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Published by afreenmine

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Published by: afreenmine on May 28, 2010
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Why wealth maximization is superior to profit maximization in today’s context?Justify your answer
:-Profit maximization has been considered as the legitimate objective of a firm because profit maximization is based on the cardinal rule of efficiency. Under perfectcompetition allocation of resources shall be based on the goal of profit maximization.A firm’s performance is evaluated in terms of profitability. Investor’s perception of company’s performance can be traced to the goal of profit maximization. But, the goal of profit maximization has been criticized on many accounts.Wealth Maximization has, been accepted by the finance managers, because itovercomes the limitations of profit maximisation. Wealth maximisation means maximizingthe net wealth of the Company’s share holders. Wealth maximisation is possible onlywhen the company pursues policies that would increase the market value of shares of thecompany.
Superiority of Wealth Maximisation over Profit Maximisation
1. It is based on cash flow, not based on accounting profit.2. Through the process of discounting it takes care of the quality of cash flows.Distant cash flows are uncertain. Converting distant uncertain cash flows into comparablevalues at base period facilitates better comparison of projects. There are various ways of dealing with risk associated with cash flows. These risks are adequately consideredwhen present values of cash flows are taken to arrive at the net present value of any project.3. In today’s competitive business scenario corporates play a key role. Incompany form of organization, shareholders own the company but the management of thecompany rests with the board of directors. Directors are elected by shareholders andhence agents of the shareholders. Company management procures funds for expansion and diversification from Capital Markets. In the liberalized set up, the societyexpects corporates to tap the capital markets effectively for their capital requirements.Therefore to keep the investors happy through the performance of value of shares in themarket, management of the company must meet the wealth maximisation criterion.-1-
4. When a firm follows wealth maximisation goal, it achieves maximization of market value of share. When a firm practices wealth maximisation goal, it is possible onlywhen it produces quality goods at low cost. On this account society gains because of thesocietal welfare.5. Maximization of wealth demands on the part of corporates to develop new products or render new services in the most effective and efficient manner. This helps the consumers asit will bring to the market the products and services that consumers need.6. Another notable features of the firms committed to the maximisation of wealthis that to achieve this goal they are forced to render efficient service to their customers withcourtesy. This enhances consumer welfare and hence the benefit to the society.7. From the point of evaluation of performance of listed firms,the most remarkable measure is that of performance of the company in the sharemarket. Every corporate action finds its reflection on the market value of shares of the company. Therefore, shareholders wealth maximization could be considered a superior goal compared to profit maximisation.8. Since listing ensures liquidity to the shares held by the investors, shareholders canreap the benefits arising from the performance of company only when they sell their shares. Therefore, it is clear that maximization of market value of shares will lead tomaximisation of the net wealth of shareholders
Your grandfather is 75 years old. He has total savings of Rs.80,000. He expectsthat he live for another 10 years and will like to spend his savings by then. He places hissavings into a bank account earning 10 per cent annually. He will draw equal amounteach year- the first withdrawal occurring one year from now in such a way that hisaccount balance becomes zero at the end of 10 years. How much will be his annualwithdrawal?Ans
:-Present Value(PV) =80000/-Amount (A) =?Interest Rat e(I) =10% No. of Year(N) =10PVAn = A {1+i)n-1} /{ i(1+i)n}80000=A{1+.10)10 }/{.10(1+.10)10}80000=A{ 1.593742/0.259374}A =80000/ 6.144567A = 13019.63 Yrly
What factors affect financial plan?
Factors Affecting Financial Plan
Nature of the industry
Here, we must consider whether it is a capital intensiveor labour intensive industry. This will have a major impact on the total assets that the firmowns.2.
Size of the Company
The size of the company greatly influences theavailability of funds from different sources. A small company normally finds itdifficult to raise funds from long X Ds X 1000 , term sources at competitive terms.On the other hand, large companies like Reliance enjoy the privilege of obtaining funds bothshort term and long term at attractive rates.3.
Status of the company in the industry
A well established companyenjoying a good market share, for its products normally commands investors’confidence. Such a company can tap the capital market for raising funds in competitive termsfor implementing new projects to exploit the new opportunities emerging from changing business environment.4.
Sources of finance available
Sources of finance could be grouped intodebt and equity. Debt is cheap but risky whereas equity is costly. A firm should aimat optimum capital structure that would achieve the least cost capital structure.A large firm with a diversified product mix may manage higher quantum of debt because the firm may manage higher financial risk with a lower business risk. Selectionof sources of finance is closely linked to the firm’s capacity to manage the risk exposure.5. The Capital structure of a company is influenced by the desire of the existingmanagement (promoters) of the company to retain control over the affairs of the company.The promoters who do not like to lose their grip over the affairs of the company normally obtain extra funds for growth by issuing preference shares and debentures to outsiders.6.
Matching the sources with utilization
The prudent policy of any goodfinancial plan is to match the term of the source with the term of investment. Tofinance fluctuating working capital needs the firm resorts to short terms finance. All fixedassets financed investments are to be financial by long term sources. It is a cardinal principle of financial planning.7.
The financial plan of a company should possess flexibility so as toeffect changes in the composition of capital structure when ever need arises. If thecapital structure of a company is flexible, it will not face any difficulty in changing thesources of funds. This factor has become a significant one today because of theglobalization of capital market.-3-

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