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Principles of Finance

Describe the 10 basic principles of finance. how does these principles relate to the goal of wealth maximization.

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The response addresses the queries posted in 1940 words with references.

//Before writing about the 'Basic Principles of Finance', it is necessary to gain knowledge about the main objective of the business organization. One should know about the relation between the principle of finance and goal of wealth maximization, which further will assist in analyzing the relation, effectively//

One of the main goals of any business organization is wealth maximization. To achieve the goal of wealth maximization, it is the essential to take good financial decisions. Financial decisions are based on some rules and logic. To know these rules and logics, it is necessary to understand finance. By understanding the principles of finance, we can better understand finance. One can take a good financial decision only after understanding the finance. So, it is necessary to achieve the goal of wealth maximization to be aware of the principles of finance. These principles unite techniques and concepts of finance. To maximize the total value of the firm principles of finance helps us to focus on the logic of financial decision making.

//Above is the discussion of relation between the principle of finance and goal of wealth maximization. As per the instructions, now I will move towards the explanation of basic principle 1 and 2 of Finance.//

Principle 1

Risk-Return Trade-off- At a time, investors have more than one investment alternatives. Each alternative has a different risk and expected returns. Investors want to invest in the alternative which gives more return than the anticipated rate of return. For higher rate of return, investors put their money in risky investments because risky investments offer higher expected returns than the anticipated rate of inflation.

The Risk- Return Relationship

To achieve the goal of wealth maximization, it is essential for any organization to take additional risk. But the return of these alternatives must be higher than the anticipated rate of return to compensate this additional risk. To value the proposed new projects, stocks and bonds, risk return relationship is a key concept (which is shown above).

Principle 2

The Time value of Money- The concept of time value of money helps us in evaluating the projects. According to this principle, worth of the dollar which is received from one year now is less than the value of the dollar which is received today. Time value of money is referred as opportunity cost of capital in economics. Opportunity cost of capital is that earning potential of today's dollar which is foregone. This concept of time value of money helps us to know the present value of future cash flows.

Time value of money concept is used in measuring the wealth, to know the present value of future costs and benefits of a project. Then if the benefits of the project are more than the costs, the project should be accepted because it will create wealth. If the costs are more than the benefits of the project, the project should be rejected because the project will not create wealth for the investor. To evaluate the ...

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