UNIVERSITY OF CAPE COAST

COLLEGE OF DISTANCE EDUCATION (CoDE)

DEPARTMENT OF BUSINESS STUDIES

SCHOOL OF GRADUATE STUDIES

MBA (FINANCE) PROGRAMME – 2018/19

FINANCIAL MANAGEMENT
FIN 801
ASSIGNMENT
Distinguish between Profit Maximization and Wealth Maximization. Outline Four (4)
limitations of Profit maximization.

BY

ALFRED DAZUGO

SB/DFN/18/0243

SUBMITTED ON

13TH JULY, 2019

Distinction between Profit Maximization and Wealth Maximization
Traditionally organizations were primarily focused on profit maximization. Profit maximization is
a short term strategy and focuses on making profits in the short term, which may result in taking
courses of action that could be harmful in the long term. A firm’s management is generally
interested in profit maximization and strives to reach projected monthly, quarterly, and annual
revenue. The goal of profit maximization is pursued by management because of the pressure put
on them by stakeholders to achieve profit goals set. Management may also be concerned with
profit maximization as this directly influences their remuneration, bonuses, and benefits.

Wealth maximization takes on a different, modern approach where organizations focus on

maximizing wealth in the long run as opposed to making short term gains. Wealth maximization
focuses on increasing the overall value of the business entity over time, instead of looking at profits
made during the short term. Wealth maximization is preferred by most shareholders who are
willing to sacrifice short term profits in order to make longer term returns. Since shareholders are
the owners of the firm, they will focus more on the longer term wealth created by the firm and will
like to see greater reinvestment made presently to achieve greater value in the future. Wealth
maximization goal is achieved when the market value of shares increase; this is one major reason
why shareholders focus on wealth maximization. As market value of shares increase (as a result
of the wealth maximization goal), shareholders can sell their shares at a higher price, thereby
making larger capital gains.

Conclusion
There is always a contradiction between Profit Maximization and Wealth Maximization. We
cannot say that which one is better, but we can discuss which is more important for a company.
Profit is the basic requirement of any entity. Otherwise, it will lose its capital and cannot be able
to survive in the long run. But, as we all know, the risk is always associated with profit or in the
simple language profit is directly proportional to risk and the higher the profit, the higher will be
the risk involved with it. So, for gaining the larger amount of profit a finance manager has to take
decisions which will boost the profitability of the enterprise. Therefore, it can be said that for day
to day decision making, Profit Maximization can be taken into consideration as a sole parameter
but when it comes to decisions which will directly affect the interest of the shareholders, then
Wealth Maximization should be exclusively considered.

Four (4) limitations of profit maximization are:

1. In Profit Maximization, profit is not defined precisely or correctly. It creates some

unnecessary opinion regarding earning habits of the business concern. For example, profit
may be long term or short term. It may be total profit or rate of profit. It may be net profit
before tax or net profit after tax. It may be return on total capital employed or total assets
or shareholders equity and so on.
2. It ignores the time value of money. Profit maximization does not consider the time value
of money or the net present value of the cash inflow. It leads certain differences between
the actual cash inflow and net present cash flow during a particular period. When the
profitability is worked out the bigger the better principle is adopted as the decision is based
on the total benefits received over the working life of the asset, Irrespective of when they
were received.
3. It ignores the quality aspects of benefits which are associated with the financial course of
action. The term 'quality' means the degree of certainty associated with which benefits can
be expected. Therefore, the more certain the expected return, the higher the quality of
benefits. As against this, the more uncertain or fluctuating the expected benefits, the lower
the quality of benefits.
4. It ignores risk. Profit maximization does not consider risk of the business concern. Risks
may be internal or external which will affect the overall operation of the business concern.