How Do Managers Maximize Share Price?

What types of decisions and proceedings should management take to exploit the stock worth of their firm? First, believe the possible link between stock prices and earnings. Does profit maximization result in supply price maximization?  If so, then a manager can simply deliberate his or her endeavor on the tangible purpose of profit maximization. Investors in the financial markets can then price the company's stock appropriately. To answer this question, we must consider the association and difference between total organization profits and earnings per share (EPS).

For example, assume IBM had 50 million shares wonderful and earned $200 million, or $4 per split.  If you owned 50 shares of the stock, your share of the total proceeds would be $200. Now presume IBM sold another 50 million shares and invested the funds conventional in assets that shaped $50 million of income. Total income would rise to $250 million, but salary per share would refuse from $4 to $250/100  = $2.50. Now your relative share of the firm's salary would be $250, far below the anticipated $400. You (and other current shareholders) would invite what is known as earnings strength, even though entire commercial profits had risen. Therefore, other belongings held constant, this example suggest that if management is paying attention in the wellbeing of its existing shareholders, it should perhaps concentrate on maximize salary per share rather than total commercial profits. If we refer back to our "firm-as-a-pie" analogy, although the pie has grown larger in this example, the new shareholders obtain a disproportionately great piece.

Next, we believe the question of whether maximization of predictable wages per share will always maximize stock- proprietor welfare. Should management also believe other factors in its conclusion? Let's believe the timing of the salary. Presume IBM had one project that would amplify income per share by $0.20 per year for 5 years, or $1 in total. Management would like to contrast this project touching an option project that would have no result on salary for 4 years but would increase salary by $1.25 in the fifth year. Because management must select between these two alternatives, such projects are referred to as equally exclusive. Which project is more valuable for shareholders? In other words, is $0.20 per year for 5 years better or worse than $1.25 in Year 5? The answer depends on which project adds the most to the value of the supply, which in turn depends on the time value of money to investor. Thus, timing is an important reason to deliberate on wealth as measured by the price of the stock rather than on earnings unaccompanied. There- fore, managers need a precise, straightforward method for assessing the crash of time on the worth of the firm's stock price.

Another concern relates to risk connected with investment projects. Assume one project is predictable to increase salary per share by $1, while another is predictable to raise salary by $1.20 per share. Now let's presume that the first project is not very risky. It is predictable that if the project is undertaken, salary will almost positively rise by about $1 per share. However, the other project is considered pretty risky by management and shareholders, so while our best estimate is that salary will increase by $1.20 per share, we must realistically believe and weigh the option that there may be no earnings augment at all, or even a decrease in overall corporate earnings. Depending on how adverse shareholders are to risk, the first scheme might be preferable to the second. Therefore, managers want a method that allows them to evaluate the trade-off precisely between the predictable income  and risks related with alternative  investment decisions.

The risk inherent in compact projected salary per share (EPS) also depends on how the rigid is financed. Many solid go insolvent every year, and the superior the use of debt, the greater the threat of liquidation.  Accordingly, while the use of debt financing may increase projected EPS, debt also increases the riskiness of predictable future salary.  There- fore, managers want to evaluate whether the extra financial risk fashioned for the rigid shareholders by the use of higher level of debt create a satisfactory reward occasion. The augment in EPS may be more than counterbalance by the higher level of risk, or the risk may not be necessary given a small augment in EPS.

If a firm is gainful, management must choose whether it should hold salary and invest them in the rigid or pay dividend to the rigid shareholders. Dividends revisit cash to shareholders, while retentions will augment future profits and thereby generate the opportunity for higher dividends in the future. Shareholders like cash dividends, but they also like the future growth in EPS that results from reinvesting earnings profitably back into the business. A financial manager decides closely how much of the current income to pay out as dividends as different to how much to retain and reinvest-that is called the dividend policy decision. The optimal dividend strategy is the one that maximizes the firm's stock price.

Our discussion thus far suggests that the firm's stock price depends on the following factors:

1. Projected earnings per share

2. Timing of the earnings stream

3. Riskiness of the projected earnings

4. Use of debt

5. Dividend policy

Every important corporate conclusion by management should be evaluate in terms of its consequence on these factors and hence on the price of the firm's stock. For example, suppose General Mills' restaurant division is allowing for developing a new line of eateries.  If management decides to implement this new policy, management first assesses whether it can be probable to increase  EPS. Is there a chance that operating costs will beat estimate, that prices and client patron- age will fall below projection, and that EPS will be summary because the new restaurant line was introduced?  How long will it take for the new restaurant division to show a profit? How should the capital mandatory to finance construction and invest in equipment be raised?  If debt is used, by how much will this amplify General Mills' riskiness?  Should General Mills reduce its current dividend and use the cash thus saved to finance the project, or should it maintain its dividend and finance the added restaurants with external capital? The methods of business finance provide a frame-work that is designed to help manager answer questions like these, plus many more.