## Objectives of Financial Management
Two main objectives are evaluated:
1. Profit Maximisation (traditional but flawed)
2. Wealth / Value Maximisation (modern, preferred)
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## Profit Maximisation
Traditionally seen as the primary objective — choose alternatives that maximise profit.
### Why Profit Maximisation CANNOT be the Sole Objective
| Problem | Explanation |
|---|---|
| Vague | "Profit" is ambiguous — short-term vs. long-term? Total profit or rate of profit? |
| Ignores Risk | Higher profits often come with higher risk; this trade-off is ignored |
| Ignores Timing | ₹1 lakh today is worth more than ₹1 lakh after 5 years (time value of money) |
| Ignores Ethics | Neglects social responsibilities, workers, consumers, and broader society |
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## Wealth Maximisation (Value Creation)
> ### Wealth = Present Value of Benefits − Present Value of Costs
- Benefits must be measured as cash flows (not accounting profit)
- Adjusted for timing (time value of money) and risk
### The Finance Manager Must Use:
- ✅ Cash Flow approach — not accounting profit
- ✅ Cost-benefit analysis
- ✅ Time Value of Money (TVM)
### Measuring Firm Value — Van Horne's Formula
> Value of Firm = Market Price per Share × Number of Shares
This market price reflects:
- Current and future earnings expected
- Timing of those earnings (earlier = more valuable)
- Risk involved (more risk → higher return expected)
- Dividend policy adopted
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## Profit vs. Wealth Maximisation — Comparison Table
| Feature | Profit Maximisation | Wealth Maximisation |
|---|---|---|
| Goal | Large amount of profits | Highest market value of shares |
| Time Focus | Short-term | Long-term |
| Risk | Ignored | Recognised |
| Timing of Returns | Ignored | Recognised |
| Shareholders | Not directly central | Central focus |
| Ease | Easy to calculate | Complex |
| Key Disadvantage | Ignores risk, timing, ethics | No clear direct link between decisions and share price |
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## When Are Both Objectives Equivalent?
When the time period is short and the degree of uncertainty is low, wealth maximisation and profit maximisation amount to essentially the same result.
In today's uncertain, multi-period world, wealth maximisation is the superior objective.
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## Conflicts Between Profit and Wealth Maximisation in Practice
1. Management vs. shareholders — Management may pursue personal goals (bonuses, short-term profit) rather than long-term shareholder wealth
2. Outside participation — Shareholders, creditors, and employees constrain self-serving management behaviour through constant supervision
3. Performance evaluation — Every stakeholder evaluates management based on whether their own objective is met; management survival is threatened if any stakeholder is ignored
4. Wealth maximisation aligns all stakeholders — owners, employees, creditors, and society; hence it is consistent with management's survival objective
5. Limitations of profit maximisation — Due to timing, risk, and social consideration issues, wealth maximisation is better in real-world multi-period conditions