Wealth Maximisation Approach

Value Maximisation Approach or Maximum net present worth.

According to this approach , financial management should take such decision’s which increase net present value of the firm and should not undertake any activity which decrease net present value. This approach eliminates all the 3 basic crificisms of the profit maximisation approach.

As the value of an asset is considered from view point of profit accruing from it, in the same manner the evaluation of an activity depends on the profits arising from it. Therefore, all 3 main decisions of financial manager-financing decision, investment decision dividend decision affect net present value of the firm. The greater the amount of net present value, the greater will be value of firm and more it will be in the interest of share holders. When the value of firm increases, the market price of equity shares also increase. Thus to maximise net present worth means to maximise the market price of shares.

This approach is considered good for the companies in present situation. This approach gives due consideration to the time value of expected income receivable over different period of time. Under this approach, risk and uncertainty is analysed with the help of interest rate. If uncertainity & time period are greater, higher rate of interest will be used to calculate present value of expected future cash benefits where as the interest rate will be lower for the projects with low risk & uncertainity. Besides, this approach uses cash flows instead of accounting profits which removes ambiguity associated the term profit.

On the basis of above explanation, we can conclude that wealth maximisation approach is better to profit maximisation approach to establish mutual relation among the various data. It is possible only through statistics. Cash and inventory management, forecast of financial needs, credit policy decision all are based on the advanced techniques of statistics.

Finance is also related to law. Any decision regarding financial policy should be in line with the laws of the country.