1.

What is the goal of a Firm?

A firm is a collection of resources that is transformed into products demanded by consumers. Any business, such as a sole proprietorship, partnership or corporation, is considered as a financial firm. Every firm is established with a view to earn by selling product or providing services. In the financial view point, each and every firm sets organizational goal to chase money from give and take policy. The earnings at short term called profit; on the other hand, earnings accumulated for long term and ultimate gain can be converted to wealth. So, Profit Maximization and Wealth Maximization are considered as typical goals of a firm. Other goals that the firm might pursue: Economic Objectives Market share Profit margin Return on investment Technological advancement Customer satisfaction Shareholder value

Non-economic Objectives

Workplace environment Product quality Service to community (CSR) All of the goals or objectives that are mentioned above are profit oriented but it is not possible to implement those goals without accumulated profit and wealth. Some of the goals are to be implemented by organizational wealth that is converted with short term profit. So, we can infer that, the Wealth Maximization is the ultimate goal a firm; in spite of short term goal profit maximization.

2.

Write down a short note: Profit Maximization and Wealth Maximization.

Profit Maximization
Profit maximization is the process by which a firm determines the price and output
level that returns the greatest profit. There are several approaches to this problem. The total revenue -- total cost method relies on the fact that profit equals revenue minus cost, and the marginal revenue -- marginal cost method is based on the fact that total profit in a perfectly competitive market reaches its maximum point where marginal revenue equals marginal cost. Any costs incurred by a firm may be classed into two groups: fixed cost and variable cost. Fixed costs are incurred by the business at any level of output, including zero output. These may include equipment maintenance, rent, wages, and general upkeep. Variable costs change with the level of output, increasing as more products is generated. Materials consumed during production often have the largest impact on this category. Fixed cost and variable cost when combined, equal total cost. Revenue is the total amount of money that flows into the firm. This can be from any source, including product sales, government subsidies, venture capital and personal funds. Marginal cost and revenue, depending on whether the calculus approach is taken or not, are defined as either the change in cost or revenue as each additional unit is produced, or the derivative of cost or revenue with respect to quantity output. It may also be defined as the addition to total cost as output increase by a single unit. Traditional approach of financial management was all about profit maximization. The main objective of companies was to make profits. Profit Maximization has to define after taking into account many things like: a. Short term, mid term, and long term profits b. Profits over period of time

Wealth Maximization
Wealth maximization is all about;
How to achieve maximum wealth while minimizing costs and inefficiencies how to spend and enjoy your wealth without the fear of ever outliving it how to pass along your wealth to whomever you choose how to ensure your plan for financial success works under all circumstances Modern Approach is about the idea of wealth maximization. This involves increasing the Earning per share of the shareholders and to maximize the net present worth. Wealth is equal to the difference between gross present worth of some decision or course of action and the investment required to achieve the expected benefits. Gross present worth involves the capitalized value of the expected benefits. This value is discounted a some rate, this rate depends on the certainty or uncertainty factor of the expected benefits. The Wealth Maximization approach is concerned with the amount of cash flow generated by a course of action rather than the profits. Hence we can have; Profit maximization relates to profits *only* while shareholder wealth also involves total company equity, debt ratios, etc. Management could focus on profit maximization over a longer period of time, while the shareholder would rather see stock values and corporate total value increase immediately. If management focused on short-term profit maximization, say at the expense of long term sales revenues, then shareholder wealth (stock price) could actually decrease as a result of the loss of market share. Shareholder wealth (more commonly referred to as shareholder value) is talking about the value of the company generally expressed in the value of the stock. Profit maximization refers to how much dollar profit the company makes. It might seem like making as much profit as possible would yield the highest value for the stock but that is not always the case. When investors look at a company they not only look at dollar profit but also profit margins, return on capital and other indicators of efficiency. Say there are two companies doing the same thing. Company A had sales of $100 million and profit of $10 million. Company B had sales of $200 million and profit of $12 million. Wall Street could look at Company B and say they are less valuable because they clearly do no operate as efficiently as Company A. So even though Company B had more profit Company A will have more shareholder value.

