Wealth maximization is the concept of increasing the value of a business in order to increase the value of the shares held by stockholders. The concept requires a company’s management team to continually search for the highest possible returns on funds invested in the business, while mitigating any associated risk of loss.
Wealth maximization simply means maximization of shareholder’s wealth. It is a combination of two words viz. wealth and maximization. A wealth of a shareholder maximizes when the net worth of a company maximizes.
- Measurement of Wealth
- Market Value of Shares
- Common Goal
- D’s Of Financial Decisions
- Shareholder’s Expectations
1. Measurement of Wealth
The main Principle of financial management is the Maximization of Shareholders Wealth. Shareholder’s Wealth is measured on the basis of economic value. Economic value is based on cash flows and not profit. Economic Value is defined as: “The present value of future cash flows generated by a decision, discounted at appropriate rate of discount which reflects the degree of associated risk“.
2. Market Value of Shares
The future cash flow is estimated for the present value. The present value is the Market price of share. As Shareholder’s wealth is equal to the market price of shares held by him, any increase in Market price of shares would result in an increase in Shareholder’s Wealth.
3. Common Goal
The Maximization of Shareholder’s Wealth is the common goal between the Shareholders and the Management. The recognition of this goal motivates the Management to allocate the available resources in an optimum way.
4. 3 D’s Of Financial Decisions
The Maximization of Shareholder’s wealth indicates that the Market price of share is related to three basic financial decisions:
The investment decisions,
The financing decision,
The dividend decision.
5. Shareholder’s Expectations
Shareholder’s expectations are about future cash flows based on current cash flows and projected future growth. The market price of share shows these expectations.