i 6:22 PM Sun 30 Aug 6 Page 18 APPENDIX Why Maximizing Shareholder Value Makes Sense We have suggested that well-functioning financial markets allow different investors to agree on the objective of maximizing value. This idea is sufficiently important that we need to pause and examine it more carefully How Financial Markets Reconcile Preferences for Current vs. Future Consumption Suppose that there are two possible investors with entirely different preferences. Think of A as an ant, who wishes to saye for the future, BEYOND THE PAGE and of G as a grasshopper, who would prefer to spend all his wealth on some ephemeral frolic, taking no heed of tomorrow. Suppose that Foun datio each has a nest egg of exactly $100,000 in cash. G chooses to spend all of it today, while A prefers to invest it in the financial market. If ns of the interest rate is 10%, A would then have 1.10 $100,000 - NPV $110,000 to spend a year from now. Of course, there are many 6:23 PM Sun 30 Aug a 37% ins 1 in a shipwreck, simply assume our life jacket and swim safely to shore. QUESTIONS 1. Maximizing shareholder value Look back to the numerical example graphed in Figure 1A.1 Suppose the interest rate is 20%. What would the ant (A) and grasshopper (G) do if they both start with $100,000? Would they invest in their friend's business? Would they borrow or lend? How much and when would each consume? 2. Maximizing shareholder value Answer this question by drawing graphs like Figure 14.1. Casper Milktoast has $200,000 on hand to support consumption in periods 0 (now) and 1 (next year). He wants to consume exactly the same amount in each period. The interest rate is 8%. There is no risk a. How much should he invest, and how much can he consume in each period? b. Suppose Casper is given an opportunity to invest up to $200,000 at 10% risk-free the interest rate stays at 8%. What should he do, and how much can he consume in cach period