Question

Write a two-page paper that explains how corporations make investing decisions. In other words, corporations can reinvest in their own business or they could invest in other businesses, perhaps their suppliers.

Answer 1

The most important thing in business is FINANCE. Financing decision decides the future of the company. But the utmost question lies with the finance managers is WHERE DOES THIS FINANCE COMES FOR? The most obvious answer are Equty or Debt or Loan.

But the question arises whether or not companies can invest their in own business and how so?

1. Today, companies earn a huge chunk of profits. Recently Apple Inc crossed 1 Trillion Dollar in Market capitalisation is the latest example of company profitability. Now these profits are used for Reinvesting in their own business or any another business the company may like. Generally what companies does is they simply form a new company. For example lHOLDING CO. Earn huge profits so they incorporate a new company and invest their money in form of EQUITY SHARES of such SUBSIDIARY COMPANY. Now with the money received from such issued capital subsidiary company starts doing business and thereafter makes profit or loss. Now if the holding co thinks that it performed well they merge or amalgamate this subsidiary company with itself. Real life example for this situation : TATA BEVERAGES LTD forms a subsidiary company TETLEY BEVERAGES and when the product ran successfully in global market TATA BEVERAGES LTD merged TETLEY BEVERAGES with themselves and now Tetley is a brand under TATA BEVERAGES. .

2. Reinvesting in own business can also be made by way of DEPARTMENTALISATION ie creating small departments and appointing Departmental heads. The most common example for this investment model iS UNILEVER INC as they have different departments for different products example SOAP DEPARTMENTS which cover brands such as Dove, Lux etc , then ORAL DEPARTMENT covering Colgate etc.

Now as discussed earlier, different sources of finance are Equity, Debt, Loan and Profits earned( called as RETAINED EARNINGS). Now why should company choose retained earnings over other source of finace!? The answer for this question is because Retained Earning are the cheapest source of finance as Equity will Dilute the shareholders holding and Debt and Loan will increase the Interest burden on company whereas Retained Earnings will only increase the profits of company without hampering shareholder’s holding and without increasing any interest burden.

Can companies also invest in other business eg suppliers?

Yes, by purchasing equity shares of such another company, the company can invest in their business too. BERKSHIRE HATHAWAY INC make its fortune by investing in others business. Another conglomerates like Reliance Industries Ltd also invest in diversified business.