ENMA 600 Cost Estimation and Financial Analysis

Question 1: Ethics Problem (Source: Gitman, 2006) What does it mean to say that managers should maximize shareholder wealth "subject to ethical constraints"? What ethical considerations might enter into decisions that result in cash flow and stock price effects that are less than they might otherwise have been? Solution: Maximizing shareholder wealth, or the stock price, involves carefully evaluating each decision’s impact on cash flow amount, timing, and risk. However, that statement includes nothing that directly incorporates the ethical aspect of decisions. The phrase “subject to ethical constraints” implies that there are ethical facets of business decisions that may or may not be a significant part of a decision’s cash flow projections. Think of all decisions being sifted through an “ethical funnel”—some decisions are unethical and do not make it through the funnel, while others are ethical and pass through the funnel. Examples of ethical considerations that might enter into decisions include not exaggerating product quality or durability, correcting environmental problems even though regulators or the general public would never know about them, and not exaggerating future cash flow projections in order to get a lower interest rate on a bank loan or bond issue. Each of these examples may decrease the size or delay the timing of cash inflows, or increase the riskiness of future cash flows—thereby reducing the stock price relative to what it could have been had one acted unethically. No doubt you have thought of other examples as well.