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Wealth or Value of a business is defined as the market price of the capital invested by shareholders.WEALTH MAXIMIZATION: Wealth maximization is a modern approach to financial management. Wealth is equal to the present value of all future cash flows less the cost. In essence. Wealth of a shareholder maximize when the net worth of a company maximizes. wealth and maximization. It is a superior goal compared to profit maximization as it takes broader arena into consideration. a shareholder holds share in the company /business and his wealth will improve if the share price in the market increases which in turn is a function of net worth. Maximization of profit used to be the main aim of a business and financial management till the concept of wealth maximization came into being. This is because wealth maximization is also known as net worth maximization. Wealth maximization simply means maximization of shareholder¶s wealth. wealth is the net present value of a financial decision. Finance managers are the agents of shareholders and their job is to look after the interest of the shareholders. To be even more meticulous. Both these objectives are well served by wealth maximization as a decision criterion to business. The objective of any shareholder or investor would be good return on their capital and safety of their capital. How to calculate wealth? Wealth is said to be generated by any financial decision if the present value of future cash flows relevant to that decision is greater than the costs incurred to undertake that activity. It is combination of two words viz. .
Where. 2. a new initiative called ³Economic Value Added (EVA)´ is implemented and presented in the annual reports of the companies. Positive and higher EVA would increase the wealth of the shareholders and thereby create value. profit maximization presents a shorter term view as compared to wealth maximization. 4. Secondly. wealth maximization considers the time value of money. Firstly. the future cash flows are discounted at an appropriate discounted rate to represent their present value. Unlike the profits. In the light of modern and improved approach of wealth maximization. 1. . the wealth maximization is based on cash flows and not profits. Higher the uncertainty.Wealth = Present Value of cash inflows ± Cost.+ CFn (1 + K) n Why wealth maximization model is superior to profit maximization? Wealth maximization model is a superior goal because it obviates all the drawbacks of profit maximization as a goal to financial decision. The discounting rate reflects both time and risk. 3. In wealth maximization. Present Value of inflows cash = (1 + K) CF1 + CF1 (1 + K) 2 +«««. Thirdly. Short term profit maximization can be achieved by the managers at the cost of long term sustainability of the business. the wealth maximization criterion considers the risk and uncertainty factor while considering the discounting rate. It is important as we all know that a dollar today and a dollar one year latter do not have the same value. Economic Value Added = Net Profits after tax ± Cost of Capital. Fourthly. cash flows are exact and definite and therefore avoid any ambiguity associated with accounting profits. the discounting rate is higher and vice-versa.
On the other hand. Wealth maximization Profit Maximization Main aim of any kind of economic activity is earning profit. 2. Profit is the measuring techniques to understand the business efficiency of the concern. Ultimate aim of the business concern is earning profit. the financial manager must determine the basic objectives of the financial management.In summary. It leads to maximize the business operation for profit maximization. Hence. it considers all the possible ways to increase the profitability of the concern. maximizes the profit of the concern. . Profit maximization 2. hence. Thus. It is the essential part of the financial manager. Profit maximization consists of the following important features. 1. It is concerned with the duties of the financial managers in the business firm. Financial Management is mainly concerned with the effective funds management in the business. Objectives of Financial Management may be broadly divided into two parts such as: 1. Profit maximization is also the traditional and narrow approach. Profit maximization is also called as cashing per share maximization. A business concern is also functioning mainly for the purpose of earning profit. For financial managers. the wealth maximization as an objective to financial management and other business decisions enables the shareholders achieve their objectives and therefore is superior to profit maximization. WEALTH MAXIMIZATION AS AN OBJECTIVE OF FINANCIAL MANAGEMENT: Effective procurement and efficient use of finance lead to proper utilization of the finance by the business concern. WEALTH MAXIMIZATION AND FINANCIAL MANAGEMENT: Financial management is an integral part of overall management. which aims at. wealth maximization is one of the objectives of the financial management. it is a decision criterion being used for all the decisions. It is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.
(v) Profitability meets the social needs also. . (ii) Profit is the parameter of the business operation.3. Drawbacks of Profit Maximization Profit maximization objective consists of certain drawback also: (i) It is vague: In this objective. (ii) Profit maximization creates immoral practices such as corrupt practice. 4. Unfavourable Arguments for Profit Maximization The following important points are against the objectives of profit maximization: (i) Profit maximization leads to exploiting workers and consumers. It creates some unnecessary opinion regarding earning habits of the business concern. (iii) Profit reduces risk of the business concern. It leads certain differences between the actual cash inflow and net present cash flow during a particular period. Profit is the parameter of measuring the efficiency of the business concern. (iii) Profit maximization objectives leads to inequalities among the sake holders such as customers. Profit maximization objectives help to reduce the risk of the business. Risks may be internal or external which will affect the overall operation of the business concern. Favourable Arguments for Profit Maximization The following important points are in support of the profit maximization objectives of the business concern: (i) Main aim is earning profit. (iii) It ignores risk: Profit maximization does not consider risk of the business concern. profit is not defined precisely or correctly. (ii) It ignores the time value of money: Profit maximization does not consider the time value of money or the net present value of the cash inflow. So it shows the entire position of the business concern. etc. public shareholders. unfair trade practice. etc. suppliers. (iv) Profit is the main source of finance.
