Submitted by :-

Seema Singh

Amit Rana

PROFIT MAXIMIZATION

V/S

SHAREHOLDER’S WEALTH

MAXIMIZATION

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

• Higher profit opportunities attractother firms to produce such goods andservices thereby intensifying thecompetition and bringing the price anequilibrium

• Since profit maximization ensures theefficient allocation and utilization ofgoods and services therefore it is anappropriate measure of a firm’sperformance

Objections to Profit Maximization:

• It assumes the market to be a perfect competition

• Changed modern business structure, divorcebetween management and ownership. Also thereare different stakeholders in a firm with differingobjectives

• 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 fortime value of money)

• It ignores risk

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.

• Through a shareholder’s point of view, thewealth created by a company is throughits action is related to the market value ofthe company’s shares.

• The market price of the share is anindication of the firm’s performance andultimately of the quality of a firm’sfinancial decisions.

• It is a concept based on cash flows over aperiod of time instead of only accountingprofits.

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 forinvesting in more risky assets

• Since its based on cash flows and not onprofits the ambiguity of profits is dealtwith

• So, profit motive of a firm cannot beignored all together but a firm should notbe driven only by making profits but alsoaim at SWM

• Divorce between management andownership in large companies

• Decision taking authority lies in thehands of managers

• Shareholders as owners of thecompany are Principals and managersare their Agents

• Theoretically, managers should act forthe best interest of the shareholders

• But managers maximize their ownwealth (in terms of salaries and perks)

• Managers only create a satisfactorywealth for shareholders (satisficing)

SOLUTION:

• Owners (shareholders) periodicallyreview the management

• Government interventions

• Giving ownership rights to themanagers