3. What is difference between Maximization? Profit Maximization

Profit Maximization and Wealth

Profit Maximization - is always used as a goal of the firm in microeconomics. Focus on short term goal to be achieved within a year. It stresses on the efficient use of capital resources. In order to maximize profit, the financial manager will implement actions that would result in maximum profits without considering the consequence of his actions towards the company's future performance. Drawbacks of Profit Maximization - Profit maximization is a short-term concept. - Profit maximization does not consider the timing of returns. - Profit maximization ignores risk.

Maximization of Shareholders' Wealth

The goal is o maximize the shareholders' wealth for whom it is being operated. It being measured by the share price of the stock, which in turn is based on the timing of returns, the amount of the returns and the risk or uncertainty of the returns. It also means maximizing the total market value of the existing shareholders' common stock. All financial decisions will affect the achievement of this goal. Shareholders' wealth maximization can be achieved by considering the present and potential future earnings per share, timing of returns, dividend policy and other factors that affect the market price of the company's stock. Next, lets look at what is Shareholders wealth is regarding the maximizing of the total market /market price of the existing shareholders common stock It can be achieved by considering many factors whether short or long term pertaining to decisions/actions made affecting the present and future earnings per share, timing of returns, dividend policy and other factors that can affect the market price of the company stock

Unlike profit maximization, it has the following advantages: Its applies to the principle of time value of money wherein a dollar received today is worth more than it is to be received say 1 year later. By considering time value of money, this will lead to an overall increase in the companys earning. To achieve shareholders wealth maximization, management needs to consider the uncertainty or risk factor. It accepts a certain degree of risk when it is compensated with the same level of return. Increase in shareholders wealth will directly lead to increase in cash flows. It is not concern only with accounting earnings/profits but CASH FLOWS. To achieve shareholders wealth maximization, the firm has to achieve all the short-term target like sales/earnings growth and dividend payout targets. Only when these short term targets being achieved, the firm will then be attractive to the potential investors which might raise the stock price.

4. Why wealth maximization is the ultimate goal of a firm?

Wealth maximization means maximizing the net present value (or wealth) of a course of action. The neat present value of a course of action is the difference between the present value of its benefits and the present value of its costs. A financial action which has a positive net present value creates wealth and therefore it is desirable. Wealth maximization objective is a widely recognized criterion with which the performance a business enterprise is evaluated. The word wealth refers to the net present worth of the firm. Therefore, wealth maximization is also stated as net present worth. Net present worth is difference between gross present worth and the amount of capital investment required to achieve the benefits. Gross present worth represents the present value of expected cash benefits discounted at a rate, which reflects their certainty or uncertainty. Thus, wealth maximization objective as decisional criterion suggests that any financial action, which creates wealth or which, has a net present value above zero is desirable one and should be accepted and that which does not satisfy this test should be rejected. Scope of financing to the Business Organization. According to the modern approach, the function of finance is concerned with the following three types of decisions - Financing decisions, Investment decisions, and Dividend policy decisions. The core objective of stockholder wealth maximization is highest market value of common stock which emphasizes the long-term, recognizes risk or uncertainty, recognizes the timing of returns, and considers stockholders return.

