Why is shareholder wealth affected by safety and liquidity? Solution Maximistion of Shareholder Wealth is the avowed objective of Financial Management. It is the central theme on which the whole of the theory of financial management is built. As we all know financial management comprises the whole gamut of concepts underlying the three main decisions that financial managers take, namely, the investing, financing and dividend (or buy back) decisions. While investing is about deciding how much to invest, in which assets to invest; financing is about decisions as to wherefrom to source the finance required for the investments and at what cost, and dividend decision is about whether to distribute profits or retain it for further investment. While making the investment, financing or dividend decisions the objective is \'Maximisation of Shareholder Wealth\'. Maximisation of shareholder wealth means maximising the present worth of the shareholders. Every decision that is taken should increase the shareholders present worth. It is due to this reason that alternatives with positive NPVs are accepted and further alternatives with higher positive NPVs are preferred. While maximising share holder wealth or more precisely the present worth of decisions, the alternatives with higher returns are preferred as they tend to give higher NPVs when discounted with the firm\'s COC. Higher returns come with greater risks as to the safety and liquidity of the investments made. By safety is meant the assurance for return of the capital and the projected return. By liquidity is meant the ease with which the investment made can be liquidated without any significant loss of value. Unless these two elements are factored in, in the decision making process, share holder wealth cannot be truly maximised. Safety and liquidity are related to the riskiness of the investment made. Risky investments have to be evaluated by making adjustments for the increased riskiness inherent in the investment. This can be done by increasing the required rate of return or weighting the cash flows for the riskiness. A rational investor would be doing such an analysis before investing. Hence, Shareholder wealth is influenced by safety and liquidity. .

1. Why is shareholder wealth affected by safety and liquidity?
Solution
Maximistion of Shareholder Wealth is the avowed objective of Financial Management. It is the
central theme on which the whole of the theory of financial management is built.
As we all know financial management comprises the whole gamut of concepts underlying the
three main decisions that financial managers take, namely, the investing, financing and dividend
(or buy back) decisions.
While investing is about deciding how much to invest, in which assets to invest; financing is
about decisions as to wherefrom to source the finance required for the investments and at what
cost, and dividend decision is about whether to distribute profits or retain it for further
investment.
While making the investment, financing or dividend decisions the objective is 'Maximisation of
Shareholder Wealth'. Maximisation of shareholder wealth means maximising the present worth
of the shareholders. Every decision that is taken should increase the shareholders present worth.
It is due to this reason that alternatives with positive NPVs are accepted and further alternatives
with higher positive NPVs are preferred.
While maximising share holder wealth or more precisely the present worth of decisions, the
alternatives with higher returns are preferred as they tend to give higher NPVs when discounted
with the firm's COC. Higher returns come with greater risks as to the safety and liquidity of the
investments made.
By safety is meant the assurance for return of the capital and the projected return. By liquidity is
meant the ease with which the investment made can be liquidated without any significant loss of
value. Unless these two elements are factored in, in the decision making process, share holder
wealth cannot be truly maximised.
Safety and liquidity are related to the riskiness of the investment made. Risky investments have
to be evaluated by making adjustments for the increased riskiness inherent in the investment.
This can be done by increasing the required rate of return or weighting the cash flows for the

2. riskiness. A rational investor would be doing such an analysis before investing. Hence,
Shareholder wealth is influenced by safety and liquidity.