Financial Management: Wealth Maximization, Capital Structure, and Global Investment are essential components of effective business decision-making. Financial management ensures the optimal allocation of resources to achieve wealth maximization while maintaining a balanced capital structure. It also encompasses investment strategies in global markets, influencing corporate growth and stability.
In this chapter, we will study the following topics:
- Wealth Maximization,
- Sources of Finance- Short and Long Term
- Capital Structure,
- Cost of Capital
- Distribution of Profit
- Banking and Non- Banking Financial Institutions (NBFIs),
- Stock Market
- Multi-National Companies (MNCs), Foreign Direct Investment (FDI), Foreign Institutional Investment (FII).
Wealth Maximization
Previous Year Questions
| Year | Question | Marks |
| 2018 | Explain the concept of wealth maximisation. | 5M |
- According to the wealth maximization objective, the managers should take decisions that maximize the shareholders’ wealth. The core idea behind wealth maximization is to increase the net worth or equity value of the business, leading to increased shareholder wealth.
- Profit maximization is the sub-set of wealth maximization. Profit maximization also increases the wealth of a business but it is a short-term measure and does not take into account the other objective of the organization.
- The wealth or value of a business is defined as the market price of the capital invested by shareholders.
The concept of wealth maximisation includes the following:
- Increasing the value of shares and dividends
- Higher return on investment
- Low risk on investment or mitigation of risk
- Detailed analysis of cash flows
- Best and efficient utilisation of resources
3D’s of Financial Management affects the value of an organization.
- Investment Decision
- It involves the allocation of financial resources to obtain the highest possible return.
- Financial Decision
- It involves decisions related to terms of acquisition of assets, financing, and raising funds, day-to-day capital, and expenditure management, etc
- Dividend Decision
- Dividend distribution policy
- What portion of the earnings is to be distributed as a dividend?
Arguments for the Wealth Maximization approach
- It overpowers the limitation of the policy of profit maximization
- It is based on the concept of cash flow. Cash flow is a measurable quantity, so it does not rely on any assumptions.
- It considers the time value of money.
- It also considers the risks of the investment
- Long-term view
- It promotes optimum and efficient utilization of resources
Arguments against the Wealth Maximization approach
- It ignores short-term economic benefits.
- It does not take into account the volatile share market.
- It may create Agency Problems between the management and the owner/shareholders of the organization.
- Agency Problem- the owners are concerned about the longer-term performance of the business; which can lead to the maximization of shareholder’s wealth. At the same time, a manager might focus on making such decisions that can bring a quick result so that they can get credit for good performance. However, in fulfilling the same, a manager might opt for risky decisions that can put the owner’s objectives at stake.
Difference Between Profit Maximization and Wealth Maximization
| Profit Maximization | Wealth Maximization | |||||
| Objective | Focuses on increasing short-term profits | It aims to increase the company’s overall value in the long run. | ||||
| Time Horizon | Short-term focus | Long-term focus. | ||||
| Risk Consideration | Often ignores or underestimates risk | Considers risk and uncertainty in decision-making. | ||||
| Measurement | It is measured by net income or earnings | It is measured by the company’s shares or equity market value. | ||||
| Sustainability | May prioritize immediate gains, potentially compromising future growth | Emphasizes sustainable growth and value creation over time. | ||||
| Decision Criteria | Decisions are based on profit outcomes | Decisions are based on the impact on the firm’s market value. | ||||
| Ethical Considerations | May overlook ethical aspects in pursuit of profit. | Incorporates ethical considerations to ensure long-term reputation and stability. | ||||
| Impact on Stock Prices | May lead to volatile stock prices due to short-term focus. | Aims for steady growth in stock prices by focusing on long-term value. | ||||
Financial Management and Investment / Financial Management and Investment
