The probable and important question(theory) of finance from chapter 1

Probable question of financial management from exam point of view

Difference between Profit Maximization and Wealth Maximization

Basis	Profit Maximization	Wealth Maximization
objectives	This approach consider those action which increase its profit as a main goal	This approach consider those action which  increase earning per share as its main goal
Clarity	Profit maximization is clear to understand but hard to interpret, because profit may have different meaning i.e profit after tax, before tax, Net, gross etc.	Wealth maximization denotes to the net present value, so it can be easily interpreted.
Time value of Money	Profit maximization doesn't consider the time value of money i.e there is no difference between Rs. 1000 of this year and next year.	Wealth maximization consider the time value of money. i.e the cash flow of this year is more useful than next year.
Risk element	It doesn't consider risk element among different financial plan.	It consider risk element as a vital factor for determining financial plan among different plan
Qualitative factor	Profit maximization goal doesn't consider the social responsibility, staff satisfaction etc.	It consider the organization prestige, public relation along with social responsibility.
Suitability	This type of goal is suitable for short term period	This type of goal is suitable and profitable for long term period.

Does profit maximization also result in stock price maximization? Under what circumstances might profit maximization not lead to stock price maximization?

In general to increase wealth of shareholder there must be a profit in an organization. But in every cases, increase in profit can't result increase in EPS. To increase the price of share, there must be an increase in earning per share, constant cash flow, good dividend policy as well as proper ratio between share and debenture ( capital structure). For example X co. earn profit of Rs. 100000 and No. of share is 10000 than EPS is Rs. 10, and Market price per share (MPS) will be 5 times of EPS equal to Rs 50. Let X co. achieves profit of Rs. 160000 by issuing 10000 shares, and capitalizing them, then EPS will be Rs. 8 (160000/20000). Now MPS will be 5 time of EPS which means 8*5= Rs 40.

In such case, we can  conclude that, organization increase his profit from Rs. 100000 to 160000 but the result is opposed to EPS and MPS because it reduce from Rs. 10 to Rs. 8 and Rs 50 to Rs. 50 respectively. Thus in every circumstance the profit maximization can't result wealth maximization.

The following circumstance profit maximization can't result increase in MPS.

i) Projected EPS: If increase in profit result decrease in EPS, then MPS will be reduced and vice versa.

ii) Time Element: Present value of benefit from projected plan determines E
PS. Other things remaining same, if the current cash flow of an organization is greater than cash flow of coming year., The EPS will increase. So time element affects the EPS of firm.

iii) Risk Element: The organization having constant cash flow, has its high value of EPS, than having dynamic cash flow. The dynamic cash flow denotes more risk, so it may reduce EPS.

iv) Use of Debt: In general, increasing in debenture than equity share , result increase in EPS. Thus in the case of equal profit among alternatives, the organization not issuing debenture will be reduced.

v) Dividend Policy: An appropriate dividend policy contributes to increase the stock price, dividend policy saving the income tax of the investor increase the EPS. Stable dividend policy increase EPS where as fluctuating dividend reduces the EPS.