Financial management

1. Financial Management Submitted by :- Seema Singh Amit Rana

2. PROFIT MAXIMIZATION V/S SHAREHOLDER’S WEALTH MAXIMIZATION

3. Profit Maximization: Based on the underlying logic of efficiency Profit maximization implies that either a firm produces maximum output for a given input or it uses minimum input for producing a given output For profit maximization a firm produces those goods & services which are more in demand in the society and therefore command a higher price which results in higher profits

4. Higher profit opportunities attract other firms to produce such goods and services thereby intensifying the competition and bringing the price an equilibrium Since profit maximization ensures the efficient allocation and utilization of goods and services therefore it is an appropriate measure of a firm’s performance

5. Objections to Profit Maximization: It assumes the market to be a perfect competition Changed modern business structure, divorce between management and ownership. Also there are different stakeholders in a firm with differing objectives May lead to wasteful & unnecessary goods & services being produced May lead to inequality in distribution of income & wealth The term profit is ambiguous It ignores the timing of the returns (no regard for time value of money) It ignores risk

6. Shareholder’s Wealth Maximization (SWM): It refers to the maximizing the Net Present Value (NPV) or wealth of a shareholder. NPV is the difference between the present value of the benefits and the present values of the costs of the shareholdings A financial action having a positive NPV creates wealth for the shareholders and should be taken up and vice versa Economic Value Addition (EVA) is the underlying logic of SWM.

7. Through a shareholder’s point of view, the wealth created by a company is through its action is related to the market value of the company’s shares. The market price of the share is an indication of the firm’s performance and ultimately of the quality of a firm’s financial decisions. It is a concept based on cash flows over a period of time instead of only accounting profits.

8. Shareholder’s Wealth Maximization: It takes into account the time value of money It takes into account the risk factor; the shareholders receive a risk premium for investing in more risky assets Since its based on cash flows and not on profits the ambiguity of profits is dealt with So, profit motive of a firm cannot be ignored all together but a firm should not be driven only by making profits but also aim at SWM

9. Agency Problems

10. Divorce between management and ownership in large companies Decision taking authority lies in the hands of managers Shareholders as owners of the company are Principals and managers are their Agents Theoretically, managers should act for the best interest of the shareholders But managers maximize their own wealth (in terms of salaries and perks)

11. Managers only create a satisfactory wealth for shareholders (satisficing) SOLUTION: Owners (shareholders) periodically review the management Government interventions Giving ownership rights to the managers

12. Thank You