Question

Give two limitations of wealth maximization objective

Answer 1

Answer:

Explanation:

Merits of Wealth Maximimization :

▪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.

▪Secondly, profit maximization presents a shorter term view as compared to wealth maximization. Short-term profit maximization can be achieved by the managers at the cost of long-term sustainability of the business.

▪Thirdly, wealth maximization considers the time value of money. It is important as we all know that a dollar today and a dollar one-year latter do not have the same value. In wealth maximization, the future cash flows are discounted at an appropriate discounted rate to represent their present value.

▪Fourthly, the wealth-maximization criterion considers the risk and uncertainty factor while considering the discounting rate. The discounting rate reflects both time and risk. Higher the uncertainty, the discounting rate is higher and vice-versa.

Demerits of Wealth Maximimization :

▪Wealth maximization considers the comparison of the value to cost associated with   the business concern. Total value detected from the total cost incurred for the business operation. It provides extract value of the business concern.

▪This concept considers both time and risk of business concern. This criteria provides efficient allocation of resources and it also ensures the economic interest of the society. The wealth maximization criterion is based on cash flows generated and not on accounting profit.

▪The computation of cash inflows and cash outflows is precise. Wealth maximization can be activated only with the help of the profitable position of the business concern. So The goal of maximizing the value of the stock avoids the problems associated with the different goals we discussed above.

▪In a simple language a good financial decisions increase the market value of the owners’ equity and poor financial decisions decrease it. So the financial manager best serves the owners of the business by identifying goods and services that add value to the firm because they are desired and valued in the free marketplace. So it is a long term concept based on the cash flows rather than profits and hence there can be a situation where a business makes losses every year but there are cash profits because of heavy depreciation which indirectly suggests heavy investment in fixed assets and that is the real wealth and it takes into account the time value of money and so is universally accepted.

Answer 2

1. Not considering profit side
2. Long term idea