...Profit Maximization and Wealth Maximization are two objectives of Financial Management. Financial Management takes cares for proper utilization of funds, such that it will increase company earnings. Profit Maximization refers to the profit of the firm should be increased while in Wealth Maximization objective of a firm is to maximise its wealth and the value of its shares. There is always a debate regarding which more important. Profit Maximization The basic concept behind profit maximization is to earn a large amount of profit. It is a short term objective of the company (every fiscal cycle). There is no consideration for risks and uncertainty. It acts as measure for operational efficiency of the company. Profit maximization is necessary for growth and survival of the company. Wealth Maximization The goal of wealth maximization is to improve market value of shares. The main focus is on achieving long term objectives. There is consideration for risks and uncertainty. It tends to gain a large market share. It accelerates the growth rate of a company. I cannot say which one is better. Profit is basic requirement for any company. Profit feeds oxygen in the system to take breathe and survive. As we know profit is directly proportional to the risk. Higher the profit, the higher will be the risk. Risk factor can be neglected for a short run (profit maximization) but in long run (wealth maximization) risks or uncertainty cannot be ignored. Shareholders invest in company in hope...
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... In finance, the goal of the firm is always described as "maximization of shareholders' wealth". Profit Maximization - is always used as a goal of the firm in microeconomics. Focus on short term goal to be achieved within a year. It stresses on the efficient use of capital resources. In order to maximize profit, the financial manager will implement actions that would result in maximum profits without considering the consequence of his actions towards the company's future performance. Drawbacks of Profit Maximization - Profit maximization is a short-term concept. - Profit maximization does not consider the timing of returns. - Profit maximization ignores risk. Maximization of Shareholders' Wealth The goal is to maximize the shareholders' wealth for whom it is being operated. It being measured by the share price of the stock, which in turn is based on the timing of returns, the amount of the returns and the risk or uncertainty of the returns. It also means maximizing the total market value of the existing shareholders' common stock. All financial decisions will affect the achievement of this goal. Shareholders' wealth maximization can be achieved by considering the present and potential future earnings per share, timing of returns, dividend policy and other factors that affect the market price of the company's stock. What is Shareholder Wealth Maximization? When business managers try to maximize the wealth of their firm, they are actually trying to increase their stock...
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...2. What are the differences between shareholder wealth maximization and profit maximization? If a firm chooses to pursue the objective of shareholder wealth maximization, does this preclude the use of profit maximization decision-making rules? Explain. The profits maximization refers to how much dollar profit the company make. Unlike the profits maximization, the definition of shareholder wealth maximization states that management should seek to maximize the present value of the expected future returns to the owners of the firm. I think the shareholder wealth maximization can include the profit- maximization model, it consider more than profit maximization model, for example, the shareholder wealth maximization mode consider the timing of return and the risk of the company, it will also consider the profit the company can make. So that we should use the shareholder maximization model for company’s decision making. 6. Explain why management may tend to pursue goals other than shareholder wealth maximization. There are some reasons for the company not use the shareholder wealth maximization for the decision making. First, the shareholder wealth maximization is a long-term goal, it need time to considering, if a company must use a short time to do the decision making, it may not use the shareholder wealth maximization model. Second, if the manager just want to maximize their own bonuses, they normally consider things based on short term goals which may not be to...
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...conflict between owners & management goals? How does the wealth maximization goal take care of those conflicts? In a large corporation stockholders (owners) are not involve in the day to day operation but the managers have the power to make decisions as to how the firms are run. Of-course, the stockholders want the managers to make decisions that are consistent with the goal of wealth maximization. However, managers’ interest can potentially conflict with owners interests. A conflict arises when the managers makes decision that are not in the best interest of the owner. These conflicts are greatest in large corporations with widely dispersed ownership. Wealth maximization goal can take care of those conflicts. Now a day’s wealth maximization is almost universally accepted as an appropriate operational decision criterion for financial management decisions. Its operational features satisfy ambiguity, timing of benefits, quality of benefits these three requirements. There are two arguments in favor of wealth maximization approach: 1. Exactness: The wealth maximization criterion is based on the concept of cash flows generated by the decision rather than accounting profit which is used in profit maximization approach. Measuring benefits in terms of cash flows avoiding the ambiguity associated with accounting profit. 2. The Timing of Benefits and Quality of Benefits: Wealth maximization approach considers both the quality and quantity of benefits....
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...shifting its focus from traditional approach to modern approach. The modern approach focuses on wealth maximization rather than profit maximization. A myopic person or business is mostly concerned about short term benefits. A short term horizon can fulfill objective of earning profit but may not help in creating wealth. For a business, it is not necessary that profit should be the only objective; it may concentrate on various other aspects like increasing sales, capturing more market share etc, which will take care of profitability. So, we can say that profit maximization is a subset of wealth and being a subset, it will facilitate wealth creation. Giving priority to value creation, managers have now shifted from traditional approach to modern approach of financial management that focuses on wealth maximization. This leads to better and true evaluation of business. For e.g., under wealth maximization, more importance is given to cash flows rather than profitability. As it is said that profit is a relative term, it can be a figure in some currency, it can be in percentage etc. Similarly, duration of earning the profit is also important i.e. whether it is earned in short term or long term. In wealth maximization, major emphasizes is on cash flows rather than profit. So, to evaluate various alternatives for decision making, cash flows are taken under consideration. Thus, maximization of wealth approach believes that money has time...
