What are the differences between accounting and economic definition of profit?
An accounting profit is the business income surplus more than the business expenses. A business makes money after it sells its goods or services. When the money made is more than the money they spend when making the goods and services, then it is said that that business has made an accounting profit. When the total cost is deducted from the total income made by a business, in case the remaining amount is positive then it is regarded as accounting profit. An accounting profit is therefore the excess of accounting income over accounting expenses.Accounting Profit = Total Income – Total Expenses
Economic profit includes opportunity cost of the firm that is used for production. The opportunity costs are the implicit costs. whenever a firm’s total revenue surpass all its economic costs both implicit and explicit the remaining goes to the entrepreneur is known as economic or pure profit. Economic profit is calculated as total revenue less all opportunity lost costs (explicit & implicit) (Copeland& Shastri, 2004).
Economic Profit = Total Income – Total Expenses – Opportunity Lost Cost
When one compares accounting profit and economic profit of an investment, it is clear that an economic profit in the at the end will quite often be less than the accounting profit, since the additional deliberation of opportunity lost cost. However, the other investment makes a loss.
From an economic perspective which capital budgeting technique is the only one that is consistent with maximizing shareholders wealth?
In an economic view, the appropriate capital budgeting technique that is responsible for maximizing a shareholders wealth is the net present value. When one deducts today’s cash outflow so as to make an investment, the remaining difference can be an increase or decrease in one’s wealth and it is known as net present value (Copeland& Shastri, 2004).
The net present value (NPV) is the current cost of all anticipated cash flows. Therefore one can refer to the net present value as the differentiation between present value of cash inflows and present value of cash outflows.
The NPV method is reliable when it comes to owners’ wealth maximization regardless of capital rationing or mutually exclusive projects.
How do capital markets benefit society?
Capital markets are vital for a society since it allow individuals to borrow funds against their expected future income (endowments). This helps the individuals to yield higher productivity growth in their businesses. The individuals borrow from others who lend surplus current income (endowments) and issue positive interest rates. This creates employment opportunities since there is growth in businesses. Capital markets guides to a competent allocation of resources to investment projects within the society.
What are the differences between CAPM and APT?
The Capital Asset Pricing Model is a unique case of the Arbitrage Pricing Model (APT) such that CAPM uses a single factor known beta as sensitivity to market price changes while the APT has various factors that does not consist of the CAPM beta. CAPM applies on the demand side’ in that it is usually based on the market’s aggregation of individual investors’ effectiveness maximization curves. APT applies on the supply side in that it normally takes account of macroeconomic factors. CAPM regard s only in a single factor while APT regards multi-factors; CAPM depends on the historical data while APT is futuristic; CAPM is more consistent as the probability may fail; CAPM is very simple to calculate while APT is difficult to calculate.
What do you believe are the weaknesses in ‘capital market efficiency’ theory what are its strengths?
Capital market efficiency theory states that market efficiency does not mean having no improbability about the future, but it is an overview of the world which might not constantly hold true, and that the market is basically resourceful for investment reasons for most individuals. The theory states it is not possible to challenge market efficiency. The future prices may not be foretold through past price analysis (Drake, 2002).
Economic Value Added (EVA) is a firm’s estimation of economic profits to be the surplus formed cost of a company’s investor’s essential return. It is calculated as the net profits following taxes deduct capital charge. A company that has a positive EVA is said to have produced wealth while the one with a negative EVA is said to have consumed capital. The key strength of the EVA is that it presents a sign of wealth formation that supports the goals of separation managers to the common business goals. However, its limitations, are viewed when it comes to financial orientation, size differences, short-term orientation and outcome orientation.
How has the role of the CFO changed over the last 25 to 50 years?
The role of the CFO has noticeably changed in the last 25 to 50 years with CFO’s moving from the occupation of reporting outcomes to being active in the operations in order to comprehend the financial impact of decisions. In addition, holistic financial and solid strategy takes into account market conditions and potential risks in the long term. Observance of the highest standards of internal and governance controls has become a critical aspect of a CFO’s role (Drake, 2002).
Copeland, T& K. Shastri (2004). FINANCIAL THEORY AND CORPORATE POLICY, FOURTH EDITION (4th Ed.). United States: Paper back
Drake, P., & Fabozzi, F. (2002). Capital budgeting: Theory and practice. New York, NY: Wiley