A Brief introduction to Objectives of Financial Management.

1. By Manisha Joshi

2. # Profit maximization
# Wealth maximization

3. Profit maximization
Arguments
Favour

4. Favour
 Profit earning – main
objective
 A Barometer for measuring
efficiency and economic
prosperity of a business
 To survive under adverse
business conditions
 For growth of a business
 For maximizing
socio-economic welfare.

5. Arguments
against

6. Wealth maximization
 Appropriate objective
 Single Substitute for a Stockholder’s Utility.
Implication : By maximising stockholder’s wealth, the
firm is operating consistently towards maximising
stockholder’s utility.

7. # Maximum refers to Maximum refers to Maximum Current Stock
Utility Shareholder’s wealth Price per share
# Stockholder’s
current wealth
in a firm
Symbolically,
W0 = NP0
Number of
shares owned
Current stock
price per share

8. Implications:
Serves the interest of
owner as well as other
stakeholders
Consistent with the
objective of owners
economic welfare
Implies long term
growth and survival
Leads to maximize
Shareholder’s utility
Considers Risk factor
and Time value of
money
Favour
A Prescriptive idea
Not socially desirable
Controversy as to
maximize stockholders
wealth OR wealth of a
firm
Difficult to achieve the
objective when
OWNERSHIP and
MANAGEMENT
differs.
Criticism

9. Conclusion
In spite of the Criticisms, it is concluded that
wealth maximization is the most appropriate
Objective of the firm.

10. Elements involved in maximizing profit.
Increase in Revenue
Minimizing Risk
Controlling cost

11. Measuring
Shareholders Value Creation
1. Economic Value Added (EVA)
2. Market Value Added (MVA)

12. Economic Value Added (EVA)
 Propounded by Stern Stewart & Co.
 Used to measure the surplus value created by an investment (Portfolio
investment).
 Used to determine whether an investment positively contributes to
Shareholders wealth.
 Better measure of Divisional performance as compared to ROA or ROI.

13.  EVA can be calculated as :
EVA = (Net operating profit after tax- cost of capital * capital invested)
OR
EVA = Return on investment - cost of capital * capital employed
Investment can be accepted only if,
Surplus (EVA) is POSITIVE

14. Market Value Added (MVA)
 It is the sum total of all present values of FUTURE EVAs.
EVA1 EVA2 EVA3
(1+C)1 (1+C)2 (1+C)3
OR
MVA = Current market value - Book value of capital employed
of a firm by the firm
Where;
Market value of firm = market value of equity + market value of debt
MVA

15.  Market value of firm > Book value of capital employed.
Then, MVA is +ve.
 Market value of firm < Book value of capital employed.
Then, MVA is -ve.