Skip to content

CS Executive · Corporate Accounting and Financial Management · Introduction to Financial Management

Rohan Engineering Ltd. has two mutually exclusive projects, each needing the same outlay. Project X gives certain cash inflows, while Project Y gives a higher expected accounting profit but with much greater uncertainty. A manager follows wealth maximisation. Which approach is consistent with this objective?

The manager should compare the risk-adjusted present values of the expected cash flows of both projects and pick the one that adds more value for shareholders. Looking only at accounting profit or only at certainty ignores part of what wealth maximisation measures.

  1. ASelect Y because its expected accounting profit is higher
  2. BSelect X because certainty always beats higher returns
  3. CCompare the present value of expected cash flows of both, adjusted for risk, and choose the one adding more value to shareholdersCorrect
  4. DSelect neither because uncertain projects must be rejected

Explanation

Wealth maximisation requires risk-adjusted present value of cash flows to be compared. Choosing Y on profit alone ignores risk and timing, while choosing X on certainty alone ignores the size of the return. Rejecting uncertain projects outright is not required by the objective.

Did you get it right without looking?

One question tells you little. A timed set on Introduction to Financial Management shows your real accuracy, how long you take and where you lose marks.

Practise Introduction to Financial ManagementFree diagnostic mock

More Introduction to Financial Management questions