What are the objectives of capital budgeting?
Financial theory, in general, rests on the principle that the aim financial management should be to make the most of the present wealth of the firm’s equity shareholders. For a firm whose equity shares are dynamically traded on the stock market, the assets of the equity shareholders is replicated in the market price of the equity shares. Therefore the aim of financial management for such firms should be to maximize the market price of equity shares.
The search of the welfare of equity shareholders is reasonable on the grounds that it donates to a competent allocation of capital in the economy. The bases for allotment of savings in the economy are anticipated return and risk. As equity share prices are based on expected return and risk, hard work to maximize equity share prices would end in an efficient allotment of resources. A different justification may be given for the aim of shareholder wealth maximization. Equity shareholders give the project (risk) capital required to begin a business firm and employ the management of the firm not directly through the board of directors. Therefore it behaves on corporate management to encourage the interests of equity shareholders.
In a case where a public sector firm the equity stock of which, being fully owned by the government, is not traded on the stock market, the goal of financial management should be to maximized and the present value of the stream of equity returns an appropriate discount rate has to be applied. A like observation may be made with respect to other companies whose equity shares are not traded or very poorly traded.
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