Wealth Maximisation

5.1. Definition

Wealth maximization focuses on improving the value or wealth of the shareholders. It's also known as value maximization or net present worth maximization. Wealth maximization considers:

• The comparison of value to cost
• Total value less the total cost
• Time and risk

5.2. Key Characteristics

• Cash Flow Based: It uses cash flows rather than accounting profit as its basis.
• Long-Term Focus: It has a long-term perspective.
• Time Value of Money: It considers the time value of money.
• Risk Considerations: It acknowledges and accounts for risk.

5.3. Wealth Maximization as a Superior Goal

The goal of maximizing the value of the stock helps to avoid the problems associated with the different goals discussed earlier. Good financial decisions increase the market value of the owners’ equity, and poor financial decisions decrease it. Financial managers serve owners by adding value to the firm through effective investment, financing, and dividend decisions.

5.4. How Wealth Maximization Overcomes Profit Maximization Shortcomings

• Planning Duration: Wealth maximization has a long-term perspective that supports long-term objectives like discretionary spending and investment.
• Risk Management: Wealth maximization is more likely to pay for hedging strategies to reduce risk, unlike profit maximization which emphasizes expense minimization.
• Pricing Strategy: Wealth maximization supports more strategic decisions like reducing prices to build market share, while profit maximization supports high prices for higher margins.
• Capacity Planning: Wealth maximization favors more investment in capacity for long-term growth over short-term sales.