Wealth maximization, also called Value Maximization, is the appropriate financial objective of an enterprise since maximizing the value of the firm benefits all the stake holders in the organization – the shareholders, employees, customers, creditors, management and the society. The share’s market price serves as a performance index. The stock holder’s wealth is the number of shares held by the stock holders multiplied by the stock price per share. Since higher the price per share means greater as the wealth, the firm should aim at maximizing the current stock price.
Value maximization is simply the extension of profit maximization to a world that is uncertain and multi-period in nature. Value maximization may be achieved through increase in profits, reduction in cost, judicious choice of funds, minimum risks, and long-run value approach.
When business managers try to maximize the wealth of their firm, they are actually trying to increase their stock price. As the stock price increases, the individual who holds the stock wealth increases. As the stock price goes up, the value of the firm increases and the net worth of the individual who owns the stock increases.
Profit maximization is basically is a single-period or, at most, a short-term goal, to be achieved within one year; it is usually interpreted to mean the maximization of profits within a given period of time. A corporation may maximize its short-term profits at the expense of its long-term profitability. In contrast, stockholder wealth maximization is a long-term goal, since stockholders are interested in future as well as present profits.
Wealth maximization is generally preferred because it considers
- wealth for the long term,
- risk or uncertainty,
- the timing of returns, and
- the stockholder’s return.
Timing of returns is important; the earlier the return is received, the better, since a quick return reduces the uncertainty about receiving the return, and the money received can be reinvested sooner.
Advantages of Wealth Maximization objective are:
- It considers the present value of cash inflows & outflows and the net effect of investment and benefits.
- It considers the risk factor by considering discount rate while calculating net present value.
