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

Under the profit maximisation objective, which of the following is a recognised limitation that wealth maximisation overcomes?

A key limitation of profit maximisation is that it ignores the risk attached to earnings and the timing of returns. Wealth maximisation corrects this by using discounted cash flows and the market value of shares, thereby reflecting both risk and the time value of money.

  1. AIt considers the timing of cash flows and the time value of money
  2. BIt ignores the risk associated with expected earnings and the timing of returnsCorrect
  3. CIt focuses on the market price of equity shares
  4. DIt measures returns in terms of net cash flows to shareholders

Explanation

Profit maximisation is criticised because it ignores risk and the timing of benefits (time value of money) and is ambiguous about which profit is meant. Wealth maximisation uses discounted cash flows and market value of shares to address these. The other options describe features of wealth maximisation, not limitations of profit maximisation.

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