Ican 2025 Strategic Financial Management Question 7

You recently had a conversation with one Director of a client company. He shared: ‘Over the weekend I was reading an article on finance in a Sunday newspaper. It said that as shareholder wealth maximisation is the generally accepted corporate objective, net present value is the most logical approach to investment appraisal’. It then went on to say that “the ‘capital asset pricing model’ is the best way to find the appropriate discount rate to use. This is apparent because you can use the average rate of return from other businesses, also it ignores the specific risk of the investment concerned.” This all seems nonsense to me. These days corporate management needs to be concerned with more than just the shareholders. What about all of the other groups who contribute to the business? They cannot be ignored. Even if shareholders’ wealth were the key issue, I do not see how NPV fits in. Surely internal rate of return is more to the point because it favours investments that get the best returns and cover financing costs. Those investments will make the shareholders richer. As for CAPM, it seems to defy all logic. It cannot be correct to ignore the returns that the investing business seeks and just concentrate on other businesses. In our business we compare weighted average cost of capital with the IRR and this seems more logical than using CAPM.’ The Director went on to say: ‘The article also said that, in theory, it does not make any difference to the shareholders whether new finance is raised from a share issue or a loan stock issue as they both cost the same. We raise all of our new finance from retained earnings, which does not cost anything, but loan finance has a cost.