Objectives of Financial management

By Manisha Joshi

# Profit maximization

# Wealth maximization

Profit maximization

Arguments

Favour

Favour Profit earning – main objective A Barometer for measuring efficiency and economic prosperity of a business To survive under adverse business conditions For growth of a business For maximizing socio-economic welfare.

Ignores Time Value of

Money

Ignores Risk Factor

Dividend Policy

STOP

Arguments against

AmbiguityProfit

maximization

Wealth maximization

Appropriate objective

Single Substitute for a Stockholder’s Utility.

Implication : By maximising stockholder’s wealth,

the firm is operating consistently towards

maximising stockholder’s utility.

# Maximum refers to Maximum refers to Maximum Current Stock Utility Shareholder’s wealth Price per share

# Stockholder’s current wealth in a firm

Symbolically,

W0 = NP0

Number of shares owned

Current stock price per share

Implications:Serves the interest of owner as well as other stakeholders

Consistent with the objective of owners economic welfare

Implies long term growth and survival

Leads to maximize Shareholder’s utility

Considers Risk factor and Time value of money

Favour

A Prescriptive idea

Not socially desirable

Controversy as to maximize stockholders wealth OR wealth of a firm

Difficult to achieve the objective when OWNERSHIP and MANAGEMENT differs.

Criticism

Conclusion

In spite of the Criticisms, it is concluded that

wealth maximization is the most appropriate

Objective of the firm.

Financial management and Profit maximization

Elements involved in maximizing profit.

Increase in Revenue

Minimizing Risk

Controlling cost

Measuring

Shareholders Value Creation

1.Economic Value Added (EVA)

2.Market Value Added (MVA)

Economic Value Added (EVA)

Propounded by Stern Stewart & Co.

Used to measure the surplus value created by an

investment (Portfolio investment).

Used to determine whether an investment

positively contributes to Shareholders wealth.

Better measure of Divisional performance as

compared to ROA or ROI.

EVA can be calculated as :

EVA = (Net operating profit after tax- cost of capital *

capital invested)

OR

EVA = Return on investment - cost of capital * capital

employed

Investment can be accepted only if,

Surplus (EVA) is POSITIVE

Market Value Added (MVA) It is the sum total of all present values of

FUTURE EVAs.

EVA1 EVA2 EVA3(1+C)1 (1+C)2 (1+C)3

ORMVA = Current market value - Book value of

capital employed of a firm by the firmWhere; Market value of firm = market value of equity +

market value of debt

MVA

Market value of firm > Book value of capital employed.

Then, MVA is +ve.

Market value of firm < Book value of capital employed.

Then, MVA is -ve.