PROFIT MAXIMIZATION VS WEALTH MAXIMIZATION

Ø  PROFIT MAXIMIZATION VS WEALTH MAXIMIZATION

·         FINANCIAL MANAGEMENT

·         BUSINESS STUDY

1.        CONTENTS

2.        MEANING AND FEATURES OF PROFIT MAXIMIZATION

3.        EVALUATION

4.        MEANING AND FEATURES OF WEALTH MAXIMIZATION

5.        EVALUATION

6.        COMPARISON

7.        PLAYLIST ON FINANCIAL MGMT ON YOU TUBE

8.        ALL THE LECTURES WILL BE UPDATED OF FINANCIAL MGMT IN NEAR FUTURE ON YOU TUBE

Ø  OBJECTIVE OF FINANCIAL MANAGEMENT

1. PROFIT MAXIMIZATION
2. SHAREHOLDER WEALTH MAXIMIZATION

Ø  PROFIT MAXIMIZATION OBJECTIVE

•   IT MEANS THE MAXIMUM PROFIT TO BE EARNED BY AN ORGANIZATION IN A GIVEN PERIOD OF TIME

•   IMPLIES THAT FIRM EITHER PRODUCES MAXIMUM OUTPUT FOR A GIVEN AMOUNT OF INPUT OR USES MINIMUM INPUT FOR PRODUCING A GIVEN OUTPUT.

•   LOGIC BEHIND PROFIT MAXIMIZATION IS EFFICIENCY

Ø  FEATURES OF PROFIT MAXIMIZATION

1.       INVESTMENT PROPOSALS ARE TAKEN ON THE BASIS OF PROFIT MAXIMIZATION

2.       TO BRING MAXIMUM PROFIT,PRICE OF THE PRODUCT AND ITS OUTPUT IS SET ACCORDINGLY

3.       RELATED TO MAXIMIZATION OF EARNING PER SHARE

4.       BAROMETER TO MEASURE THE EFFICIENCY,SURVIVAL AND GROWTH OF THE BUSINESS

Ø  EVALUATION

•   MERITS

1.       YARD STICK AGAINST PERFORMANCE IS TO BE MEASURED

2.       EFFICIENT UTILIZATION OF RESOURCES

3.       PROFITS ARE NECESSARY TO BEAR THE SHOCK AND UNCERTAINTY IN FUTURE

4.       BEST CRITERION OF DECISION MAKING

Ø  DEMERITS

1.       IGNORES THE TIME VALUE OF MONEY

2.       THE TERM IS VAGUE

3.       IGNORES THE RISK FACTOR

4.       FOCUS ON SHORT RUN PROJECTS

5.       NOW IT TREATED AS UNREALISTIC,DIFFICULT AND INAPPROPRIATE

Ø  SHAREHOLDER WEALTH MAXIMIZATION

• MAXIMIZING THE SHAREHOLDERS’ ECONOMIC WELFARE IS EQUIVALENT TO MAXIMIZING THE UTILITY OF THEIR CONSUMPTION OVER TIME. THE FUNDAMENTAL OBJECTIVE OF A FIRM IS TO MAXIMIZE THE MARKET VALUE OF ITS SHARES.
• A WEALTH OF SHAREHOLDER MAXIMIZES WHEN THE NET WORTH OF A COMPANY MAXIMIZES. ALSO KNOWN AS NET WORTH MAXIMIZATION.
• WHEN MARKET PRICE OF THE SHARE INCREASES ( WHICH IS A FUNCTION OF NET WORTH)AND THE WEALTH OF SHAREHOLDER WILL ALSO IMPROVE
• SHAREHOLDER’ CURRENT WEALTH=NUMBER OF SHARES x CURRENT MARKET PRICE
• WEALTH IS USED BY SHAREHOLDER TO MAXIMIZE THE UTILITY
• WE CAN SAY IT IS MAXIMIZING SHAREHOLDER’S UTILITY.
• MAXIMIZING THE NET PRESENT VALUE OF A COURSE OF ACTION TO SHAREHOLDERS
•  A POSITIVE NPV CREATES THE WEALTH AND DESIRABLE
• A NEGATIVE NPV BRINGS LOSSES AND AVOIDED
• NPV OF A FIRMS ARE ADDITIVE IN NATURE.              ( PRINCIPLES OF VALUE-ADDITIVITY)
• BENEFITS ARE MEASURED IN TERMS OF CASH FLOWS NOT ACCOUNTING PROFIT.

•   MERITS

1.       OVERCOME THE LIMITATIONS OF THE POLICY OF PROFIT MAXIMIZATION

2.       IT SERVES THE INTERESTS OF SUPPLIERS,FINANCIER,EMPLOYEES AND MANAGEMENT

3.       BASED ON THE CONCEPT OF CASH FLOW AND THEY ARE REALITY NOT ANY SUBJECTIVE INTERPRETATION

4.       CONSIDER THE TIME VALUE OF MONEY AND THROUGHOUT HE PROCESS OF DISCOUNTING,QUALITY OF THE  CASH FLOW IS SHOWN.

5.       IT ALSO MEASURE THE RISK BY CALCULATING NET PRESENT VALUE

•   LIMITATION OF WEALTH MAXIMIZATION

1.       NOT SOCIALLY DESIRABLE

2.       CONFLICT BETWEEN THE WEALTH OF FIRM OR WEALTH OF SHAREHOLDERS

3.       AGENCY PROBLEMS ( MANAGER’S VS SHAREHOLDERS’ GOALS)

4.       IT IS PRESCRIPTIVE IDEA

Ø  COMPARISON BETWEEN PROFIT MAXIMISATION

•   PROFIT MAXIMIZATION

1.       BASED ON ACCOUNTING PROFIT AND OBJECTIVE IS TO EARN MAXIMUM PROFIT

2.       FOCUSES ON SHORT TERM

3.       IGNORES THE TIME VALUE OF MONEY

4.       IT IGNORES THE TIMING OF RETURN

•   WEALTH MAXIMIZATION

1.       ACHIEVE HIGHEST MARKET VALUE OF THE STOCK AND MAXIMIZE THE VALUE OF THE SHAREHOLDERS

2.       FOCUSES ON LONG TERM

3.       TAKES INTO ACCOUNT THE TIME VALUE OF THE MONEY

4.       RECOGNIZES THE RISK AND UNCERTAINTY

5.       RECOGNIZES THE TIMING OF RETURN