## Objectives of Financial Management
Two main objectives are debated in FM:
1. Profit Maximisation — historically seen as the primary goal
2. Wealth / Value Maximisation — the preferred modern objective
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## Profit Maximisation
Traditionally considered the primary objective — the finance manager chooses alternatives that maximise profit.
### Why Profit Maximisation CANNOT be the Sole Objective
If profit is given undue importance, the following problems arise:
| Problem | Explanation |
|---|---|
| Vagueness | 'Profit' is ambiguous — short-term vs long-term? Total profit vs rate of profit? |
| Ignores Risk | Higher profit usually comes with higher risk; single-minded profit focus may lead to accepting overly risky proposals |
| Ignores Timing | ₹1 lakh profit next year ≠ ₹1 lakh profit in 5 years — time value of money is ignored |
| Ignores Ethics | Social responsibilities, employee welfare, environmental obligations, and consumer interests are neglected |
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## Wealth Maximisation (Value Creation)
The preferred objective of modern FM.
$$\text{Wealth} = \text{PV of Benefits} - \text{PV of Costs}$$
- Benefits must be measured as cash flows, NOT accounting profit
- Applies time value of money (discounting future cash flows)
- Applies cost-benefit analysis
- Considers risk in evaluating returns
### How is Firm Value Measured?
According to Van Horne:
$$\text{Value of Firm} = \text{Market Price of Share} \times \text{Number of Shares}$$
This market price reflects:
- Current and future earnings
- Timing of those earnings (earlier = more valuable)
- Risk involved
- Dividend policy
> If share price is high → investors believe the firm is doing well → wealth is maximised
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## Comparison Table
| Aspect | Profit Maximisation | Wealth Maximisation |
|---|---|---|
| Goal | Largest amount of profit | Highest market value of shares |
| Objective | Profit | Value / Wealth |
| Time horizon | Short-term focus | Long-term focus |
| Risk | Ignores risk | Recognises and adjusts for risk |
| Timing of returns | Ignores timing | Considers time value of money |
| Shareholders | Requires immediate resources | Considers shareholders' return |
| Advantage | Easy to calculate; easy to link decisions to profit | Long-term, risk-adjusted, time-aware |
| Disadvantage | Short-sighted; ignores risk and timing | No clear formula linking decisions to share price; may cause management anxiety |
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## Conflicts Between the Two Objectives
1. Management as decision-maker may pursue personal goals (profit maximisation) rather than shareholder wealth
2. Outside participation (shareholders, lenders) constrains management from pursuing only personal goals through constant stakeholder supervision
3. Survival of management depends on satisfying all stakeholders — employees, creditors, customers, government
4. Wealth maximisation is generally consistent with the interests of ALL groups (owners, employees, creditors, society) — making it aligned with management's survival goal
5. Where time is short and uncertainty is low, both objectives yield essentially the same result
6. In the long run and with uncertainty, wealth maximisation is clearly superior