Market capitalization (market cap) is defined as stock price times shares outstanding.

To explore market cap, let’s use an example. Suppose that your team wants to expand the asset base by $40 million.

You begin by answering the question, “What is our financial structure?” You decide upon a Leverage () of 2.0, or 50% debt 50% equity. Therefore, you need $20 million in new equity.

When you look at your projected earnings, you believe you can retain $5 million in profits. It follows you must raise $15 million from the sale of new stock. If the stock price is $30, you must issue $15M/30 = 200 thousand shares.

The implications for other performance measures include:

• Stock price: With more shares outstanding, it will be more difficult to grow EPS and dividends. Therefore stock price will grow more slowly.
• Market share: Depends on the type of investment. Since you can match new debt with the new equity, you can grow the asset base quickly. If used to expand the product line, the company gets big faster than if you use retained earnings alone. However, if the company investmen s are intended to reduce costs (probably via automation) , then market share will stay flat or even fall.
• ROS: Also depends upon the type of investment. Product line expansions tend to hold ROS constant. Productivity improvements improve ROS.
• Asset turnover: Likely falls somewhat. The asset base grows, but depending on the type of investment, sales could stay flat. Either way, there are more assets.
• ROA: Can grow, but because of the larger asset base, will grow slowly at best and could fall.
• ROE: Can grow, but will grow slowly at best.
• Cumulative profits: Grows. The larger asset base produces wealth, but producing it efficiently is not a concern.

At a big picture level, issuing stock quickly raises capital and makes it easier and quicker to achieve strategic goals. Differentiators can introduce new products. Cost leaders can improve productivity more quickly.

Linking Financial Structure and Performance Measures to Strategy and Tactics

Financial structure and performance measures are intertwined. Suppose you were given these performance priorities:

Measure	Weighting
Cumulative Profit	30%
Average Market Share	30%
Average ROS	0%
Average Asset Turnover	0%
Average ROA	0%
Average ROE	0%
Ending Stock Price	0%
Ending Market Cap	40%
Total	100%%

Compared with an average company, how would your tactics be affected?

Invent a new product?	Yes. More products make it easier to achieve high market share.
Reduce price?	Probably, because it would drive up sales, and if we can hold ROS constant, our absolute profit must increase.
Add automation?	Possibly. It could improve profits, and if we drop price, we can increase sales.
Add capacity?	Yes, as needed. We would hope to drive up demand.
Increase promotion and sales budgets?	Yes, to drive up demand.
Abandon a segment to concentrate on a niche position?	No.
Harvest an old product?	Doubtful.
Would you grow the asset base in general?	Yes. A large asset base drives up sales. There are no inhibitions on asset growth in these measures.
Issue stock?	Yes.
Pay dividends?	Perhaps, but you are not powerfully motivated. So long as stock price is maintained, you can raise adequate new equity through stock issues.
Add debt?	Yes.

Over time, the financial structure these measures tend to produce will create a large, relatively inefficient company.The struggle between management and owners varies from company to company. A major factor in the outcome is the degree to which ownership is concentrated. Your situation in the simulation would be comparable to a wholly owned subsidiary or to a company with a very large voting block of conservative stockholders. You cannot do any of the things managers love to do. Instead, you must maximize the present and future wealth of the owners.