it is the indirect name of the profit maximization. (v) The ultimate aim of the wealth maximization objectives is to maximize the profit. Wealth maximization means maximizing the net wealth of the . because it overcomes the limitations of profit maximization. Wealth maximization is also known as value maximization or net present worth maximization. The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern. (iii) Wealth maximization creates ownership-management controversy. It provides extract value of the business concern. which involves latest innovations and improvements in the field of the business concern. (ii) Wealth maximization is nothing. Wealth maximization has been accepted by the finance managers. (v) It ensures the economic interest of the society. (iii) Wealth maximization considers both time and risk of the business concern. Total value detected from the total cost incurred for the business operation. (vi) Wealth maximization can be activated only with the help of the profitable position of the business concern. (ii) Wealth maximization considers the comparison of the value to cost associated with the business concern. (iv) Management alone enjoy certain benefits. This objective is an universally accepted concept in the field of business. it is also profit maximization. Unfavourable Arguments for Wealth Maximization (i) Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities.Wealth Maximization: Wealth maximization is one of the modern approaches. Favourable Arguments for Wealth Maximization (i) Wealth maximization is superior to the profit maximization because the main aim of the business concern under this concept is to improve the value or wealth of the shareholders. (iv) Wealth maximization provides efficient allocation of resources.
An example of Wealth maximization: X LTD is listed company engaged in the business of FMCG (fast moving consumer goods). because it overcomes the limitations of profit maximization. There are some arguments which are superior in wealth maximization: Wealth maximization is based on the concept of cash flows. When the company informs the stock exchange of the conclusion of the meeting of the decision taken the stock market reacts unfavorably with result that the next days¶ closing of quotation was 30% . Wealth Maximization: Wealth maximization has been accepted by the finance managers. WEALTH MAXIMIZATION AS A FUNCTION OF FINANCE: Wealth maximization is one of the goals of financial Management and functions of finance. Wealth maximization means maximizing the net wealth of the company¶s share holders. Wealth maximization is possible only when the company pursues policies that would increase the market value of shares of the company. Wealth maximization is possible only when the company pursues policies that would increase the market value of shares of the company.company¶s share holders. Cash flows are a reality and not based on any subjective interpretation. Listed means the company¶s share are allowed to be traded the officially on the portals of the stock exchange. Take a decision in one of the bond meeting to enter into the business of power generation. It considers time value of money translates cash flows occurring of different periods into a comparable value of cash flows is considered critically in all decisions as it incorporates the risk associated with the cash flow stream. On the other hand there are many subjective elements in the concept of profit maximization. the board of directors of X LTD.
financial objective of a firm. In the course of performing these functions finance manager takes the following decisions: . Functions of finance: Finance functions are closely related to financial decisions. Shareholders¶ wealth maximization is reflected in the market value of the firms¶ shares. The question now is why the market reacted in this manner. When a company creates wealth from a course of action it has initiated the share holders benefit because such a course of action will increase the market value of the company¶s share. Required rate of return is the return that the investors want for making investment in that sector. Experts in financial management have endorsed the view that the goal of financial management of a firm is maximization of economic welfare of its shareholders. The time value factor so translated becomes the required rate of return.maximization of wealth of its shareholders. The functions performed by a finance manager are known of finance functions. Investors in this FMCG Company might have thought that the risk profile of the new business (power) that the company wants to take up is higher compared to the risk profile of the existing FMCG business as X LTD. Goals of financial Management: Goals means . Therefore the risk profile of the company gets translated into a time value factor. There are two versions of the goals of financial management of the firm which are profit maximization and wealth maximization. market value of company¶s share declines. Maximization of economics welfare means . when they want a higher return.less than of the previous day. Any project which generates positive net present value creates wealth to the company. A firm¶s contribution to the society is maximized when it maximizes its value.
all organizations must be innovative. the volume of sales or any other activities should be stepped up. wealth maximizations are primary goal of any firm. Investment decision: Investment decisions are also know as capital budgeting decisions.Policies on utilization of spontaneous finance effectively. Since company¶s range in the capital market have a major impact on its ability to procure funds by issuing securities in the capital markets. Dividend Decisions: Dividend yield is an important of an investor¶s attitude towards the security (stock) in his portfolio management decisions.Policies an receivable management. ELEMENTS OF WEALTH MAXIMIZATION: Increase in Profits: A firm should increase its revenues in order to maximize its value. 3. Innovation demands managerial proactive actions. Dividend policy influences the dividend yield on shares. For this purpose. 4. Projective organizations continuously search for innovative ways of performing the activities of the organization.Formulation of cash management strategies. Liquidity Decision: Liquidity decisions are concerned with working capital management. Innovation is wider in nature. It is a normal practice .Financial decision: To survive and grow. Thus. 2. But dividend decision is a major decision made by a fiancé manager.Formulation of inventory policy. The important element of liquidity decisions are: 1. It is concerned with the day-to-day financial operation that involves current assets and current liabilities. dividend policy. Capital budgeting decisions lead to investment in real assets.
