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

Which of the following is the principal weakness of profit maximisation as the objective of a firm's financial management, when compared with wealth maximisation?

The main weakness of profit maximisation is that it ignores the timing of returns (time value of money) and the risk attached to them. Wealth maximisation corrects this by discounting expected cash flows at a risk-adjusted rate, so it gives a better guide for financial decisions.

  1. AIt ignores the timing of returns and the risk attached to themCorrect
  2. BIt requires the firm to compute the market price of its shares
  3. CIt focuses on the long-term cash flows of the firm
  4. DIt treats the interests of shareholders as the only priority

Explanation

Profit maximisation looks at accounting profit for a period and does not distinguish between profits earned earlier or later, nor between safe and risky profits. Wealth maximisation discounts cash flows at a risk-adjusted rate. The option on long-term cash flows describes wealth maximisation, not a weakness of profit maximisation.

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