OBJECTIVE of A FIRM

Goals or objectives are missions or basic purposes raison deter of a firms existence. They direct the firms actions. A firm may consider itself a provider of high technology, a builder of electronic base, or a provider of best and cheapest transport services. The firm designs its strategy around such objectives and accordingly, defines its markets, products and technology. To support its strategy, the firm lays down policies in the areas of production, purchase, marketing, technology, finance and so on. Major objectives which a firm might have Profit Maximisation model: This model argues that firms seek to maximize their profits. This is their ultimate goal of survival. There are several approaches to this problem. The total revenue -- total cost method relies on the fact that profit equals revenue minus cost, and the marginal revenue -- marginal cost method is based on the fact that total profit in a perfectly competitive market reaches its maximum point where marginal revenue equals marginal cost. Total Cost-Total Revenue Method

To obtain the profit maximizing output quantity, we start by recognizing that profit is equal to total revenue minus total cost. Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph. Finding the profit-maximizing output is

as simple as finding the output at which profit reaches its maximum. That is represented by output Q in the diagram. There are two graphical ways of determining that Q is optimal. Firstly, we see that the profit curve is at its maximum at this point (A). Secondly, we see that at the point (B) that the tangent on the total cost curve (TC) is parallel to the total revenue curve (TR), the surplus of revenue net of costs (B,C) is the greatest. Because total revenue minus total costs is equal to profit, the line segment C,B is equal in length to the line segment A,Q.Computing the price at which to sell the product requires knowledge of the firm's demand curve. The price at which quantity demanded equals profit-maximizing output is the optimum price to sell the product. Marginal Cost-Marginal Revenue Method

If total revenue and total cost figures are difficult to procure, this method may also be used. For each unit sold, marginal profit equals marginal revenue minus marginal cost. Then, if marginal revenue is greater than marginal cost, marginal profit is positive, and if marginal revenue is less than marginal cost, marginal profit is negative. When marginal revenue equals marginal cost, marginal profit is zero. Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero - or where marginal cost equals marginal revenue. This is because the producer has collected positive profit up until the intersection of MR and MC (where zero profit is collected and any further production will result in negative marginal profit, because MC will be larger than MR). The intersection of marginal revenue (MR) with marginal cost (MC) is shown in the next

diagram as point A. If the industry is competitive (as is assumed in the diagram), the firm faces a demand curve (D) that is identical to its Marginal revenue curve (MR), and this is a horizontal line at a price determined by industry supply and demand. Average total costs are represented by curve ATC. Total economic profits are represented by area P, A, B, C. The optimum quantity (Q) is the same as the optimum quantity (Q) in the first diagram. Wealth Maximisation Model: The theory of corporate finance suggests an alternative financial objective to profit maximisation that can provide a day-to-day focus for management. This theory assumes that managements main job is to maximise the value or wealth of the business. Within this context, management seeks to ensure that investments made by the business earn a return that is satisfactory to shareholders. The wealth which a firm generates for its shareholders can be determined by any one of the following parameters: Cash Value Added (CVA): The difference between the operating cash flow that a company demands and the operating cash flow it generates. Operating cash flow demanded is the cash the company requires to meet its business costs within a given period. Operating cash flow generated is all of the cash that a business generates through sales and investments without any reductions for non-cash expenses such as depreciation, amortization, deferred interest expenses and so on. Businesses must cover their operating costs - otherwise they operate at a deficit or become insolvent. Therefore, the cash value that a business can add to its bottom line is a very important measure of the business's financial solvency and success. A business that adds no cash to its operation on an ongoing basis is suffering. At the same time, however, when a business's CVA is regularly very high, it may have to invest more to continue to grow. Economic Value Added (EVA) It is defined as the value of an activity that is left over after subtracting from it the cost of executing that activity and the cost of having lost the opportunity of investing consumed resources in an alternative activity. In business terms, one could calculate EVA as Income from Operations - rate of interest in sovereign debt, if sovereign debt can be considered an alternative

opportunity to invest working capital and equity. The concept of Economic Profit is closely linked to EVA. However, Economic Profit is not adjusted. Market Value Added (MVA): It is the difference between the current market value of a firm and the capital contributed by investors. If MVA is positive, the firm has added value. If it is negative the firm has destroyed value. The amount of value added needs to be greater than the firm's investors could have achieved investing in the market portfolio, adjusted for the leverage (beta coefficient) of the firm relative to the market. The formula for MVA is: MVA = Market Value of Capital - Capital invested

Economic Profit: A firm is said to be making an economic profit when its revenue exceeds the total opportunity cost of its inputs. It is said to be making an accounting profit if its revenues exceed the total price the firm pays for those inputs.In a single-goods case, economic profit happens when the firm's average cost is less than the price of the product or service at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and the price. Apart from the above two models firms might have the following objectives also: Sales Maximisation Model: This model argues that businesses try to maximise sales or revenues rather than profits. There are several possible motives for such an objective: Grow or sustain market share Ensure survival Discourage competitors (particularly new entrants to a market)

