Log In Sign Up. Download Free PDF. Jiwan Bhattarai. Download PDF. A short summary of this paper. Question 1 Explain as to how the wealth maximisation objective is superior to the profit maximisation objective.
The maximisation of profit is often considered as an implied objective of a firm. To achieve the aforesaid objective various type of financing decisions may be taken. They even sometime may adopt policies yielding exorbitant profits in short run which may prove to be unhealthy for the growth, survival and overall interests of the firm. The profit of the firm in this case is measured in terms of its total accounting profit available to its shareholders.
It takes into account present and prospective future earnings per share, the timing and risk of these earnings, the dividend policy of the firm and many other factors that bear upon the market price of the stock. The value maximisation objective of a firm is superior to its profit maximisation objective due to following reasons.
The value maximisation objective of a firm considers all future cash flows, dividends, earning per share, risk of a decision etc. A firm that wishes to maximise the shareholders wealth may pay regular dividends whereas a firm with the objective of profit maximisation may refrain from dividend payment to its shareholders. The market price of a share reflects the shareholders expected return, considering the long-term prospects of the firm, reflects the differences in timings of the returns, considers risk and recognizes the importance of distribution of returns.
The profit maximisation can be considered as a part of the wealth maximisation strategy. Question 2 Discuss the conflicts in Profit versus Wealth maximization principle of the firm. It is at best a limited objective. Whereas, on the other hand, wealth maximisation, as an objective, means that the company is using its resources in a good manner.
If the share value is to stay high, the company has to reduce its costs and use the resources properly. If the company follows the goal of wealth maximisation, it means that the company will promote only those policies that will lead to an efficient allocation of resources. With the shift in paradigm it is imperative that the role of Chief Financial Officer CFO changes from a controller to a facilitator.
November Answer The information age has given a fresh perspective on the role financial management and finance managers. With the shift in paradigm it is imperative that the role of Chief Finance Officer CFO changes from a controller to a facilitator. In the emergent role Chief Finance Officer acts as a catalyst to facilitate changes in an environment where the organisation succeeds through self managed teams.
The Chief Finance Officer must transform himself to a front-end organiser and leader who spends more time in networking, analysing the external environment, making strategic decisions, managing and protecting cash flows. In due course, the role of Chief Finance Officer will shift from an operational to a strategic level.
Of course on an operational level the Chief Finance Officer cannot be excused from his backend duties. The knowledge requirements for the evolution of a Chief Finance Officer will extend from being aware about capital productivity and cost of capital to human resources initiatives and competitive environment analysis. Massie, author of The Essentials of Management. Massie said that financial management is a business activity responsible for obtaining and using company funds to achieve effective operations.
The first objective is to ensure that the company has a healthy cash flow. The application of financial management can monitor the amount of income or expenditure. By monitoring, companies can anticipate so that cash flow is not harmful. The implementation of financial management, which is closely related to efforts to improve the efficiency of the use of company funds. You can carry out supervision and eliminate costs that are deemed ineffective and replace them with profitable activities.
Financial management can also be used when you want to achieve goals to achieve higher profits. You can get this condition by doing careful financial planning. Here, the company can adjust the capital composition to balance between equity and debt. The final objective is an effort to assess the level of security in investment activities. Apart from having the stated objectives, there are five functions in the implementation of financial management by the Company, namely:.
When the Company has estimated, the next step is to determine the capital structure. This stage requires an analysis of the ratio of debt to equity in the short or long term.
The next function is the decision to choose the source of company funding. Apart from the equity capital owned by the Company, there are several choices of sources of funding from third parties that the right funding source can obtain. External source options include the issuance of shares, bank or financial institution loans, and debt securities.
Profit maximization simply means the maximizing the income of the firm. Traditionally, a business firm is regarded as an economic entity whose fundamental objective is the maximizing of profit. Profit can be maximized by maximizing the different between total revenue and cost of firm.
A firm earning sound profit is considered that it is achieving its goal. Arguments in favor of profit maximization: a. Understandable: It is simple and straightforward.
Decision Criteria: Decision inside firm is taken on the basis of whether firm is having positive difference between revenue and cost. Incentives to work: Profit is considered as incentives to work. Some corporations are practicing gain sharing between manager, staffs and shareholders on the basis of profit. Measurement of efficiency: Firm is earning profit means; it has managed its input resources efficiently, so that goods or services produced by it are low cost or qualitative in compare to its competitors.
Shortcomings of goal of profit maximization: a. Vague and ambiguous: Profit maximization conveys different meaning to different people. Profit may be long-term or short-term, after tax or before tax, rate of return on capital employed or assets or equity. Which profit is to be maximized is not clear. Ignore the time value of money: It ignores the timing of earning. Earlier realization is greater valuable than later realization of earnings.
Ignore the risk elements: It ignores the consistency of earning pattern. Fluctuation on firm earning creates more risk. It assumes same sizes of profits with different size of risks are equal. Incomplete: Due to the ignoring of time value of money and risk this objective is incomplete. QN3 What are the differences between Profit maximization and Firm Value maximization of goal of firm?
The difference between the stock price maximization and profit maximization are: Profit maximization Wealth maximization 1 Profit maximization represents large 1 Wealth maximization represents highest amount of profits. QN4 Which goal would you like to recommend to a firm stock price maximization or profit maximization? There are two goals of the firm: stock price maximization and profit maximization. Stock price maximization is recommended due to the following reasons: Reasons for recommendations: 1.
The meaning of stock price maximization is clear stock price or wealth: maximization means the maximizing the net present value of a course of action. The net present value of a course of action is the difference between the present value of its benefits and the present value of costs.
A financial action resulting in positive net present value should be accepted and negative present value should be rejected. If net present value maximize, then wealth will be maximized and then stock price. It considers time value of money: maximizing value takes the time value of money into account.
For example, if we could choose between the following two alternatives, we might be indifferent if our emphasis were solely on maximizing earnings. We could reinvest the difference in earnings for Alternative B one period sooner.
It considers the risk element: Funds that are received this year have more value than funds that may be received five years from now.
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