Objectives of financial management
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Transcript of Objectives of financial management
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.