Chapter 2 • A framework for financial decision making
Financial decision making has six steps
1 Define objective(s).
2 Identify possible courses of action.
3 Assemble data relevant to the decision.
4 Assess the data and reach a decision.
5 Implement the decision.
6 Monitor the effects of the decision.Objectives
l Various possibilities suggested: for example, maximisation of profit.
l Maximisation of shareholders’ wealth is generally accepted as the key object-
ive because it takes account of returns and risk, and provides a practical
measure.Problems
l Conflicts of interest between shareholders and directors.
l Can lead to costs for shareholders.
l Arise in various contexts in business finance.Financing, investment and separation
l If there is the opportunity to borrow and lend money, investment and financ-
ing decisions can be separated.
l Businesses should invest in all opportunities that have a rate of return higher
than the borrowing/lending rate in order to maximise shareholders’ wealth.
l Personal preferences of individual shareholders are irrelevant to directors
because shareholders can maximise these for themselves.
l The financing method does not affect shareholders’ wealth.
l These assertions are based on simplifying assumptions.Summary
The subject of corporate objectives has been widely dealt with in the literature. Cyert and March
(1963), to which reference was made in the chapter, discusses it at length. Most finance texts
devote some space to it, as do most business economics texts. The article by Pike and Ooi
(1988) to which reference was made in the chapter is worth reading, as is the original article by
Hirshleifer (1958), also referred to in the chapter and reviewed in the appendix. Lumby and
Jones (2003) clearly explain the separation theorem and its formal derivation. A more extensive
treatment of relevant costs is provided in McLaney and Atrill (2008), Chapter 8.