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Background Caledonia Products Essay

c. Why should Caledonia focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project?

Free cash flows are being focused on because it the amount that Caledonia will receive and they will be able to reinvest that amount. Caledonia should analyze the free cash flow so that they are able to see the real amount of value or what the cost may be. The marginal value from the project would be in the incremental cash flow. The earnings would be much less if they were looking at it through the accounting profits. It would be less because of the depreciation would be considered an expense causing a larger expense for Caledonia. Describe factors Caledonia must consider if it were to lease versus buy First Caledonia must figure out if they will have enough cash flow to pay the bill each month. Leasing would give Caledonia the benefit of decreasing costs. The down side of leasing would mean that Caledonia will not be out of the lease until it has been paid off and the company who leased the property will be the owners until that is completed. Buying property means that the item is usually in better condition, better value, and they will own it. Prices are often better when buying than with leasing. Tax expenses may be a downside of owning the property.

b. What does the risk-return trade-off mean?

It is the principle that potential return rises with an increase in risk. Low levels of uncertainty (low risk) are associated with low potential returns, whereas high levels of uncertainty (high risk) are associated with high potential returns. According to the risk-return tradeoff, invested money can render higher profits only if it is subject to the possibility of being lost.

a. What are the differences between the goals of profit maximization and maximization of shareholder wealth? Which goal do you think is more appropriate?

Profit maximization emphasizes the efficient use of capital resources but it does not apply to a specific time frame where profits are to be measured. Firms have to learn to behave rationally in order to increase their profits. Nonetheless, it doesn’t apply the real-world complexities that financial managers have to address in making their decisions. Typically, this is the goal of the firm. On the other hand, maximization of shareholder wealth maximizes of the price of the existing common stocks. This is solely in the best interest of the shareholders because it will provide the most benefit to society.


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