Question 1 OR (a)
Is profit maximisation an operationally feasible criterion?
6 marks
- Time to write
- About 12 minutes
Question
Question 1 OR (a) · 6 marks"The profit maximization criterion for financial decision-making is operationally feasible." Explain, with arguments, whether this statement is true or false?
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
- true or…A verdict for each (True or False), then the reason that decides it.
- ExplainTie the answer to the quoted statement: say what it means first, and come back to it at the end.
Write it in this order
A step that gives the answer away stays hidden: tap it to see it.
- Read each statement; find the word that decides it 1 min
- 1 Statement identified as false 1 mark 2 min
- 2 Arguments: vagueness, timing, risk, financing 4 marks 7 min
- 3 Wealth maximisation as the operational alternative; conclusion 1 mark 1 min
- Check: a verdict and a reason for every statement 1 min
Short on time? Step 2 carries 4 of the 6 marks: guard its minutes.
Try it first. About 12 minutes for 6 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 statement is false. Profit maximisation is not an operationally feasible criterion for financial decisions. The DU text concludes that it is "inappropriate and unsuitable as an operational objective of financial management". The arguments are these.
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.
Arguments against the statement
- Profit is vague. The criterion does not say which profit is to be maximised: short-term or long-term, before or after tax, total profit or the rate of profit. A criterion that cannot be stated exactly cannot guide a decision.
- It ignores the timing of benefits. It treats ₹1 of profit this year and ₹1 in five years alike, so it ignores the time value of money and cannot rank projects whose returns come at different times.
- It ignores risk. Every profitable opportunity is accepted, whatever its risk; two projects with the same expected profit but very different uncertainty look equal.
- It ignores the financing side. It looks only at profitability, not at how the decision is financed and the risk of that financing; a firm may even borrow beyond its capacity to fund a profitable project.
Maximising the return on investment, a variant often suggested, steers decisions the same way and has the same defects.
The feasible alternative. Wealth (value) maximisation removes these defects. It judges a decision by the present value of the cash flows it generates, discounted at a rate that reflects their risk and timing, and its result shows in the market price of the share. Because the benefit, its timing and its risk are all defined, it can be applied to real decisions, which is why it is the accepted operational criterion.
Conclusion. Profit maximisation is a sound everyday aim of a business, but as a rule for choosing among financial alternatives it is not operationally feasible. The statement is therefore false.
Where the 6 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Statement identified as false | 1 |
| 2 | Arguments: vagueness, timing, risk, financing | 4 |
| 3 | Wealth maximisation as the operational alternative; conclusion | 1 |
| Total | 6 |
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