Indicate the correct code for the combination from the following regarding the superiority of the wealth maximisation over the profit maximisation objective of the financial management : (a) It takes into account long term stability and survival of the firm. (b) It takes care of all other objectives of the firm like exploring and expanding markets, etc. (c) It is based on the assumption of perfect competition in the market. (d) It considers risk alongwith returns. Code :
(a), (b) and (d)
(a), (b) and (d) — option 3. The exception is (c).
The two objectives. Profit maximisation was the traditional goal of the firm; wealth maximisation — maximising the market value of the shareholders’ equity — replaced it as the accepted objective of financial management, and the reasons are exactly what this question lists.
| Ground of superiority | Why it holds |
|---|---|
| (a) Long-term stability and survival | Profit maximisation is vague about when. Wealth maximisation discounts a stream of cash flows over the firm’s whole life, so decisions that boost this year’s profit at the cost of the future — deferring maintenance, cutting research — reduce value and are correctly rejected |
| (b) Accommodates the firm’s other objectives | Market expansion, brand building and employee development depress current profit but raise expected future cash flows, and therefore raise value. Wealth maximisation can account for them; profit maximisation cannot |
| (d) Considers risk along with return | The decisive advantage. Value is the present value of expected cash flows discounted at a risk-adjusted rate, so a risky rupee is worth less than a safe one. Profit maximisation treats a rupee of profit as a rupee whatever the risk taken to earn it |
Why (c) is wrong. The assumption of perfect competition belongs to the profit maximisation objective in classical economic theory, and it is one of the standard criticisms of it — real markets are imperfect. Wealth maximisation makes no such assumption; it works from cash flows, timing and risk in whatever market the firm actually faces. Recognising that (c) is an assumption rather than an advantage, and belongs to the other objective, eliminates options 1, 2 and 4 together.
The three defects of profit maximisation, which wealth maximisation is designed to cure :
| Defect | Explanation |
|---|---|
| Ambiguity | Which profit — short run or long run, before or after tax, total or per share? |
| Ignores timing | ₹100 today and ₹100 in five years are counted alike; the time value of money is disregarded |
| Ignores risk | Two projects with the same expected profit are treated as equal however different their variability |
How wealth maximisation is expressed operationally : accept a project if its net present value is positive, since NPV is precisely the addition to shareholder wealth. That is why NPV, and not the accounting rate of return, is the theoretically correct capital-budgeting criterion.
Hence, the answer is (a), (b) and (d).
Similar Questions
A public works project is proposed that has total present-worth benefits of ₹ 75 million and total present-worth cost of ₹ 55 million. In deliberating this proposal, some members of the Municipal Board have suggested that the project has a total present-worth disbenefits of ₹ 15 million; other members feel that ₹ 15 million should be treated as a cost. What will be the benefit cost ratio and net benefits value while considering the disbenefits as a cost?
Select the correct statement/s from the following :
Statement I : The slope of the NPV profile reflects how sensitive the project is to discount rate changes.
Statement II : To find total NPV of more than one projects, their NPV cannot be added.
Statement III : The certainty equivalent coefficient applies adjustments to both, the cash flows (in the numerator) and the discount factor (in the denominator).
Statement IV : The risk - adjusted discount factor applies adjustment for risk only to the discount factor (denominator).
Codes :
Capital budgeting is concerned with :
Which combination of the following statements about the net present value method of the investment project appraisal is correct ?
(a) It considers all the cash flows from the project
(b) It gives more weightage to distant flows than near-term flows
(c) It considers the time value of money
Code :
In which of the following appraisal criteria of capital budgeting, the use of varying opportunity cost of capital as a discount factor is possible ?
(a) NPV
(b) IRR
(c) Pay-back Period
(d) ARR
Select the correct statement/s from the following:
Statement I: The slope of the NPV profile reflects how sensitive the project is to discount rate changes.
Statement II: To find total NPV of more than one projects, their NPV cannot be added.
Statement III: The certainty equivalent coefficient applies adjustments to both, the cash flows (in the numerator) and the discount factor (in the denominator).
Statement IV: The risk-adjusted discount factor applies adjustment for risk only to the discount factor (denominator).
Codes:
Statement – I : In general, the NPV and IRR methods lead to the same acceptance or rejection decision when a single project is involved.
Statement – II : The inconsistency in ranking of competing projects as per the NPV and IRR methods lies in the implicit assumptions with regard to different rates of returns on re-investment of intermediate cash flows.
Code :
Under the Modified Accelerated Cost Recovery System (MACRS) an asset in the “5 year property class” would typically be depreciated over how many years ?
In case the firm makes varying investments on the different investment projects, the appropriate project evaluation technique would be, which one of the following?
A company issues 11% debentures of ₹ 100 each for an amount aggregating ₹ 2,00,000 at 10% premium, redeemable at par after 5 years. The company tax rate is 40%. The cost of debt is:
Important Questions from Capital Budgeting
- Assume B is social benefits, C is social costs, r is the social discount rate, t is the time and T is the life of the investment project. The Net Present Value (NPV) of a project is
- In certainty-equivalent approach, risk adjusted cash flows are discounted at
- Statement - I : In payback period method, the risk of the project is adjusted by lessening the target payback period.
Statement - II : Sensitivity Analysis helps in calculation of net present value of the proposal.
Code : - Which one of the following equates the present value of cash out flows and the present value of expected cash inflows from a project ?
A public works project is proposed that has total present-worth benefits of ₹ 75 million and total present-worth cost of ₹ 55 million. In deliberating this proposal, some members of the Municipal Board have suggested that the project has a total present-worth disbenefits of ₹ 15 million; other members feel that ₹ 15 million should be treated as a cost. What will be the benefit cost ratio and net benefits value while considering the disbenefits as a cost?
