Question

-comprenensively ihe requirements being asked for. Cite theories and concepts to justify your discussion. Part I. Financial management introduction (20 points) 1. Discuss fully the factors (a) within the company and (b) within the economy have affected and are likely to affect the degree of variability in the (1) earnings per share (2) dividends per share (3) market price per share of common stock 2. Explain the factors that influence the firm's stock prices. Will profit maximization always result in stock price maximization? Explain

Answer 1

Answer 1

Factors within the economy affect the earnings of a firm

Fundamental analysis is a way that analyse the future dividend and share price of a firm.

There are umpteen factors in the market which influence the share price. These fundamental factors are bound into three cycles. One such cycle is economy. Many fundamental factors are there in this cycle for which changes take place in the earnings of a firm.

1. Degree of completion

If the firm competition sustains in the market a firm is unable to increase its earnings as in the case of monopoly business where competition is low due to small volume of players in the market such type of firm can easily increase its earnings by enhancing its sell price. Therefore, this economic factor can distinguish the earning capacity of the share of the monopoly firm where significant change in the earning per share can be observed comparing to the earnings per share of a competitive firm as in the competitive market the buyers will look for smallest price so any competitive firm is restrained to increase its sell price which makes the difference between the earnings per share of a monopoly firm and a competitive firm.

2. Strength of demand

When the demand of the product produced by a particular firm is high it yields higher earnings per share(EPS) for its shareholders. The demand of a product is understood by the volume of customers who use that product comparing with similar products present in the market. When an alternative product is introduced in the market which is very effective and user friendly and also bearing competitive price it may lead to decrease the existing demand of the product so it will impact the earnings per share of the firm.

3. State of economy

When the economy runs in a full swing generally the growth can be observed for most of the firm. However, when such state is changed the growth of the firm is also affected by such change. Therefore, state of economy shows the direction of growth of the firm which also influence the earnings per share of a firm.

4. Economies of scale

When a firm introduces latest and costly equipment in the production process it may lead to increase the volume of production. although the fixed of the firm getting increased but at the same time a proportionate savings in cost can also be obtained due to higher level of production to meet the requirement of the market. It affects the earnings of the firm and enables to increase the earnings per share.

5. Inflation

The presence of inflation in the market has a considerable impact of the performance of the firm. The business plan cannot be effective when inflation is high in the market and leads to cost escalation and affects the earnings of the firm for which EPS gets affected.

Economic factors that affect dividend per share

1. Growth rate of national income

The rate of growth in an economy is a valid variable for the share investors. There are several parameters by which such growth rate can be measured. The growth rate shows the prosperity of the economy which influences the firm’s performance. In the boom period of the business cycle a firm earns comprehensive profits and generally a firm keeps aside the part of the profit to combat the situation of the recession stage. It influences the dividend income of the shareholders as the real distribution of dividend conflict with expected dividend of the shareholders.

2.Interest rates

It is another economic factor the change of which influences the earnings of a firm. When the interest rate increases which is risk free in the market influences the investors to get the benefit of such rise of the interest amount. Therefore, to prevent the shareholders of the firm dividend amount sought to be increased otherwise the existing shareholders may sell their shares.

3. Infrastructure

The availability of various facilities like power, transportation, affects the performance of the firm and thus the earnings of the firm can increase by virtue of such improved performance the yield of which can also be enjoyed by the dividend holders due to the increase profits of the firm. It increases the dividend per share of the firm.

4. Legal rules

In case of dividend payment the firm has to obey certain norms and conditions so that the capital of the firm remains unaffected. The implication of tax on the earnings of the firm can affect the dividend amount as the tax reduces the earnings of the firm. When such tax rate is changed such change in tax rate impacts the earnings of the firm and thus affect the dividend policy of the firm.

Economic factor affects the market price per share

1. Inflation

The varied rate of inflation affects the market price of a share. when the inflation rate is high it brings erosion in the purchasing power so when the demand falls for low purchase the market price of the share also falls.

2. Government revenue, expenditure and deficits

When government expenditure is more than revenues it creates budget deficits which is responsible to welcome inflation in the market for which the market price of the share falls.

3. Exchange rate

The change in exchange rate influences the importer and exporters and such change also affects the market price of the share as the depreciation in dollar price alters the competitive position of the US products in the foreign markets and as a result export increases. It affects the market price of a share.

Factors within the company affect the earnings

1 Quantitative factors

In the income statement the revenues are required to check considering the costs of goods sold of the firm. Control of the merchandise cost is an important factor to increase the net income of the firm.

The inventory calculation is an important tool to determine the right earnings of the firm as devalued inventory may lead to create less amount of profits.

2. Internal information

The internal information of the firm by means of annual reports when produce to the outsiders it influences the mindset of the outsiders in the matter of investment in the firm. When the earnings of the firm is high it attracts the investors to the firm and thus the market value of the firm gets increased which leads to create more revenue earnings in the future.

3 The ratio analysis

Analysing the financial performance of the firm through ratio analysis techniques in the case of earnings per share the profitability related to investment ratios are sought to be checked which express the current financial position of the firm. if the result of the ratios are satisfactory it encourages the outsiders to invest further in the firm thus increases the earnings of the firm.

Factors within the firm affect the dividend per share

1 Trends of profit

By analysing several years performance of the financial report if it is found that the growth of profit of the firm is steady and the earnings are considerably good in that case the shareholders may raise their voice to increase the amount of dividend due to such steady growth of earnings.

2 Repayment of debt

If the debt obligation is high it may affect the dividend policy of the firm to meet such debt obligation.

3 Margin of net profit

When the margin of net profit is high comparing the margin of net profit of the past years it influence the dividend price.

Factors within the firm affect the market price of share

• demand and supply of the market influence the market price of share
• Sentiments of the investors impacts on price of the share in the market
• Bullish trend of market influences the price of share in the market
• Bearish market tends to keep the share price low due to de-growth market condition.

Answer 2

As just from the immediate previous analysis we have found the trend of market price of shares influenced by the several factors prevailed in the market.

profit maximization result in stock price maximization

It is not true as profit maximisation refers higher earnings per share it does not express the high valued stock. It is because the stock price maximization depend on the discounted cash flows of the firm comparing with discounted outflow of cash. It is happened in the case of profit maximization technique.