Assignment#1

 Subject:
Finance For Engineers
 Topic:
Assignment: What is meant by "Shareholder Wealth
Maximization"? How does the finance cycle helps the management to
reach this goal?

 Submitted To:
Sir . Ahsan Ahmed

 Submitted By:

Muhammad Hamad Gul (21870 MSEM Sem 1)

Riphah internation School of Business &

Management, Lahore
Assignment Title: What is meant by "Shareholder Wealth
Maximization"? How does the finance cycle helps the management to
reach this goal?

Shareholder /Stake Holder Wealth Maximization:

The ability of the company to increase the value of its stock for all the
stakeholders/Shareholders is referred to as Wealth Maximization. It is a
long-term goal and involves multiple external factors Tangible &
Intangible like sales, products, services, market share, etc. It assumes
the risk and recognizes the time value of money given the business
environment of the operating entity. It is mainly concerned with the long-
term growth of the company and hence is concerned more about fetching
the maximum chunk of the market share to attain a leadership position.

Universally accepted goal of a business entity has been to increase the

wealth for the shareholders of the company as they are the actual owners
of the company who have invested their capital given the risk inherent in
the business of the company with expectations of high returns.
Finance managers are the agents of shareholders and their job is to
look after the interest of the shareholders. The objective of any
shareholder or investor would be a good return on their capital and
safety of their capital.
Both these objectives are well served by wealth maximization as a
decision criterion for business.
 Increase in Wealth = Present Value of cash inflows – Cost.

ADVANTAGES OF WEALTH MAXIMIZATION MODEL

Wealth maximization model is a superior model because it removes all the
drawbacks of profit maximization as a goal of a financial decision.
The wealth maximization is based on cash flows and not on profits.
Secondly, profit maximization presents a shorter term view as compared
to wealth maximization which present longer term.
Thirdly, wealth maximization considers the time value of money. It is
important as we all know that a dollar today and a dollar one-year latter
do not have the same value. In wealth maximization, the future cash
flows are discounted at an appropriate discounted rate to represent their
present value.
Fourthly, the wealth-maximization criterion considers the risk and
uncertainty factor while considering the discounting rate. The
discounting rate reflects both time and risk. Higher the uncertainty, the
discounting rate is higher and vice-versa.
How Finance Cycle helps to Achieve this Goal ?
Utilization of Firm Assets must be efficient its means each dollar have value
The wealth maximization as an objective to financial management and other
business decisions enables the shareholders to achieve their objectives and
therefore is superior to profit maximization. For financial managers, it is a
decision criterion being used for all the decisions. A new initiative called
“Economic Value Added (EVA)” is implemented and presented in the
annual reports of the companies. Positive and higher EVA would increase
the wealth of the shareholders and thereby create value.

Capital investment decisions of a firm have a direct relation with wealth

maximization. All capital investment projects with an internal rate of
return (IRR) greater than cost of capital or having positive NPV or creates
value for the firm. These projects earn more than the ‘required rate of
return’ of the firm. In other words, these projects maximize the wealth of
the shareholders because they are earning more than what they can earn
by investing themselves.