Gradable Assignment 1 - 1 Elucidate that shareholders wealth maximization is a better objective than profit after tax maximization Wealth maximization

Gradable Assignment 1 - 1 Elucidate that shareholders...

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1. Elucidate that shareholder’s wealth maximization is a better objective than profit after tax maximization. Wealth maximization is a modern approach to financial management. Maximization of profit used to be the main aim of a business and financial management till the concept of wealth maximization came into existence. It is a superior goal compared to profit maximization as it takes broader arena into consideration. Wealth or Value of a business is defined as the market price of the capital invested by shareholders. Wealth maximization simply means maximization of shareholder’s wealth. It is combination of two words viz. wealth and maximization. Wealth of a shareholder maximize when the net worth of a company maximizes. To be even more meticulous, a shareholder holds share in the company or business and his wealth will improve if the share price in the market increases which in turn is a function of net worth. This is because wealth maximization is also known as net worth maximization. Finance managers are the agents of shareholders and their job is to look after the interest of the shareholders. The objective of any shareholder or investor would be good return on their capital and safety of their capital. Both these objectives are well served by wealth maximization as a decision principle to business Wealth = Present Value of cash inflows – Cost Where, Present Value of cash inflows = CF 1 + CF 2 + ……….. + CF n (1 + K) (1 + K) 2 (1 + K) n Wealth maximization model is a superior model because it obviates all the drawbacks of profit maximization as a goal to financial decision. o Firstly, the wealth maximization is based on cash flows and not profits. Unlike the profits, cash flows are exact and definite and therefore avoid any ambiguity associated with accounting profits.
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