Question

Explain how we can reach to the two following criteria using the Fisher's Separation Theorem: 1. A single investment criterion, NPV, is enough for management if shareholder wealth maximization is the goal. (4p) 2. All investors (hence the society) will be better off if they also can trade their preferences on capital markets.(3.5p)

Answer 1

1. In the present case, it has been required to explain that single investment criterion, NPV is enough for management if shareholder wealth maximization is the goal. If the shareholder wealth maximization is the only goal then the capital budgeting technique has been dedicately deployed to determine the financial viability of the proposed projects. In other words, net present value (NPV) evaluates the financial viability of the project by taking into consideration many factors which are incoroporated into the model such as cash flows, discount rate, tenure of the project and many others. As per the fisherman's theorem, objective of the corporation will be the maximization of present worth of irrespective of preference of shareholders. Therefore, using the Fisherman's separation theorem, one could move to net present value (NPV) technique.

2. As per the Fisherman's theorem, the preferences of the shareholders are ignored because the objective of theorem is to maximize the present worth of the organization. In other words, if the actual objective of theorem will be maximized then it is very obvious that shareholder's objective will also be achieved. Therefore, using Fisherman's theorem one could reach the event where whole society will be better off if they can also trade on their preferences on capital markets.