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

Which statement about the relationship between the market price of a company's equity shares and wealth maximisation is correct?

Market price of equity shares reflects investors' collective expectations about future cash flows and their risk. Therefore it serves as the performance indicator for wealth maximisation: decisions that raise the share price add to shareholder wealth, while those lowering it destroy wealth.

  1. AMarket price acts as a performance indicator because it reflects investors' expectations of the firm's future cash flows and riskCorrect
  2. BMarket price is irrelevant because wealth is measured only by book profits
  3. CMarket price is fixed by the company's board and does not change with decisions
  4. DMarket price measures only the dividend paid in the current year

Explanation

In an efficient market, the share price captures expected future cash flows, their timing and risk, so financial decisions that raise it increase shareholder wealth. The board does not fix the price, and it is not limited to current dividends or book profit.

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