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Sami Byanju Diran Bodenhorn, Goals of Business Finance: The Coincident Profit Hypothesis , The journal of Finance, vol. XIX, no. 1 I. Introduction and summary Since the traditional concept of profit was difficult to apply to investment decisions and wealth maximization, the concept of cash flow was developed associated, with the cash flow theory of stock value. The major properties of this concept of profit that differentiates it from its traditional concept are:a. It can be used in decision ma
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  Sami ByanjuDiran Bodenhorn, Goals of Business Finance: The Coincident Profit Hypothesis , The journalof Finance , vol. XIX, no. 1I.   Introduction and summarySince the traditional concept of profit was difficult to apply to investment decisions and wealthmaximization, the concept of cash flow was developed associated, with the cash flow theory of stock value. The major properties of this concept of profit that differentiates it from itstraditional concept are:-a.   It can be used in decision making within the firm since profit maximization is instockholders' interest.b.   The profit of the firm coincides with the stockholders' income in each period.c.   Past profit can be measured from market values.II.   Cash Flows and Stock ValuationThis section presents the definition of cash flows and a theory of stock pricing based on cashflow analysis. In defining cash flows, distinction between transactions involving goods orservices, financial obligations and cash balances are taken into consideration. The net cashflow in any period is the difference between cash received by the firm from purchasers, debtorsor banks and the cash used by the firm to increase cash balances to pay for goods or services,to pay interest or debt or to lend. Positive cash flow represents cash payment to stockholdersand negative results into cash payment by stockholders i.e new stock subscription. Cash flowtheory says that the value of the stock is the present value of the future net cash flows. Theinvestment decision on stock price is favorable if the present value of the net cash flow ispositive. Similarly, the theory also implies that a decision to undertake investment projects infuture influences the value of stock today. The stock value is entirely based upon future cashflows.III.   The Cash Flow concept of profitIn this section cash flow profit is defined as the increase in the stock value plus the net cashflow of the period. Here the profit is defined in connection with particular period and reflectssome of the activities of the firm during the period. This concept of profit is significantlydifferent from the conventional concept which can be termed as 'earning' rather than profit.Earning of a period is concerned with difference between the sales revenue and cost. Earningsare not influenced by changed expectations about the future whereas profits are. This sectionfurther distinguishes the term pure profit and business profit or income.Pure profit is defined as the difference between actual end of period wealth and expected endof period wealth.Business profit on the other hand is defined as difference between end of period wealth andinitial investment.  IV.   The depreciation problemThis section is concerned with the handling of depreciation. It is shown that depreciationexpenses understate capital costs unless implicit interest is charged on the book value of networth. The inclusion of implicit interest expense on net worth makes the present value of thecosts charged to equity capital in each year minus the debt repayment plus implicit interestequal to the initial investment.V.   The maximization problemIn this section it follows that the correct calculation of capital costs is necessary for decisionmaking. Maximization of earning is not in stockholders interest while the maximization of pureearning is. It further states the present value of the pure earning of a project does not depend onthe depreciation pattern, even though it is charged as an expense in various periods. Thetraditional profit concept cannot be used in decision making unless the implicit interest ischarged as an expense and the decision is independent of the pattern of depreciation, whichconfirms the cash flow analysis.VI.   The timing problemThis section shows that cash flow profit and stockholders' income coincide in every timeperiod, since it is based on the return which the stockholder would get if the firm liquidated asa going concern. Traditional profit is based on the return which the stockholders would get if the firm liquidated its assets.VII.   The measurement problemThe last section points out briefly the advantages of having a profit concept which can bemeasured from market values. As earning maximization is not the in the stockholder's interest,it is not a satisfactory measure of performance. Thus the business profit is the only satisfactorymeasure of performance.
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