Finance concepts are the basic principles that help us understand the common practices in finance as well as unique and uncommon difficult situations. In the context of the Guillermo scenario, the following finance principles and concepts can be identified:
The Principle of Two-Sided Transactions
The principle of Two-Sided Transactions recognizes that every transaction, the accounting system always records a debit and a credit, and that there is a party on each side of the transaction. Application of this principle leads to Total Assets being equal to the sum of Total Liabilities and Equity, as is the case on Guillermo’s financial statements. (Emery, Finnerty, & Stowe, 2007).
The Principle of Self-Interested Behavior
The Principle of Self-Interested Behavior states that, all other factors remaining constant, all parties to a financial transaction would choose the course of action that would be most financially beneficial to themselves. This is because most business interactions are transacted at “arm’s-length”. Getting the most good out of available resources is the primary consideration in such impersonal transactions. (Emery, Finnerty, & Stowe, 2007).
Guillermo Navallez had ready supply of timber and relatively inexpensive Labor for a long time, yet he prized his products at a premium. He was therefore trying to get the most benefit from his products.
The Principle of Incremental Benefits
The Principle of Incremental Benefits says that the value derived from choosing a particular alternative over other alternatives is determined by the unique benefit the decision provides, which can not be found when the other alternatives are chosen. Incremental expected cash flows can be used to quantify such incremental benefits. (Emery, Finnerty, & Stowe, 2007).
From Guillermo’s income statement, net income in the current scenario, under Hi-Tech, and as a broker have been compared, in a bid to determine these incremental benefits.
The Signaling Principle: Actions Convey Information
According to Emery, Finnerty, & Stowe, 2007, The Signaling Principle is another extension of the Principle of Self-Interested Behavior, which addresses the problem of asymmetric information. Assuming self-interested behavior, we can guess at the information or opinions behind the decisions we observe.
The low prices that the foreign competitor charged in the Guillermo scenario indicated that they were producing furniture at a much lower cost.
The Principle of Valuable Ideas
The Principle of Valuable Ideas states that value can be created by new products. It states that people with new ideas can use those ideas to create extraordinary positive value for themselves. The product’s value can further be enhanced by the ability to hold a patent granting the exclusive rights to produce a unique product. (Emery, Finnerty, & Stowe, 2007).
Guillermo sold his furniture at a higher price because of the value added by his patented coating process.
The Behavioral Principle
The Behavioral Principle states that sometimes firms wait to see what their peers are doing so as to learn or copy from them. (Emery, Finnerty, & Stowe, 2007).
This is a direct application of the Signaling Principle, which states that actions convey information, while the Behavioral Principle says, in essence, “Let’s try to use such information.” In the Guillermo scenario for example, most of the firms in the furniture industry were combining to form fewer but bigger firms.
Reference
Emery, D., Finnerty, J., & Stowe, J. (2007). Corporate Financial Management. Prentice Hall: Pearson Education, Inc.