Wealth Maximization Objective Is A Wide

Topics: Net present value, Rate of return, Discounted cash flow Pages: 1 (582 words) Published: November 18, 2014
Wealth maximization objective is a widely recognized criterion with which the performance a business enterprise is evaluated. The world wealth refers to the net present worth of the firm. Therefore, wealth maximization is also stated as net present worth. Net present worth is difference between gross present worth and the amount of capital investment required to achieve the benefits. Gross present worth represents the present value of expected cash benefits. Gross present worth represents the present value of expected cash benefits discounted at a rate, which reflects their certainty or uncertainty. Thus, wealth maximization objective as decisional criterion suggests that any financial action, which creates wealth or which, has a net present value above zero is desirable one and should be accepted and that which does not satisfy this test should be rejected. The wealth maximization objective when used as decisional criterion serves as a very useful guideline in taking investment decisions. This is because the concept of, wealth is very clear. It represents present value of the benefits minus the cost of the investment. The concept of cash flow is more precise in connotation than that of accounting profit. Thus, measuring benefit in terms of cash flows generated avoids ambiguity. The wealth maximization objective considers time value of money. It recognizes that cash benefits emerging from a project in different years are not identical in value. This is why annual cash benefits of a project are discounted at a discount rate to calculate total value of these case benefits. At the same time, it also gives due weightage to risk factor by making necessary adjustments in the discount rate. Thus, cash benefits of a project with higher risk exposure is discounted at a higher discount rate (cost of capital), while lower discount rate applied to discount expected cash benefits of a less risky project. In this way, discount rate used to determine present value of future...
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