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...What is Shareholders’ Wealth Maximization? Shareholders are individuals who own a share of a firm or an organization by buying stocks of that organization and as a result they are entitled of any financial profit made by any economic activity that generates those profits. Shareholders Wealth Maximization is a modern approach adopted by financial management that aims to increase the wealth of shareholders in a long term process rather than making short term profits. This objective can be achieved by maintaining a relatively high stock market price of the company which will reflect the wealth of its shareholders and affect the company’s behaviors in regards to decision making. As the stock price increases, the wealth of those who hold the stock increases as well and the net value of the company increases as a result. This decision making process takes into consideration any risk factors that might compromise the main objective and for this reason the financial manager must be aware and in full knowledge about the parameters that could affect the stock price. What is profit maximization? Profit maximization is basically the process of identifying the most efficient manners in which the highest net income, or profit, with the resources and market share in hands can be obtained. The major difference between profit maximization and shareholders’ wealth maximization is that the former focuses on relatively high gains in short periods of time that can be gained through, for example;...
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...Wealth maximization is all about How to achieve maximum wealth while minimizing costs and inefficiencies • how to spend and enjoy your wealth without the fear of ever outliving it • how to pass along your wealth to whomever you choose • how to ensure your plan for financial success works under all circumstances Modern Approach is about the idea of wealth maximization. This involves increasing the Earning per share of the shareholders and to maximize the net present worth. Wealth is equal to the difference between gross present worth of some decision or course of action and the investment required to achieve the expected benefits. Gross present worth involves the capitalized value of the expected benefits. This value is discounted a some rate, this rate depends on the certainty or uncertainty factor of the expected benefits. The Wealth Maximization approach is concerned with the amount of cash flow generated by a course of action rather than the profits. Hence we can have; Profit maximization relates to profits *only* while shareholder wealth also involves total company equity, debt ratios, etc. Management could focus on profit maximization over a longer period of time, while the shareholder would rather see stock values and corporate total value increase immediately. If management focused on short-term profit maximization, say at the expense of long term sales revenues, then shareholder wealth (stock price) could actually decrease as a result of the loss of market share...
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...liabilities and stockholders’ equity (right) side of the balance sheet. They answer such questions as how much debt should we have and should the debt be short or long term or should we borrow in foreign currency? The third major question deals with managerial decisions. These decisions are primarily concerned with firm’s policies and day-to-day operating and financial decisions. They answer such questions as how large should the firm be, and how fast should it grow? 2. What are three problems associated with using profit maximization as the goal of the firm? What is shareholder wealth maximization? How does shareholder wealth maximization deal with these three problems? The three problems associated with using profit maximization as the goal of the firm are the following: First, profit maximization is vague. Profit has many different definitions such as accounting profit based on book value or economic profit based on market value. Second, profit maximization...
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...company’s wealth is more suitable than maximizing its profit as a goal of the business, it is because maximizing profits relates to profits only, and it assumes away the problems such as uncertainty of returns and the timing of returns, while maximization of the market value of the owners’ equity has take into all the considerations of all the financial decisions, such as wealth for the long term; risk or uncertainty; the timing of returns; and the stockholders’ return. Maximization of profits is regarded as the most commonly cited goal, always concern with the operational plans, but it is not a suitable objective at all, because there are many alternatives inside this outlined goal, For example, does that mean a short term or long term maximization target? Or what kind of profit is the target focuses on? It is not a fully appropriate objective, partly because it does not specify the timing or duration of expected returns. Is the investment project that will produce $100,000 return 5 years from now more valuable than the project that will produce annual returns of $15,000 in each of the next 5 years? An answer to this question depends upon the time value of money to the firm and to investors at their interest. Another shortcoming of aiming at maximizing profit is that it does not consider the risk or uncertainty in the process of making profits. Some investment projects are more risky but the profit cannot reflect this situation. As a result, the prospective profit would be...
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...business firm have to decide from where they will raise fund, where they will invest and how much of the profit will be distributed among the shareholders. “Finance” Came from Latin word “finis” means “dealing with the money”.finace is called the art and science of managing money. At the micro level, finance is the study of financial planning, asset management and fund raising for business and financial institutions. At the macro level, finance is the study of financial institution and financial markets and how they operate within the financial systems in both the domestic and global economics. Scholar’s view: “Finance consists of providing and utilizing the money, capital rights, credit and funds of any kind which are employed in the operation of an enterprise.” _George R Terry “Finance is concerned with the process, institutionsmarkets and instruments involved in the transfer of money among and between individuals, business and governments”. _Lawrence J Gitman From the above discussion, it can be said that finance is the process of financial planning, identification of sources of fund raising, investment of fund, protection of fund, distribution of profit to achieve the goal of the organization. Question-2: What is business finance? Ans: Generally, finance...
