Question 1
Wealth versus profit maximisation; a rupee now or later
18.75 marks
- Time to write
- About 38 minutes
From an older CBCS paper
Question
Question 1 · 18.75 marksQ1. 'As the goal of financial management, wealth maximisation is superior to profit maximisation'. Do you agree? Explain.
Explain, too, whether Rs 120,000 received today is better than Rs 150,000 that will come in 3 years from today? (Make your own assumption in explaining this)
Reworded from the university paper: names and figures differ, 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
- Do…?Explain…?Two asks in one question: answer both.
- Do you agree?…?A yes-or-no question: answer it in your first line, then explain why.
What the paper leaves open
No mark is printed for the question; the paper asks for any four of six, equal marks.
Write it in this order
- Read the data; note exactly what is asked 2 min
- 1 Problems of profit maximisation 5 marks 9 min
- 2 Wealth maximisation and why it is superior 5 marks 9 min
- 3 Time value of money and the assumption 3 marks 6 min
- 4 Present value comparison and break-even rate 5.8 marks 10 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Try it first. About 38 minutes for 18.75 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.
Part 1: yes, wealth maximisation is the superior goal.
Profit maximisation and its problems. It has traditionally been argued that the firm's objective is to maximise profit, but this is at best a limited objective:
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.
- "Profit" is vague: short-term or long-term, total or rate of profit, before or after tax.
- It ignores risk: risky proposals often promise higher profit, and a profit goal would accept them regardless.
- It ignores the timing of returns: profits ten years away are treated like profits now.
- It is too narrow: it ignores obligations to workers, consumers and society.
Wealth maximisation. It judges each decision by its economic value: the present value of the cash flows it generates, discounted at a rate reflecting their risk. It is precise (cash flows), allows for timing (discounting) and risk (the discount rate), and shows up in the share price. It removes the technical limitations of profit maximisation and is universally accepted as the operational criterion.
Part 2: ₹1,20,000 today or ₹1,50,000 in three years? Money has time value: a rupee now can be invested to earn a return, the future is uncertain, and inflation erodes purchasing power, so future money must be discounted.
Assumption: the opportunity cost of money (what ₹1,20,000 could earn if invested now) is 10% a year.
- PV of ₹1,50,000 receivable in 3 years = 1,50,000 × 0.751 = ₹1,12,650, which is less than ₹1,20,000.
- So ₹1,20,000 today is better: invested at 10% it would grow to about ₹1,59,720 in three years.
- The two are equal at a rate of (1,50,000 ÷ 1,20,000)^(1/3) − 1 = 7.72% a year. Below that rate the ₹1,50,000 later is better; above it, the ₹1,20,000 now.
Where the 18.75 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Problems of profit maximisation | 5 |
| 2 | Wealth maximisation and why it is superior | 5 |
| 3 | Time value of money and the assumption | 3 |
| 4 | Present value comparison and break-even rate | 5.75 |
| Total | 18.75 |
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