Objectives of a Firm. Maximisation of Profits Maximisation of profits ( Milton Friedman) Most common...
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![Page 1: Objectives of a Firm. Maximisation of Profits Maximisation of profits ( Milton Friedman) Most common and theoretically easy Profits indispensable for.](https://reader030.fdocuments.in/reader030/viewer/2022020319/56649f145503460f94c2992f/html5/thumbnails/1.jpg)
Objectives of a Firm
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Maximisation of Profits
Maximisation of profits ( Milton Friedman)• Most common and theoretically easy• Profits indispensable for a firm’s survival • Whatever the stated objective, bottom line is
always important • Achieving other objectives depends on the
firm’s ability to maximise profits• Reliable measure of firm’s efficiency and
future performance
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Maximisation of Profits
• Golden Rule of Profit Maximization
• Profit = TR – TC
• Profit maximizing output is at the point where the gap between TR and TC is maximum
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Maximisation of Profits
• Which measure of profit- gross/ net/ before/ after tax-?
• Time period- current/ next year/ neat 5/10 years?
• If future profit, time value of money
• Impossible to max profits in competitive markets
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Maximisation of Sales Revenue
Baumol’s hypothesis: Managers aim at Maximisation of firm’s total Revenue rather than profits
In competitive markets, sales volume determines market leadership
• Separation of management and ownership- For managers, salary and other earnings are more closely related to sales revenue rather than to profits;
• Measure of performance
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Maximisation of Sales Revenue
• Sales revenue important for financial institutions and banks while financing;
• Data on trends in sales revenue is a readily available indicator of performance;
• Consistently maintaining profits is difficult for managers but increasing sales revenue is feasible
• Growing sales strengthen competitive spirit
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Maximisation of Sales Revenue
• Empirical evidence does not lead to decisive conclusion on Baumol’s hypothesis
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Maximising Firm’s Growth Rate
Marris’ Hypothesis of Maximising Firm’s Growth Rate: When this happens, managers maximise their own utility function as well as that of the owners.
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• Owners(shareholders) aim at maximising profits and market share;
• Managers aim at better salary, job security and growth
• The two sets of aims can be achieved by maximising growth
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• G= GD =GC where GD= f(d,k) & GC= f(r, π)
• GD= Demand for firm’s product where d
• is diversification and k is success rate)
• GC=Growth rate of capital supply
• R is weighted average of 3 financial ratios π is rate of increase of profit
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• The above proposition has the following constraints:
• Um= Utility function for managers
Um= f(Salary, power, status, security)
Uo= Utility function for shareholders
• Uo= f(profit, market share, brand image)
Managers must try to maximise GD and GC
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Maximising Managerial Utility Function
• Williamson’s Hypothesis of Maximising Managerial Utility Function-
• Combination of profit and growth maximisation objectives
• Managers apply their discretionary power to maximise their own utility function
• Includes variables like salary, prestige, power, job security, professional satisfaction
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• Um= f(S, M, ID)
• S= Salary
• M= Managerial emoluments
• ID= power of discretionary investment
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Objectives of a Firm
• Entry Prevention and Risk Avoidance• “Reasonable Profit”- to prevent entry of
competition, project a favourable public image, restraining trade union demands, maintaining customers’ goodwill, to prevent possibility of government take-over
• For public sector, objective is to maximise social gains- for private sector, maximising profits is a strong aim.
• Modern corporations like to pursue multiple objectives.
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• Rothschild’s hypothesis of Long run survival and Market share Goals- Attainment and retention of a constant market share
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Break Even Analysis
• In traditional theory of the firm, the basic objective of the firm is to maximise profits.
• But profit is maximum at a certain level of output and it is difficult to know what would be the profit-maximising output at the outset;
• Even if it is known it can not be achieved at the outset of production;
• In real life, firms begin their activity even at a loss in anticipation of profits in future.
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Break Even Analysis
• Firms can plan better if they know the level of production where cost and revenue break even- the profitable and non-profitable range of production-
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Break Even Point
• Break Even Analysis is a technique used to study the relationship between total costs, total revenue, and total profits and losses over the whole range of stipulated output
• Break Even Point- Point where TR=TC and therefore no profit , no loss position.
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Break Even Point
TFC
TC
TR
Profit
Loss
Output/ Sales
XO
Y
Tot
al R
even
ue/
cost
Break even Point
Variable Cost
Fixed Cost
BB
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Break Even Analysis
Uses of Break-Even Analysis
• The technique gives a preview of profit prospects and is a tool of profit planning. Profit can be forecast if estimates of revenue and cost are available
• It integrates the cost and revenue estimates to ascertain profits and losses associated with different levels of output
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• Effect of change in volume of sales, sale price, and cost of production can be appraised.
• Helps inter-firm comparisons on profitability
• The concept emphasises the importance of capacity utilisation
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Break Even Analysis
Limitations:• Static: Dynamic forces such as changes in prices,
technology, efficiency and capacity are not taken into account
• Can not be applied if cost and price data can not be ascertained beforehand
• Can not be applied where historical data are not relevant for estimating future costs and price.
Despite limitations, useful tool in production planning.
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Determining Break Even Point
Given the following total cost and total revenue functions, find the BEP:TC= 480+10Q and TR= 50Q
BEP=TFC/ (P-AVC)
From the above, we getTFC= 480 AVC= 10 per unit
Since TR=P.Q, P=50
BEP= 480/ (50- 10) =480/40 = 12 units
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Determining Break Even Point
TC= 480+10Q and TR= 50Q
At 12 units TC= 480+(10 *12)= 600
TR= 50* 12 = 600
Thus, TR=TC
Net profit is zero.