In your own words, outline and provide examples of how a company could pursue shareholder wealth maximization in relation to the following concepts 1

1. Capital Structure:

Firstly, Capital Structure describes a firm's finances in terms of the balance between its debts and equity. So, the company chooses adding debt in capital structure. It provides returns to shareholder as well. For higher returns to the shareholder, company will invest more in any easy and profitable project, by using lenders money.

Example: In a company which has some equity in capital structure, say $500 million. They will give $600 million debt in the balance at lower cost than that of equity. And then invest the money in project which gives $100 million to lenders. The remaining $25 million will be available for euity holders in the company.

2. Risk & Return:

Taking a risk can give good returns to the company if the risks are upto a safer level. Beyond that, it may lead to lose all the money invested. So, its a crucial part in wealth maximization.

Example: If a company invests in a risky project which atleast returns 30%, then the probability of the success of the project is around 0.7. Although the project is risky, the company invests in the project. As the project gets a higher rate of success, it leads to the shareholder walth maximization.

3. Cost of Capital:

When there is decrease in the cost of obtaining fund or decrease in the opportunity cost of fund, then there will be increase in present value from any project. This causes shareholder wealth maximization by the Cost of Capital.

Example: If a project A has cost of capital 15% and another project B has cost of capital of 10%. Here, project B with 10% cost of capital will results in shareholder wealth maximization. Because, project A has higher cost of capital when compared to project B.

4. Capital Budgeting:

  Capital budgeting is a process of understanding investments and expenses in order to obtain the higher returns on investment. Choosing a profitable investment also matters in Capital Budgeting. It has several techniques of budgeting like Payback period method, net present value, Accounting Rate of Return etc,.

Example: For 2 projects A and B, A has NPV of $200 million and B has NPV of $150 million. In this project A with higher NPV will give shareholder wealth maximization.

5. Dividends:

A dividend is a share of profits and retained earnings that a company pays out to its shareholders. Higher the dividends, higher the declarations for shareholder.

Example: In a company, the year has came to end with higher returns. Those returns were declared per common share according to the value of investments. Which leads to shareholder wealth maximization.