Wealth / Value Maximisation
We will first like to define what is Wealth / Value Maximization Model. Shareholders wealth are the result of cost benefit analysis adjusted with their timing and risk i.e. time value of money.
So,
Wealth = Present value of benefits – Present Value of Costs
It is important that benefits measured by the finance manager are in terms of cash flow. Finance manager should emphasis on Cash flow for investment or financing decisions not on Accounting profit. The shareholder value maximization model holds that the primary goal of the firm is to maximize its market value and implies that business decisions should seek to increase the net present value of the economic profits of the firm. So for measuring and maximising shareholders wealth finance manager should follow:
- Cash Flow approach not Accounting Profit
- Cost benefit analysis
- Application of time value of money.
How do we measure the value/wealth of a firm? According to Van Horne, “Value ofa firm is representedby the marketpriceof the company’s common stock. The market price of a firm’s stock represents the focal judgment of all market participants as to what the value of the particular firm is. It takes into account present and prospective future earnings per share, the timing and risk of these earnings, the dividend policy of the firm and many other factors that bear upon the market price of the stock. The market price serves as a performance index or report card of the firm’s progress. It indicates how well management is doing on behalf of stockholders
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