Uncertainty About Expected Benefits (Profits)

TABLE 1.2

Uncertainty About Expected Benefits (Profits

Uncertainty About Expected Benefits (Profits)

 It is dear from Table 1.2 that the total returns associated with the two alternatives are identical in a normal situation but the range of variations is very wide in case of alternative B, while it is narrow in respect of alternative A. To put it differently, the earnings associated with alternative B are more uncertain (risky) as they fluctuate widely depending on the rate of the economy. Obviously, alternative A is better in terms of risk and uncertainty. The profit maximization criterion fails to reveal this.

To conclude, the profit maximization criterion is inappropriate and unsuitable as an operational objective of investment, financing and dividend decisions of a firm. It is not only vague and ambiguous but it also ignores two important dimensions of financial analysis, namely, risk, and time value of money, It follows from the above that an appropriate operational decision criterion for financial management should (i) be precise and exact, (ii) be based on the bigger the better principle, (iii) consider both quantity and quality dimensions of benefits, and (iv) recognize the time value of money. The alternative to profit maximization that is, wealth maximization is one such measure.

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