Question 1 OR (a)
Wealth maximisation as a decision criterion rather than a goal
4 marks
- Time to write
- About 8 minutes
From an older CBCS paper
Question
Question 1 OR (a) · 4 marks"Wealth maximisation" is only a criterion for decisions, and not a goal of a firm. Explain. 4
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- ExplainEach point stated, then explained in a line or two.
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 Goal versus decision criterion 1 mark 2 min
- 2 Wealth maximisation as the operational criterion 1½ marks 3 min
- 3 Why it is not the firm's goal; conclusion 1½ marks 2 min
Short on time? Trim steps 2 and 3 evenly rather than skip one: each is capped at its own marks.
Try it first. About 8 minutes for 4 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
The distinction. A goal is what the firm as a whole is trying to achieve; a decision criterion is the yardstick by which the finance manager chooses between alternative courses of action. Wealth (value) maximisation is the firm's financial objective, but its working force lies in the second role: it is the test applied to each financial decision.
1Quick cash today: the deal is struck even as the godown behind them crumbles.
Weaknesses of profit maximisationIt ignores the risk of the profits; it ignores the timing of costs and returns.
2Asha weighs time against risk on the scale—and the share price curve climbs behind her.
Strengths of wealth maximisationIts result is visible in the market price of the share.
Wealth maximisation as a criterion. It is universally accepted as the operational decision criterion of financial management: each decision is judged by its economic value, the present value of the cash flows it generates, discounted at a rate that reflects their risk. That makes it workable for choosing projects, sources of finance and dividends: the alternative that adds most to present value is chosen.
Why it is not the whole goal of the firm.
- A firm pursues several goals at once: survival, growth, market share, service to customers, welfare of employees and obligations to society. Profit maximisation, for example, has been criticised precisely because it ignores social considerations and obligations to workers, consumers and society.
- Managers, as agents, may also pursue goals of their own; wealth maximisation tells them how to choose, not what the firm exists for.
- Wealth maximisation serves these wider goals by providing a common measure for financial decisions: a firm that creates value can better survive, grow and meet its obligations.
Conclusion. The two roles are compatible: wealth maximisation is the financial objective, and in practice it works as the rule the finance manager applies to each financial decision. The goals of the firm as a whole are wider, and the criterion is a means of pursuing them efficiently.
Where the 4 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Goal versus decision criterion | 1 |
| 2 | Wealth maximisation as the operational criterion | 1.5 |
| 3 | Why it is not the firm's goal; conclusion | 1.5 |
| Total | 4 |
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