Question

A. Explain the importance of conducting an environmental scan. Also include a discussion of the forces of an environmental scan.

B. Explain the significance of a required rate of return.

C. Explain the relationship between the life cycle concept and dividend policy.

Answer 1

A. Explain the importance of conducting an environmental scan. Also include a discussion of the forces of an environmental scan:

• Environmental scanning is necessary because there are rapid changes taking place in the environment that has a great impact on the working of the business firm. Analysis of business environment helps to identify strength weakness, opportunities and threats
• Every organization has an internal and external environment. In order for the organization to be successful, it is important that it scans its environment regularly to assess its developments and understand factors that can contribute to its success. Environmental scanning is a process used by organizations to monitor their external and internal environments.

Forces :

• Events – These are specific occurrences which take place in different environmental sectors of a business. These are important for the functioning and/or success of the business. Events can occur either in the internal or the external environment. Organizations can observe and track them.
• Trends – As the name suggests, trends are general courses of action or tendencies along which the events occur. They are groups of similar or related events which tend to move in a specific direction. Further, trends can be positive or negative. By observing trends, an organization can identify any change in the strength or frequency of the events suggesting a change in the respective area.
• Issues – In wake of the events and trends, some concerns can arise. These are Issues. Organizations try to identify emerging issues so that they can take corrective measures to nip them in the bud. However, identifying emerging issues is a difficult task. Usually, emerging issues start with a shift in values or change in which the concern is viewed.
• Expectations – Some interested groups have demands based on their concern for issues. These demands are Expectations.

B. Explain the significance of a required rate of return:

The required rate of return is the minimum return an investor expects to achieve by investing in a project. An investor typically sets the required rate of return by adding a risk premium to the interest percentage that could be gained by investing excess funds in a risk-free investment.

The required rate of return is useful as a benchmark or threshold, below which possible projects and investments are discarded. Thus, it can be an excellent tool for sorting through a variety of investment options. However, management might deliberately opt to ignore this metric and invest heavily in an area considered to be of long-term strategic importance to t

C. Explain the relationship between the life cycle concept and dividend policy:

• Empirical literature on life cycle theory of dividends relies on the notion that firms at early stage of their life cycle need to inject more capital to increase their growth opportunities. As the result, firms pay lower dividends, maintain low retained earnings to total equity ratio and face lower agency problems. On the basis of the research by DeAngelo et al. (2006), many of the later studies were in agreement that low retained earnings to total equity (RE/TE) ratio reflects growth firms, however, high RE/TE ratio reflects mature firms where retained earnings may get bigger in size due to low growth prospects at mature stage of life cycle
• The firm life cycle theory of dividends (Baker, 2009) is based on the notion that as a firm matures, its ability to generate cash overtakes its ability to find profitable investment opportunities. Eventually, the optimal choice is for the firm to distribute its free cash flow to shareholders in the form of dividends. According to the firm life cycle theory of dividends, a young firm faces a relatively large investment opportunity set but is not sufficiently profitable to be able to meet all its financing needs through internally generated cash. As a result, the firm will conserve cash by forgoing dividend payment to shareholders. Over time, after a period of growth, the firm reaches the maturity stage in its life cycle. At this point, the firm’s investment opportunity set is diminished, its growth and profitability have flattened, systemic risk has declined, and the firm generates more cash internally than it can profitably invest. Eventually, the firm begins paying dividends to distribute its earnings to shareholders.