Question 1 (a)
Wealth maximisation and sustainable value; future value of an annuity
9 marks
- Time to write
- About 18 minutes
Question
Question 1 (a) · 9 marksExplain the way in which wealth Maximisation emphasises sustainable value creation for shareholder. Suppose Mr Kunal puts a four-year annuity of ₹3,600 per year into a bank account paying 7% interest, compounded yearly. What will this annuity's future value be?
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
- Explain…What…?2 asks, each with its own marks below. Answer both.
What the paper leaves open
"For shareholder" is printed so and kept.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Wealth maximisation and sustainable value creation 5 marks 9 min
- 2 Future value of the annuity 4 marks 7 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Try it first. About 18 minutes for 9 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.
Wealth maximisation and sustainable value creation. Wealth maximisation judges every decision by the present value of the cash flows it will produce, discounted at a rate that reflects their timing and risk. This directs management towards lasting value rather than short-term profit:
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.
- Long-term view: cash flows over the whole life of an investment count, so a decision that lifts this year's profit but harms later years is rejected.
- Risk is priced: riskier or more distant flows are discounted more heavily, so value is created only by returns that exceed the risk-adjusted cost of capital.
- Cash, not accounting profit: value rests on cash that can actually be paid to shareholders or reinvested.
- Measured by the market: shareholders' wealth shows in the market price of the share, which reflects investors' view of the firm's future cash flows, so only decisions the market judges sustainable raise it.
Future value of Mr Kunal's annuity. The future value of an ordinary annuity is Sn = A × FVIFA(i, n), the annual deposit times the compound value factor of an annuity. Deposits of ₹3,600 at the end of each year for 4 years at 7%:
| Deposit at end of year | Years compounded | Factor (1.07ⁿ) | Value at end of year 4 (₹) |
|---|---|---|---|
| 1 | 3 | 1.2250 | 4,410.15 |
| 2 | 2 | 1.1449 | 4,121.64 |
| 3 | 1 | 1.0700 | 3,852.00 |
| 4 | 0 | 1.0000 | 3,600.00 |
| Future value | 4.4399 | 15,983.79 |
FVIFA(7%, 4) = (1.07⁴ − 1) ÷ 0.07 = 4.4399, so future value = 3,600 × 4.4399 = ₹15,983.79 (₹15,984 with the table value 4.440).
Where the 9 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Wealth maximisation and sustainable value creation | 5 |
| 2 | Future value of the annuity | 4 |
| Total | 9 |
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