WEALTH MAXIMIZATION

AJAY KURIEN

WEALTH MAXIMISATIONWealth maximisation is the appropriate objective of

an enterprise. Financial theory asserts that wealth

maximisation is the single substitute for a

stockholder’s utility. When the firm maximises the

stockholder’s wealth, the individual stock holder can

use this wealth to maximize his individual utility. It

means that by maximizing stockholder’s wealth the

firm is operating consistently towards maximizing

stockholder’s utility.

A stockholder’s current wealth in a firm is the

product of the no: of shares owned multiplied

with the current stock price per share

Stockholder’s current wealth = No: of shares owned * Current stock price/ share

Or

Wo = NPo

Higher the stock price per share the greater will be the stockholder’s wealth. Thus a firm should aim at maximizing its current stock price. This objective helps in increasing the value of shares in the market. The share’s market price serves as a performance index or report card in progress. It also indicates how well management is doing on behalf of the shareholder.

It can be concluded by ;

Maximum utility Maximum

stockholder’s wealth Maximum

stock price per share

However, the maximization of the market price of

the share should be in the long run. The long run

implies a period which is long enough to reflect the

normal market value of the shares irrespective of

short-term fluctuations.

While pursuing the objective of wealth

maximization, all efforts must be put in fourth for

maximising the current present value of any course of

action. Every financial decision should be based on

cost benefit analysis. If the cost is lower than the

benefit, the decision will help in maximising the

wealth.

Implications of wealth maximisation

There is a rationale in applying wealth

maximising policy as on operating financial

management policy. It serves the interest of

suppliers of loaned capital, employees,

management and society. Besides share

holders, there are short-term and long term

suppliers of funds who have financial interest

in the concern. Short-term lenders are

primarily interested in liquidity position so

that they get payments in time.

Advantages :

It serves the interests of owners, (equity

share holders ) as well as other share holders.

The objective of wealth maximisation implies

long-run survival and growth of the firm.

It takes into consideration the risk factor and

time value of money as the current present

value of any particular course of action is

measured.

The effect of dividend policy on market price

of share is also considered.

Disadvantages:

It is a prescriptive idea.

The objective of wealth maximisation is

not socially desirable.

There is some controversy as to

whether the objective is to maximise the

shareholder’s wealth or the firms wealth

which includes other financial claim

holders.

ThANk yOu........