Introduction to Finance

DISCUSSION QUESTION 4
At times, the fi eld of fi nance is criticized for being short-term oriented—managers are 
accused of making decisions based upon the near-time impact on stock price rather than 
the long-term good of the company. Some argue that fi nancial techniques lead to nonsus-
tainable and environmentally unfriendly decisions by a fi rm’s chief offi
cers. Based upon 
what you’ve learned thus far in this and other chapters, are these criticisms fair and 
appropriate? If they are, what tools should managers use to make decisions?
Applying Finance To...
• Institutions and Markets 
Financial institutions and markets play 
an indirect role in the capital budgeting process. The participants in 
the markets use the fl ow of information from the fi rm and its compet-
itors, as well as economic and industry conditions, to evaluate fi rms. 
Their analysis and reactions are seen in the fi rm’s stock price changes 
and bond rating changes. In turn, market return expectations are used 
to determine the discount rate in the NPV calculation. This process 
will be covered in Chapter 18.
• Investments 
Investors, security analysts, and portfolio managers 
are continually evaluating a fi rm’s performance. Investment in pro-
jects likely to return a positive NPV is a sign of forward-thinking 
managers who have shareholder interests at heart. Stock price and 
bond ratings respond favorably to a fi rm’s wealth-maximizing capital 
budgeting and resource allocation decisions.
• Financial Management
A way to operationalize shareholder 
wealth maximization is to identify and select projects expected to 
have positive net present values. Managers must use capital budget-
ing evaluation techniques, adjust project evaluation for risk, and seek 
to invest in projects that enhance shareholder value.
Summary
LO 17.1 
A fi rm’s long-term success depends on its strategy and 
its competitors’ actions. The capital budget allocates funds to dif-
ferent projects, usually long-term, that are primarily used to pur-
chase fi xed assets to help a fi rm build or maintain a competitive 
advantage. Potential projects can arise from a review of the fi rm’s 
mission, objectives, goals, and strategies (MOGS) or a SWOT 
(strengths, weaknesses, opportunities, threats) analysis by manage-
ment. Attractive capital budgeting projects usually arise from one 
or more of the following sources of a fi rm’s competitive advantage: 
economies of scale, product diff erentiation, absolute cost advant-
ages, diff erences in access to distribution channels, or government 
policy that favors one group of fi rms over another (or over new 
entrants).