Chapter 1 Assignment Q1-2 Explain how the valuation model given in Equation 1. 2 could be used to describe the integrated nature of managerial decision making across the functional areas of business. This equation can be used to examine how the expected value maximization model relates to firm’s various functional departments. The marketing department often has primary responsibility for promotion and sales (TR); the production department has primary responsibility for development costs (TC); and the finance department has primary responsibility for acquiring capital and, hence, for the discount factor (i) in the denominator.
These functional areas have lots of important overlaps. The marketing department can help reduce costs for a given level of output by influencing customer order size and timing. The production department can stimulate sales by improve quality. Other departments, such as accounting, HR, transportation and engineering, can provide information and services vital to sales growth and cost control. All the activities can affect the risk of firms and the discount rate used to determine present values.
Thus, all managerial decisions should be analyzed in terms of their effects on value, as expressed in this equation. Q1-3 Describe the effects of each of the following managerial decisions or economic influences on the value of the firm: A. The firm is required to install new equipment to reduce air pollution. New equipment installed will increase the operating cost. And the sales may increase if the customers have positive attitude to firm’s environmental friendly policy. B.
Through heavy expenditures on advertising, the firm’s marketing department increases sales substantially. Heavy expenditure on advertising will increase revenues, cost and the demands of customers, which may influence the discount rate. C. The production department purchases new equipment that lowers manufacturing costs. New equipment that lowers manufacturing costs will reduce the total cost. And the lower price may increase the sales because of the increase of demands. D. The firm raises prices.
Quantity demanded in the short run is unaffected, but in the longer run, unit sales are expected to decline. Higher price will decrease the demands of customers and will influence the revenue. E. The Federal Reserve System takes actions that lower interest rates dramatically. Lower interest rate will reduce the cost and discount rate. F. An expected increase in inflation causes generally higher interest rates, and, hence, the discount rate increases. Higher rate of inflation increases the discount rate and decrease the present value of a constant income stream.
Q1-6 Which concept — the business profit concept or the economic profit concept — provides the more appropriate basis for evaluating business operations? Why? The economic profit concept provides the most appropriate basis for evaluating business operations, because it considers implicit costs of capital into profit formula and is more comprehensive. Even sometime business profit is positive, economic profit could be negative, because economic profit concept takes all additional factors into consideration.