 Build the prestige of the senior management who like to be seen running a large rather than a particularly profitable business Achieve bonuses if these are based on revenues rather than profits Management Discretion Model: In this model, Williamson argues that management act to further their own interests in other words to achieve personal utility rather than to meet the interests of outside investors. Businesses run with this kind of objectives tend to deliver high levels of remuneration to management rather than the highest possible profits. Consensus Model: The consensus model presents a slightly more complicated model of business objectives. In this case, it is argued that a business is an organizational coalition of shareholders, managers, employees and customers each with different objectives. Management therefore try to reach a consensus with these different groups each of which must settle for less than they would otherwise want. Shareholders, therefore have to settle for profits that are less than the theoretical maximum, perhaps to ensure that employees do better. Profit Maximisation vs Wealth Maximisation: The basic purpose for which a business organization runs is maximization of returns for its shareholders. Now, returns to a shareholder can be in two forms viz.; maximization of Earning Per Share (EPS) or maximization of Market Price of Share (MPS). Now, maximization of EPS depends on an increase in companys performance in which companies often take huge amount of risk as MPS is product of EPS and Price Earning Ratio (P/E) of organization which is inversely proportional with risk i.e.; higher the risk lower would be the P/E ratio and lower would be the MPS. Hence, the companies are often unable to determine if they should go for wealth maximization or profit maximization and therefore the question here arises that whether an organization can

achieve both Profit Maximization and Wealth Maximization simultaneously or not. Before answering this question it is important to look into limitations of both these doctrines. Limitations of The Doctrine of Profit Maximization Measuring profit of organizations, in itself is full of ambiguities. For ex. Whether Book profit, Actual profit, Inflation Adjusted Profit is to be taken. Also, there are several ways to compute depreciation. Many companies claim that their sole objective is not profit maximization and they have social objectives to fulfill. For example, when there was increase in steel prices TISCO India announced that it would not increase steel prices for next 6 months since they had a social objective to fulfill and hence when they could have maximized their profit, they did not do the same because of their social objectives. Also, equating performance with profit is against social norms since unscrupulous ways to gain profit can be used by the organizations. Limitations of The Doctrine of Wealth Maximization: Measuring Wealth is more tedious to that of measuring value. For example,Wealth = MP * Number of Shares and MP of shares changes every moment. Wealth maximization concept is always long term concept and it does not take into account of speculations that take benefit of short term change in prices with the help of insider information. Also, Wealth is MP and MP of scrip does not affect the management of company since they aim at good management and better growth prospects hence increasing the P/E ratio and do not take care of EPS or MPS of the company. Now that we have seen that both the doctrines of profit maximization and wealth maximization have inherent limitations in themselves, it can be advised that a company should go for achieving profit maximization in short run and wealth maximization without taking much risk so as to insure that shareholders get both the short term as well as long term returns while the growth of the business organization is also ensured.

Importance of EVA: Economic Value Added (EVA) is considered to be one of the most important indicators of the wealth creation by a company. It is a blossoming model for corporate financial disclosure in India. EVA measures whether the operating profits are enough compared to the total cost of capital employed. It indicates the net wealth created by the production of goods and services during a specified period in a company. An enterprise may survive without profits but its survival is impossible without adding value. EVA is the difference between the net operating profits and opportunity cost of all capital invested in an enterprise. It is an alternative to the turnover based models. It is an estimate of true economic profit or the amount by which earnings fall short of the required minimum rate of return that shareholders and lenders could get by investing in other securities of comparable risk. EVA is a broader financial measure of judging the output of a corporate to the economic growth and development of the nation. The rational behind EVA is that shareholders have an expectation about what to get from the company at the beginning of the period . this is the minimum return that a company must give to its shareholders. But EVA measures what the shareholders get above this minimum. In a nutshell, EVA can be visualized as: 1. A most accurate value based measure of financial performance practically the same as economic profit. 2. A measure indicating the amount of shareholder wealth created or destroyed during each year. 3. A framework for complete financial management and incentive compensation. An organization can perk up EVA by any of the three options: 1. Earn more profit without using more capital. 2. Downsize unprofitable units or divisions. 3. Invest when the return is more than the marginal cost of capital. COMPUTATION OF EVA- different methods. 1. profit after taxes minus the cost of equity( multiplied by the share capital base) 2. net operating profit before interest but after tax minus the weighted average cost of capital(multiplied by the capital employed).

3. profit after interest and tax plus the interest component adjusted for taxes minus( WACC * total capital employed) The proponents of EVA argue that it is superior to other measures for the following reasons: 1. It has a higher correlation with the market value of the firm. 2. Under the traditional financial management system inconsistencies arise among the various parameters. EVA unites all the employees in pursuit of a single goal of creating value which simplifies and eases decision making. 3. EVA provides a broader picture of true profits as it does not consider only the cost of equity but also the cost of borrowed capital. 4. Further, it links the management compensation to the shareholder value in a much refined manner i.e. with EVA bonus targets set every year as a percentage gain in EVA and with no cap on maximum amount of bonus payment. 5. It is also closely linked to NPV.

6. It makes the managers responsible for a measure that they have more control over( the return on capital and the cost of capital) rather than the one that they feel the cannot control( the market price per share) 7. EVA is also gaining popularity because of its impartiality towards stakeholders. 8. Moreover it is influenced by all the decisions that managers have to make like the investment and the dividend decisions.