It is true that management need to be concerned with all of „stakeholders‟ in the business. This may mean that managers need to balance „maximisation of shareholders‟ wealth‟ (MSW) with the objectives of others.

It can be argued that the welfare of other stakeholders is not inconsistent with MSW. Normally, unless other stakeholders are getting, at least, a fair deal from the business, this will be at odds with MSW. For example, if suppliers are being treated unfairly by the business, they will seek ways to avoid dealing with the business. This may not be open to them in the short-term, but in the longer-term it probably will be, and this will be to the disadvantage of shareholders.

Once MSW is accepted as the key objective, NPV is the only totally logical approach to business investment decision-making. This is because the NPV is the net increase in wealth caused by the investment.

Investments give rise to various outflows of cash that have the effect of reducing the shareholders‟ wealth and inflows, which have the opposite effect. Were all these flows to occur simultaneously, assessing investments would be simple; net inflows would represent an increase in wealth and net outflows the opposite. In practice, the various cash flows do not occur simultaneously but at various points in time, often at points wide apart. Since investors do not view N1 receivable next year as being as valuable as N1 receivable today, a direct comparison between total inflows and total outflows cannot be made.

Discounting enables the various effects on wealth to be assessed on a common basis. All of the cash flows are converted to their value at the same point in time, normally the present time, and the net effect on wealth assessed. None of the other popular investment appraisal techniques looks specially at wealth.

IRR is the average return on the investment over its lifetime, taking account of the fact that, typically, cash will be flowing into and out of the investment project at various times over its life.

The key weakness of IRR is that it is a rate of return and, as such, it is not directly concerned with wealth. It would always indicate that a large percentage return on a small investment is preferable to a smaller percentage return on a large investment, when it is quite possible for the latter to have a more favourable effect on shareholders‟ wealth. Thus using IRR does not necessarily lead to undertaking investments that make shareholders richer, though it should not make them poorer.

It is fair to say that IRR typically gives the same signals as NPV, so its use will tend to lead to wealth maximising investments, but NPV should always lead to the correct decision if MSW is accepted.

CAPM (capital asset pricing model) is a device for deriving investors‟ required returns from an investment. It says that the expected return is the risk-free rate plus a risk premium. The risk premium depends on the average risk premium for all risky investments and the level of risk of the investment under consideration, relative to the average.

Theory and evidence suggest that investors an only expect a premium relating to systematic risk, i.e. the risk arising from factors that tend to be common, though differentially severe, to most risky investments. Specific risk, because it can be, and in practice is, diversified away, does not attract a risk premium.

It would not be correct to ignore the risk of the particular investment under consideration, but it is logical to ignore the specific risk. Often when using CAPM to derive a discount rate for use with NPV, and average risk premium for businesses engaged exclusively in the activity of the particular investment is used. This is logical because all investments in a particular area of business can be expected to have a similar level of systematic risk.

WACC and CAPM are not in conflict. WACC simply takes account of the required returns of the various providers of a business’s finance. CAPM is a means of deriving the cost of each of these elements. So logically WACC could use CAPM-derived required returns, averaging them according to how important they are, by value, to the business. WACC, if it based on the business’s own data, is an average rate of return for all the business’s activities, some of which will be more risky than others. This may well provide an inappropriate rate for NPV discounting or comparison with the IRR.

In theory (Modigliani and Miller-ignoring taxes) shareholders‟ wealth is not affected by the approach taken to financing the business (equity or debt). Since debt is relatively low risk, lenders expect lower returns than equity holders, but the existence of debt increases the shareholders‟ risk and the net effect on shareholders‟ wealth is nil.

This theory was revised by Modigliani and Miller who said that if account is taken of the fact that interest on debt is tax deductible, increasing amounts of debt reduce the average cost of capital and make shareholders wealthier.

In practice there is a limit to the amount of debt finance a business can take on because high levels of debt expose it to the risk of incurring the costs of financial distress (bankruptcy). In practice there seems to be some level of debt financing that balances the benefits of tax relief against the potential costs of bankruptcy. This will vary from business to business depending on such things as the nature of their commercial activities.

It does not cost anything to retain profit, in the sense of costs of making a share issue. In that sense loan stock issues are relatively cheap and share issues relatively expensive, particularly public issues.

Retained earnings certainly have cost in terms of returns required by the shareholders. These shareholders incur an opportunity cost if their profits are retained instead of being paid to them as dividends. Naturally they expect to be compensated for this cost. Since their funds are being invested in the same business as the original share capital, they expect similar returns.