Normative dimensions According to (Boatright, 2010) the descriptive, instrumental and normative dimensions of shareholder wealth maximization are mutually supporting. The descriptive dimension concerns a particular empirical view of laws, markets, motives and behaviors. The view posits relatively efficient markets, market-oriented institutions, and self interested economic rationality. Descriptively, the view that management (i.e, officers and directors) has strong fiduciary duties on behalf of shareholders, which are established by law and enforced by the market for corporate control. The instrumental dimension concerns the prescriptively best approach to managing a public corporation on behalf of the shareholders and handling the interests of multiple stakeholders in the corporation and its activities. The prescription is that shareholder wealth maximization will most efficiently and effectively advance the interests of shareholders and stakeholders and thus social welfare in a market economy. Companys common stock Shareholders wealth is represented in the market price of the companys common stock, which, in turn, is the function of the companys investment; financing and dividend decision3.Managements' primary goal is shareholders' wealth maximization, which translates into maximizing the value of the company as measured by the price of the companys common stock. Shareholders like cash dividends, but they also like the growth in EPS that results from ploughing earning back into the busines5s. The optimal dividend policy is the one that maximizes the company's stock price which leads to maximization of shareholders' wealth and thereby ensures more rapid economic growth. (International Research Journal of Finance and Economics, 2008) Time value of money The wealth maximization objective considers time value of money. It recognizes that cash benefits emerging from a project in different years are not identical in value. This is why annual cash benefits of a project are discounted at a discount rate to calculate total value of these cash benefits. At the same time, it also gives due weightage to risk factor by making necessary adjustments in the discount rate. Thus, cash benefits of a project with higher risk exposure is discounted at a higher discount rate (cost of capital), while lower discount rate applied to discount expected cash benefits of a less risky project. In this way, discount rate used to determine present value of future streams of cash earning reflects both the time and risk. (http://www.mbaknol.com/business-finance/) Wealth maximization goal as decision criteria suggests that any financial action which creates wealth or which has discounted stream of future benefits exceeding its cost, is desirable and should be accepted and that which does not satisfy this test should be rejected. The goal of wealth maximization is supposed to be superior to the goal of profit maximization due to the following reasons: a) It uses the concept of future expected cash flows rather than the ambiguous term of profits. As such measurement of benefits in terms of cash flows avoids ambiguity. b) It considers time value of money. It recognizes that the cash flows generated earlier are more valuable than those generated earlier. That is why while computing value

of total benefits; the cash flows are discounted at a certain discounting rate. At the same time, it recognizes the concept of risk also, by making necessary adjustments in discounting rate. As such, cash flows of a project involving higher risk are discounted at a higher discounting rate and vise versa. Thus, the discounting rate used to discount future cash flows reflects the concepts of both time and risk. Cost The value of an asset is judged not in terms of its cost but in terms of the benefit it produces. Similarly the value of a course of action is judged in terms of benefits it produces less the cost of undertaking it. The benefits can be measured in terms of stream of future expected cash flows, but they must take into consideration not only their magnitude but also the extent of uncertainty. Investing in wealth maximization approaches may experience losses in the short-run but yield substantial profit in the long-run. Also, a firm that wants to show a short-term profit may, for example, postpone major repairs or replacement, although such postponement is likely to hurt its long-term profitability. (Putra, 2010). Financial decision making Effective financial decision making requires an understanding of the goal(s) of the firm. What objectives should guide business decision makingthat is what should management t try achieve for the owners of the firm? The most widely accepted objective of the firm is to maximize the value of the firm for its owners that is to maximize shareholder wealth. Shareholder wealth is represented by the market price of the firms common stock (Moyer, et.al, 2009) According to (Ellsworth, 2002) in this time of great paradox the allegiance of maximization of shareholder wealth is stronger than ever before; yet the importance of shareholders contribution to competitive advantage has never been smaller. Capital is readily available and has given way to knowledgeto the ingenuity and dedication of peopleas the key to competitive advantage and wealth creation. Critique Much has been spoken about wealth maximization but there is a school of thought with a view that wealth maximization does not necessary lead to economic development. Wealth maximization excludes distributional considerations in that many people in the public sphere especially the poor may be excluded and therefore it may lead to unfairness especially in an economy controlled by forces of demand and supply. Another critique is that even though wealth maximization tries to predict the future, future economic performances can be volatile and unpredictable the best example being the world financial crisis otherwise known as the credit crunch. Conclusion It is now accepted that the objective of the business should be to maximize its wealth and value of shares of the company. The object can also be stated as maximization of the value.