Wealth Maximisation refers to all the efforts put in for maximizing the net present value (i.e. wealth) of any particular course of action which is just the difference between the gross present value of its benefits and the amount of investment required to achieve such benefits.
Wealth Maximisation refers to all
the efforts put in for maximizing the net present value (i.e. wealth) of any
particular course of action which is just the difference between the gross
present value of its benefits and the amount of investment required to achieve
Wealth maximisation principle is
also consistent with the objective of ‘maximising the economic welfare of the
proprietors of the firm’. This, in turn, calls for an all out bid to maximise
the market value of shares of that firm which are held by its owners. As Van
Horne aptly remarks, the market price of the shares of a company (firm) serves
as a performance index or report card of its progress. It indicates how well
management is doing on behalf of its share-holders.
The wealth maximization objective
serves the interests of suppliers of loaned capital, employees, management and
society. This objective not only serves shareholders interests by increasing
the value of holding but also ensures security to lenders also. According to
wealth maximization objective, the primary objective of any business is to
maximize share holders wealth. It implies that maximizing the net present value
of a course of action to shareholders.
According to Solomon, net,
present – value or wealth of a course of action is the difference between the
present value of its benefits and the present value of its costs. The objective
of wealth maximization is an appropriate and operationally feasible criteria
to chose among the alternative financial actions. It provides an unambiguous
measure of what financial management should seek to maximize in making
investment and financing decisions on behalf of shareholders. However, while
pursuing the objective of wealth maximization, all efforts must be employed for
maximizing the current present value of any particular course of action. It
implies that every financial decision should be based on cost – benefit
analysis. The shareholders, who obtained great benefits, would not like a
change in the management. The share’s market price serves as a performance
index. It also reflects the efficiency and efficacy of the management.
The Necessity of a Valuation
Model portend has shown how the attainment of the objective of maximising the
market value of the firm’s shares (i.e. wealth maximisation) requires an appropriate
Valuation model to assess the value of the shares of the firm in Question. The
Financial Manager should realise or at least assume the extent of influence
various factors are capable of wielding upon the market price of his company’s
shares. If not he may, not be able to maximise the value of such shares.
management is concerned with mobilization of financial resources and their
effective utilization towards achieving the organization its goals. Its main
objective is to use funds in such a way that the earnings are maximized.
Financial management provides a framework for selecting a proper course of
action and deciding a viable commercial strategy. A business firm has a number
of objectives. Peter Driven has outlined the possible objectives of a firm as
1. Market standing
4. Economical use of physical and financial resources
5. Increasing the profitability
6. Improved performance
7. Development of worker’s performance and co-operatives
8. Public responsibility
The wealth maximizing criterion
is based on the concept of cash flows generated by the decision rather than
according profit which is the basis of the measurement of benefits in the case
of profit maximization criterion. Measuring benefits in terms of cash flows
avoids the ambiguity associated with accounting profits.
maximisation of present value (or wealth) of a course of action is considered
appropriate operationally flexible goal for financial decision-making in an
organisation. The net present value or wealth can be defined more explicitly in
the following way:
Where A1 and A2 represent the stream of benefits expected to occur if a course of action is adopted. Co is the cost of that action and K is the appropriate discount rate, and W is the Net present worth or wealth which is the difference between the present worth or wealth of the stream of benefits and the initial cost.
The management of an organisation maximises the present value not only for shareholders but for all including employees, customers, suppliers and community at large. This goal for the maximum present value is generally justified on the following grounds:
i. It is consistent with the object of maximising owners’ economic welfare.
ii. It focuses on the long run picture.
iii. It considers risk.
iv. It recognises the value of regular dividend payments.
v. It takes into account time value of money.
vi. It maintains market price of its shares
vii. It seeks growth is sales and earnings.
Maximizing the shareholders’ economic welfare is equivalent to maximizing the utility of their consumption every time. With their wealth maximized, shareholders can afford their cash flows in such a way as to optimize their consumption. From the
shareholders point of view, the wealth created by a company through the actions
is reflected in the market value of the company’s shares.
Tags : Financial Management - Finance – An Introduction
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