectations

1b-6 Firm value and International Frame-
work
Globalization of production, distribution,

financing and investments

Valuation Model for a Global Enterprise
A global company’s financial decisions

include how much business to conduct in
each country/ market and how much
financing to obtain in each currency.
Its financial decisions determine its exposure

to the international market environment?

Contd

(contd)

Valuation Model for a Global Firm
 Global: Valuing International Cash Flows- PV
m 
n 

E CFj , t  E ER j , t   
 j 1 
Value =   
t =1  1  k  t

 
E (CFj,t ) = expected cash flows denominated in
currency j to be received by the U.S. / Indian
parent at the end of period t
E (ERj,t ) = expected exchange rate at which
currency j can be converted to dollars / Rs at the
end of period t
k = the weighted average cost of capital
of the U.S. / Indian parent company
The cost
Kirt of financing
C. Butler, our operations
Multinational and represents
Finance, South-Western thePublishing,
College average cost
3e of debt and 4-82
The Firm: CFM, Decision Making& Wealth Creation
Consider, India(Q4,2018), Uber, ICICI Bank, Ford, Govt. Regulation

ECONOMIC ANALYSIS AND ECONOMIC, POLITICAL, AND
DECISIONS SOCIAL, REGULATORY
ENVIRONMENT
Unsystematic Risk = 0 Market Risk | Systematic Risk= ?
1. Demand Analysis and 1. Macro-Economic & Business Conditions
Forecasting (Trends, Cycles, and Seasonal Effects)
2. Factor Market Conditions (Capital, Labor,
2. Production and Cost Analysis Land, and Raw Materials)
3. Pricing Analysis 3. Competitors Responses
4. External, Legal, and Regulatory Constraints
4. Capital Expenditure Analysis.

Risk
Cash Flows
Firm Value
(Shareholders’ Wealth)
Shareholder Wealth Maximization:
The International Frame-work and

Conclusions

THANK YOU

Firm, Value & Wealth Creation

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Topic 1b

Goals of the Firms:

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-1

 Economics(& business analysis) studies human behaviour as a relationship

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-2

Managerial Decision Problems

Microeconomics Macroeconomics Interna. Eco

Application of Economic Theory and Tools of

 What does it mean when the US $ is strong against

INR or weak against Japanese ¥ ?

Economy-wide factors : 30 – 35%

Industry factors : 15 – 20%

Company factors : 30 – 35%

Other influences : 15 – 20%

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-8

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-9

Consider Toyota Motors operations in India. Toyota faces

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-10

Objective function : Maximize ( present value) profit (S1,

In this, the following decision-rule can be created.

Decision Rule : Choose strategy S1 if profit (S1) > profit

Choose strategy S2 if profit (S1) < Profit (S2)

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-11

For our analysis the premise is that:

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-12

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-13

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-14

 Company bartering its products..!?

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-15

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-16

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-17

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-18

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-19

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-20

CONSTRAINTS GOALS & OBJECTIVES

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-21

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-22

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-23

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-24

• The trade-off between external transaction costs and the

• E.g.: Why cant IMT-N own and run Food Court or

• D. To manage Uncertainty & RISK-MANAGEMENT

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-25

- Total Revenue(TR) minus Total Cost(TC)

total revenue: product markets

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-27

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-28

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-29

•Other goals that the firm might pursue:

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-30

•Other goals that the firm might pursue:

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-31

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-32

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-33

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-34

 A. Explain how IKEA’s Ingvar Kamprad, Reliance’s

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-35

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-36

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-37

 IKEA is a Swedish-founded multinational group that designs and sells ready-to-assemble

Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e 4-38

The Goal of the