or by pushing an inferior quality into the market. however. the management will have to consider the interest of pure or equity stockholders as the central focus of financial policies. it will have to accept fixed and recurring obligauons. will have to be weighed properly. no gain" . are bound to affect the prospects of a firm rather adversely over a period of time. For permanent progress and sound reputation. However.quick" methods. A firm has to make every effort to reduce cost of capital and launch economy drive in all its operations. Sources of Funds: A firm has to make a judicious choice of funds so that they maximize its value. Minimum Risks: Different types of risks confront a firm. it will have to adopt an approach which is consistent with the goals of financial management in the long-run. The sources of funds are not risk-free. In theory. or. too. the average cost is minimum and the marginal cost and marginal revenue are equal. While keeping the goal of maximization of the value of the firm. to be precise.is a common adage. profits are maximized when a firm is in equilibrium. in the world of business uncertainties. a corporate manager will have to calculate business risks. should be sounded here. Reduction in Cost: Capital and equity funds are factor inputs in production. it will have to increase ownership funds into the corporation. An increase in sales will not necessarily result in a rise in profits unless there is a market for increased supply of goods and unless overhead costs are properly controlled. Long-run Value: The goal of financial management should be to maximize long run value of the firm. financial risks or any other risk that may work to the disadvantage of the firm before embarking on any particular course of action. A firm will have to assess risks involved in each source of funds. At this stage. It may be worthwhile for a firm to maximize profits by pricing its products high. While issuing equity stock. The advantages of leverage. by resorting to cheap and "get-rich. however. .for a firm to formulate and implement all possible plans of expansion and take every opportunity to maximize its profits. "No risk. While issuing debentures and preferred stock. Such tactics. or by ignoring interests of employees. A word of caution.
employees and society at large. Wealth maximization is a clear term. Wealth maximization guide the management in framing consistent strong dividend policy. the present value of cash flow is taken into consideration.Advantages of Wealth Maximization 1. It also leads to confusion in. (Quantitatively). adjustment is made to cover the risk that is associated with the investments. and misinterpretation of financial policy because different yardsticks may be used by different interests in a company. they have created an imbalance which is widely believed to have been instrumental in generating a movement to promote more socially conscious business behaviour. Criticisms of Wealth Maximization The concept of wealth maximization is being criticized on the following grounds: The objective of wealth maximization is not descriptive. 5. Here. The net effect of investment and benefits can be measured clearly. . because. their influence has become more pervasive. As corporations have grown bigger and more powerful. The concept of increasing the wealth of the stockholders differs from one business entity to another. 4. 2. while calculating the Net Present Value at a particular discount rate. to earn maximum returns to the equity holders. The concept of wealth maximization is universally accepted. 3. It considers the concept of time value of money. it takes care of interests of financial institution. owners. Financial management will then have to rise equal to the acceptance of social responsibility of business. The concept of wealth maximization considers the impact of risk factor. Academicians and corporate officers alike have urged the advisability of more socially conscious business management. The present values of cash inflows and outflows helps the management to achieve the overall objectives of a company.
But it is a necessary condition for business success. . In other words. However.Financial management should not only maintain the financial health of a business. To the creditors. employees. which will keep the business liquid and solvent. the aggregate value of the common stock will be maximized. financial management will have to ensure that expectations raised by the corporation are fulfilled with a proper use of several tools at is disposal. If it is properly supported and nurtured by efficient activities at all stages. Wealth maximization is an objective which has to be achieved by those who supply loan capital. The objective finds its place in these segments of the corporate sector.supportive policies. financing. there are various other factors which may support or frustrate financial management by supportive or non. It may. it will positively ensure desired results. In other words. It should try to have a healthy concern which can maintain regular employment under favourable working conditions. Financial management should take into account the enterprise¶s legal obligations to its employees.but should also help to produce a rate of earning which will reward the owners adequately for the use of the capital they have provided. This is achieved when the management of a firm operates efficiently and makes optimal decisions in areas of capital investments. the management must ensure administration. however. society and management. be described as a pre-requisite of a successful business. it should ensure an effective management of finance so that it may bear the desired fruits for the organization. If this is done. The wealth of owners of a firm is maximized by raising the price of the common stock. a good financial management alone cannot guarantee that a business will succeed. though not the only one. although the immediate objectives of Financial Management may be to maintain liquidity and improve profitability. The operating objective for Financial Management is to maximize wealth or the net present worth of a firm. dividends and current assets management. Moreover. Wealth maximization is as important objective as profit maximization.
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