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CA Intermediate · Financial Management and Strategic Management · Scope and Objectives of Financial Management

A firm's finance manager is evaluating whether the company's decisions should aim at increasing the market value of the equity shares rather than just the annual profit. Which of the following is a recognised limitation of profit maximisation as the objective of financial management?

Profit maximisation ignores the time value of money and the risk of earnings. It treats profits arising in different years as equal and does not distinguish safe from risky returns, so wealth maximisation is preferred as the objective.

  1. AIt ignores the time value of money and the risk attached to earningsCorrect
  2. BIt requires the firm to pay out all earnings as dividends
  3. CIt focuses on the long-term market price of the share
  4. DIt considers the timing and risk of cash flows

Explanation

Profit maximisation is criticised because it is vague about which profit, ignores the timing of benefits (time value of money) and ignores the risk of earnings. The other options describe features of wealth maximisation or are unrelated claims about dividends.

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