Topics: Finance, Net present value, Rate of return Pages: 9 (2350 words) Published: May 14, 2013

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Course : MBA
Semester : Second
Module No: MB0045
Date of Submission : 30.01.2013
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Directorate of Distance Education
Signature of Sikkim Manipal University Signature of Evaluator II-Floor, Syndicate HouseCenter Cordinator

Q1. What are the goals of financial management?

Ans. Goals of Financial Management
Financial management means maximisation of economic welfare of its shareholders. Maximisation of economic welfare means maximisation of wealth of its shareholders. Shareholder’s wealth maximisation is reflected in the market value of the firm’s shares. Experts believe that, the goal of financial management is attained when it maximises the market value of shares. There are two versions of the goals of financial management of the firm – Profit Maximisation and Wealth Maximisation.

Let us now discuss the goals of financial management in detail. 1. Profit maximisation
Profit maximisation is based on the cardinal rule of efficiency. Its goal is to maximise the returns with the best output and price levels. A firm’s performance is evaluated in terms of profitability. Profit maximisation is the traditional and narrow approach, which aims at maximising the profit of the concern. Allocation of resources and investor’s perception of the company’s performance can be traced to the goal of profit maximisation. Profit maximisation has been criticised on many accounts.

The concept of profit lacks clarity. What does profit mean?
o Is it profit after tax or before tax?
o Is it operating profit or net profit available to shareholders?

• In this sense, profit is neither defined precisely nor correctly. It creates unnecessary conflicts regarding the earning habits of the business concern. Differences in interpretation of the concept of profit thus expose the weakness of profit maximisation. • Profit maximisation neither considers the time value of money nor the net present value of the cash inflow. It does not differentiate between profits of current year with the profits to be earned in later years. • The concept of profit maximisation fails to consider the fluctuations in profits earned from year to year. Fluctuations may be attributed to the business risk of the firm. Risks may be internal or external which will affect the overall operation of the business concern.

• The concept of profit maximisation apprehends to be either accounting profit or economic normal profit or economic supernormal profit.

Profit maximisation as a concept, even though has the above-mentioned drawbacks, is still given importance as profits do matter for any kind of business. Ensuring continued profits ensure maximisation of shareholder’s wealth. Following figure depicts the two goals of financial management.

2. Wealth maximisation
The term wealth means shareholder’s wealth or the wealth of the persons those who are involved in the business concern. Wealth maximisation is also known as value maximisation or net present worth maximisation. This objective is an universally accepted concept in the field of business. Wealth maximisation is possible only when the company pursues policies that would increase the market value of shares of the company. It has been accepted by the finance managers as it overcomes the limitations of profit maximisation.

The following arguments are in support of the superiority of wealth maximisation over profit maximisation: • Wealth maximisation is based on the concept of cash flows. Cash flows are a reality and not based on any subjective interpretation. On the other hand, profit maximisation is based on accounting profit and it also contains many subjective elements.

• Wealth maximisation considers time...
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