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...Xin Zheng xinzheng@callutheran.edu Chapter 1 2. What are the differences between shareholder wealth maximization and profit maximization? If a firm chooses to pursue the objective of shareholder wealth maximization, does this preclude the use of profit maximization decision-making rules? Explain. Profit maximization means the company makes profit maximize. Maximize shareholder wealth states that management needs to bring maximize the value for its owners by make the most efficient resources and reasonable financial management. Therefore, shareholder wealth maximization include the profit-maximization model, it considers not only profit maximization model, but also the timing of return and the risk of the company. The most important the company will consider how much the profit it can make. Therefore, we should use the shareholder maximization model when company do decision making. 6. Explain why management may tend to pursue goals other than shareholder wealth maximization. When a company has to make a decision in a short time, it will use the profit maximization model. The reason is that the shareholder wealth maximization is a long-term goal; it takes time to consider and analysis. On the other hand, if the manager wants only to maximize bonuses, they will not consider the benefit of shareholders. So they will not consider things by using the shareholder wealth model. 13. Metropolitan Life Insurance Company, Swiss Bank Corporation, and several other holders of RJR...
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...What is Shareholder Wealth Maximization and Should Firms Pursue it? Who owns a business firm? The shareholders. Those individuals who have bought shares of stock, which indicate ownership in the firm. Even if your business is a one-person shop, you are the shareholder. If the business is a huge conglomerate, then it has a Board of Directors made up of the shareholders who own shares of the firm based on how much money they have invested. Because the shareholders own the firm, they are entitled to the profits of the firm. Shareholder wealth is the appropriate goal of a business firm in a capitalist society. In a capitalist society, there is private ownership of goods and services by individuals. Those individuals own the means of production to make money. The profits from the businesses in the economy accrue to the individuals. What is Shareholder Wealth Maximization? When business managers try to maximize the wealth of their firm, they are actually trying to increase their stock price. As the stock price increases, the individual who holds the stock wealth increases. As the stock price goes up, the value of the firm increases and the net worth of the individual who owns the stock increases. What About the Managers of the Firm People often think that the managers of a firm own the firm. In the case of a very small business, that might be true if there is one owner that also manages the firm. Remember, however, that the one owner is a shareholder of the firm. In a larger...
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...Lesson # 1 Financial Management: Introductory Notes and Words Concepts of Finance and Financial Management Financial Management refers to the proper management of finance functions of an enterprise or organization. In other words, financial management is concerned with the financial decision-making and other financial aspects. Thus, financial management involves financial planning, financial organization, financial coordination and control, financial reporting, financial mergers, combinations and acquisitions, insurance and tax management etc. Financial planning is concerned with the act of deciding in advance the financial activities that are essential if the enterprises are to achieve their financial goals and objectives. These financial activities mainly consist of properly estimating financial needs; selecting the proper sources of finances; procuring the requisite funds; proper utilization of the funds and custody and safekeeping of funds. Financial organization is the grouping of the finance functions into various divisions, departments, sections and sub-sections of the enterprises for their proper and efficient performance. That is, financial organization deals with the proper allocation of the finance functions amongst the various financial executives. Financial coordination and control deal with the proper adjustment of the finance function and evaluation of the same in relation to the predetermined standards. Financial reporting is the proper collection and...
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...These costs have taken the form of increased cost of material, labor, and equipment on one hand and lost productivity and market competition on the other. These adverse effects on business have been in direct conflict with the cardinal management objective of maximization of shareholder wealth realistically measured in terms of market value of shareholder equity. Proponent for government regulations to business have argued that shareholder wealth maximization is not realistic and that there should be a balanced attention to all what they call stakeholders interest in which also the providers of risk capital are part. Nevertheless it is true that one cannot maximize interests of all stakeholders simultaneously. There is a need of prioritizing, and it would be in the best interest of all stakeholders to start with maximization of shareholder wealth since it is all-inclusive with positive spread effects to the society as a whole. References: American Law Institute (1994). Principles of corporate governance: Analysis and recommendations. St. Paul, MN: ALI Publishers.V.1, Pt...
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...a modern enterprise? The scope of the financial management is to secure the capital needed by the enterprise, and employ it in production and marketing activities, in such a way that it can generate the sufficient returns on invested capital, with an intention to maximise the wealth of the owners. The financial manager plays the crucial role in the modern enterprise by supporting investment decision, financing decision, and also the profit distribution decision. He/she also helps the firm in balancing cash inflows and cash outflows, and in turn to maintain the liquidity position of the firm. How does the modern financial manager differ from the traditional financial manager? Does the modern financial manager's role differ for the large diversified firm and the small to medium size firm? The traditional financial manager was generally involved in the regular finance activities, e.g., banking operations, record keeping, management of the cash flow on a regular basis, and informing the funds requirements to the top management, etc. But, the role of financial manager has been enhanced in the today's environment; he/she takes an active role in financing, investment, distribution of profits, and liquidity decisions. In addition, he/she is also involved in the custody and safeguarding of financial and physical assets, efficient allocation of funds, etc. The role of financial manager in case of diversified firm is more complicated in comparison with a small and medium...
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