Question

Discuss how dividen, investment and financing interact ? (500words)

Does dividen payment affect the firm's value or the original shareholders' wealth ? Why (500words)

Answer 1

Ans 1) Investment, financing & dividend decisions. It is correct to say that these decisions are inter related because the underlying objective of these 3 decisions is the same, i.e. maximisation of shareholder's wealth. Since investment, financing & dividend decisions are all interrelated, one has to consider the joint impact of these decisions on the market price of the company's share & these decisions should also be solved jointly.The decision to invest in a new project needs the financing for the investment. The financing decision, in turn, is influnced by & influences dividend decision because retained earnings used internal financing deprive shareholders of their dividends. An efficient financial management can ensure optimal joint decisions. This is possible by evaluating each decision in relation to its effect on the shareholder's wealth.

Financing Decision

Financial decision is important to make wise decisions about when, where and how should a business acquire fund. Because a firm tends to profit most when the market estimation of an organization’s share expands and this is not only a sign of development for the firm but also it boosts investor’s wealth. Consequently, this relates to the composition of various securities in the capital structure of the company.

Factors affecting Financing Decisions

• Cost: Financing decisions are all about allocation of funds and cost-cutting. The cost of raising funds from various sources differ a lot. The most cost-efficient source should be selected.
• Risk: The dangers of starting a venture with the funds from various sources differ. Larger risk is linked with the funds which are borrowed, than the equity funds. This risk assessment is one of the main aspects of financing decisions.
• Cash flow position: Cash flow is the regular day-to-day earnings of the company. Good or bad cash flow position gives confidence or discourages the investors to invest funds in the company.
• Control: In the situation where existing investors need to hold control of the business then finance can be raised through borrowing money, however, when they are prepared for diluting control of the business, equity can be utilized for raising funds. How much control to give up is one of the main financing decisions.
• Condition of the market: The condition of the market matter a lot for the financing decisions. During boom period issue of equity is in majority but during a depression, a firm will have to use debt. These decisions are an important part of financing decisions.

Dividend Decision

Dividends decisions relate to the distribution of profits earned by the organization. The major alternatives are whether to retain the earnings profit or to distribute to the shareholders.

Factors Affecting Dividend Decisions

• Earnings: Returns to investors are paid out of the present and past income. Consequently, earning is a noteworthy determinant of the dividend.
• Dependability in Earnings: An organization having higher and stable earnings can announce higher dividend than an organization with lower income.
• Balancing Dividends: For the most part, organizations attempt to balance out dividends per share. A consistent dividend is given every year. A change is made, if the organization’s income potential has gone up and not only the income of the present year.
• Development Opportunity: Organizations having great development openings if they hold more cash out of their income to fund their required investment. The dividend announced in growing organizations is smaller than that in the non-development companies.

Investment Decision

These are also known as Capital Budgeting Decisions. A company’s assets and resources are rare and must be put to their utmost utilization. A firm should pick where to invest in order to gain the highest conceivable returns.This decision relates to the careful selection of assets in which funds will be invested by the firms. The firm puts its funds in procuring fixed assets and current assets. When choice with respect to a fixed asset is taken it is known as capital budgeting decision.

Factors Affecting Investment Decision

• Cash flow of the venture: When an organization starts a venture it invests a huge capital at the start. Even so, the organization expects at least some form of income to meet everyday day-to-day expenses. Therefore, there must be some regular cash flow within the venture to help it sustain.
• Profits: The basic criteria for starting any venture is to generate income but moreover profits. The most critical criteria in choosing the venture are the rate of return it will bring for the organization in the nature of profit for, e.g., if venture A is getting 10% return and venture В is getting 15% return then one must prefer project B.
• Investment Criteria: Different Capital Budgeting procedures are accessible to a business that can be utilized to assess different investment propositions. Above all, these are based on calculations with regards to the amount of investment, interest rates, cash flows and rate of returns associated with propositions. These procedures are applied to the investment proposals to choose the best proposal.

Ans 2) When a company pays cash dividends to its shareholders, its stockholders' equity is decreased by the total value of all dividends paid. However, the effect of dividends changes depending on the kind of dividends a company pays. As we'll see, stock dividends do not have the same effect on stockholder equity as cash dividends.

When a company is doing well and wants to reward its shareholders for their investment, it issues a dividend.Dividends also offer a good way for companies to communicate their financial stability and profitability to the corporate sphere in general. Stocks that issue dividends tend to be fairly popular among investors, so many companies pride themselves on issuing consistent and increasing dividends year after year. In addition to rewarding existing shareholders, the issuing of dividends encourages new investors to purchase stock in a company that is thriving.

Dividends are generally paid in cash or additional shares of stock, or a combination of both. When a dividend is paid in cash, the company pays each shareholder a specific dollar amount according to the number of shares they already own. A company that declares a $1 dividend, therefore, pays $1,000 to a shareholder who owns 1,000 shares.

In a stock dividend, shareholders are issued additional shares according to their current ownership stake. If the company in the above example issues a 10% stock dividend instead, the shareholder receives an additional 100 shares. Some companies offer shareholders the option of reinvesting a cash dividend by purchasing additional shares of stock at a reduced price.

Stockholder equity represents the capital portion of a company's balance sheet.The stockholders equity can be calculated from the balance sheet by subtracting a company's liabilities from its total assets. Although stock splits and stock dividends affect the way shares are allocated and the company share price, stock dividends do not affect stockholder equity.

Stockholder equity also represents the value of a company that could be distributed to shareholders in the event of bankruptcy. If the business closes shop, liquidates all its assets, and pays off all its debts, stockholder equity is what remains. It can most easily be thought of as a company's total assets minus its total liabilities.

One of the chief components of stockholder equity is the amount of money a company raises through the sale of shares of stock, called equity capital. However, even private companies, which are not publicly traded, have stockholder equity.

Though uncommon, it is possible for a company to have a negative stockholder equity value if its liabilities outweigh its assets. Because stockholder equity reflects the difference between assets and liabilities, analysts and investors scrutinize companies' balance sheets to assess their financial health.