1-9.Why is profit maximization, by itself, an inappropriate goal? What is meant by thegoal of maximization of shareholder wealth?
Banking & FinanceFinance ManagementGrowth & Empowerment Show Although Profit and Wealth Maximization sound pretty similar, there are some major differences between them. While profit maximization aims at increasing the profit of a firm, wealth maximization has a larger role to play and it deals with the wellbeing of the stakeholders as a whole. Profit Maximization Vs Wealth MaximizationHere are some major differences between profit maximization and wealth maximization in brief.
Note − Wealth maximization plays a larger role in business than profit maximization.
Note − Profit maximization does not cover the risk factors associated with finance and operations but wealth maximization does.
Note − Profit maximization is a theory of the past, while wealth maximization is a modern theory.
Updated on 12-Aug-2021 14:11:25
May 24, 2022 May 24, 2022/
Profit maximization is the process by which a business arranges its prices and cost structure to achieve the highest possible profit. The central goal of the organization is to increase its profits. What is Wealth Maximization?Wealth maximization is the concept of increasing the value of a business in order to enhance the value of the shares held by its stockholders. This may involve additional investments in intellectual property and strategic positioning, as well as attention to managing the risk profile of a business. Comparing Profit Maximization and Wealth MaximizationThe essential difference between the maximization of profits and the maximization of wealth is that the profits focus is on short-term earnings, while the wealth focus is on increasing the overall value of the business entity over time. These differences are substantial, as noted below. Planning DurationUnder profit maximization, the immediate increase of profits is paramount, so management may elect not to pay for discretionary expenses, such as advertising, research, and maintenance. Under wealth maximization, management always pays for these discretionary expenditures.
Under profit maximization, management minimizes expenditures, so it is less likely to pay for hedges that could reduce the organization's risk profile. A wealth-focused company would work on risk mitigation, so its risk of loss is reduced. Pricing StrategyWhen management wants to maximize profits, it prices products as high as possible in order to increase margins. A wealth-oriented company could do the reverse, electing to reduce prices in order to build market share over the long term. Capacity PlanningA profit-oriented business will spend just enough on its productive capacity to handle the existing sales level and perhaps the short-term sales forecast. A wealth-oriented business will spend more heavily on capacity in order to meet its long-term sales projections. It should be apparent from the preceding discussion that profit maximization is a strictly short-term approach to managing a business, which could be damaging over the long term. Wealth maximization focuses attention on the long term, requiring a larger investment and lower short-term profits, but with a long-term payoff that increases the value of the business. May 24, 2022/
Financial management pursues two sorts of goals-profit maximization and wealth maximization. One is concerned with earning profits, whereas the other is concerned with adding value. Profit maximization is an inappropriate goal because it’s short term in nature and focus more on what earnings are generated rather than value maximization which comply to shareholders wealth maximization. Wealth maximization overcomes all the limitations that profit maximization possesses. In the short term, profit maximization may pursue such action which might be proved harmful in the long run. On the other hand, wealth maximization might not seem beneficial in the short run, but in the long run-this purpose fulfills the goal of shareholders that is add value. So, whenever there is a comparison, profit maximization is inferior to wealth maximization. The focus has been made on this difference throughout the paper.
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