Wealth Maximization Objective

Wealth Maximization Objective is also known as “Value Maximization” or “Net Present Worth Maximization.” This objective is considered appropriate for decision making. Wealth means the wealth of shareholders. The wealth of shareholders is determined by the market value of shares.

Wealth also signifies Net Present Value(NPV) which is the difference between the present value of cash inflows and the present value of cash outflows. In this way, wealth maximization objective considers the time value of money and assign different values to cash inflows occurring at different point of time. So, according to the wealth maximization objective, investments should be made in such a way that it maximizes Net Present Value.

Arguments in favor of Wealth Maximization objective

  1. It is superior: This objective is superior to profit maximization as its main aim is to maximise shareholder’s wealth.
  2. It is precise and unambiguous: It is based on the concept of cash flows rather than profit. The concept of profit in the profit maximization objective is vague and ambiguous.
  3. Considers time value of money: Wealth maximization objective takes into account the time value of money as it considers timing of cash inflows. The cash flows occurring at different period of time are discounted with appropriate discount rate.
  4. Considers risk: This objective also considers future risk associated with occurrence of cash flows. This is done with the help of discounting rate. Higher the discount rate, higher the risk and vice-versa.
  5. Ensures efficient allocation of resources: Resources are allocated wisely to increase shareholder’s wealth.
  6. Ensures economic interest of society: When wealth of shareholder is maximized, it ultimately upholds economic interest of society.

Unfavorable arguments for Wealth Maximization objective

  1. Creates owner-management problem: The concept of wealth maximization creates owner-management problem as owners want to maximize their profits and management want to maximize shareholder’s wealth.
  2. Ignores other stakeholders: This objective has been criticized on the ground that it is inclined towards wealth maximization of shareholders only and ignores other stakeholders such as creditors, suppliers, employees etc.
  3. Criteria of market value is not fair: The criteria of wealth maximization is based on market value of shares which is not a correct measure. Because value of shares could increase or decrease due to other economic factors which are beyond the control of the firm.
  4. It is just another form of profit maximization: Ultimate  aim is to earn maximum profits. Without earning profits wealth cannot be maximized.
  5. Management alone enjoy certain benefits.
  6. It is not suitable for present-day businesses.

This content is inspired from the books Advanced Financial Management by Dr SP GUPTA. If you really want to master the subject, buy the book from the link below

Share with friends