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

Why is wealth maximisation regarded as a superior objective of financial management compared with profit maximisation?

Wealth maximisation is superior because it measures the present value of expected cash flows, adjusted for risk and timing, and so reflects the value created for shareholders. Profit maximisation relies on accounting profit and ignores the time value of money, risk and quality of earnings.

  1. AIt considers the timing and risk of cash flows and focuses on the value of the firm to shareholdersCorrect
  2. BIt ignores risk so that managers can take higher-return projects
  3. CIt concentrates on maximising short-term accounting profit per year
  4. DIt requires the firm to avoid all external financing

Explanation

Wealth maximisation looks at the present value of future cash flows adjusted for risk, so it accounts for time value and uncertainty. Profit maximisation uses accounting profit, ignores timing and risk, and may favour short-term results. The option saying risk is ignored is wrong because wealth maximisation explicitly discounts for risk.

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