ASSIGNMENT CORPORATE FINANCE

FACTORS AFFECTING FINANCIAL DECISIONS

Decisions that involve: (1) determining the proper amount of funds to employ in a firm; (2) selecting projects and capital expenditure analysis; (3) raising funds on the most favorable terms possible; and (4) managing working capital such as inventory and accounts receivable. Some of the factors that affect investment decisions, financing decisions and dividend decisions are listed in this assignment.

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FACTORS AFFECTING INVESTMENT DECISIONS

1. Return: Investments are made to earn returns. The return expectation can be
the amount received as interest, dividend received on stocks, capital appreciation on assets and many more. Different investments have different returns. Returns from an investment depend on its rating, liquidity and time horizon of the investment.

2. Risk: Savings becomes investment because of the risk factor. Different investment
products have different risk. Government securities, bank deposits have higher safety and negligible risk. Equity shares have higher risk on the other end. It can give hige profit and at the same time has the potential to erode the capital. Risk and return are directly related. Higher the risk taken, higher can be the return, similarly low return comes with low risk.

3. Safety: An investment is considered to be safe, if there is a certainty of return of

capital without any loss of the same. The safety on probable return is generally illustrated by the ratings of the investment vehicles. A (AAA) bond signifies highest possibility of return of capital with accrued benefits to the bond holder. This is a prime characteristic of investments, as every investor invests to get back his/her capital together with profit.

4. Liquidity: It is an important feature of any investment. The yield on any investment

is to an extent a function of liquidity. It can be defined as the property of an investment, wherein it can be converted in cash on demand, without loss in value. Liquidity in marketable assets are provided by the market, while non marketable assets like fixed deposits cannot be liquidated in market but can be offered for premature repayment to bank.

5. Tax efficiency: Some investments offer tax benefits, while others don't. An ideal
investment is that which offers tax efficient return commensurate to risk with safety and liquidity.

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FACTORS AFFECTING FINANCING DECISIONS

1. Companys Tax Exposure: Debt payments are tax deductible. As such, if a
company's tax rate is high, using debt as a means of financing a project is attractive because the tax deductibility of the debt payments protects some income from taxes.

2. Financial Flexibility: This is essentially the firm's ability to raise capital in bad
times. It should come as no surprise that companies typically have no problem raising capital when sales are growing and earnings are strong. However, given a company's strong cash flow in the good times, raising capital is not as hard. The lower a company's debt level, the more financial flexibility a company has. The airline industry is a good example. In good times, the industry generates significant amounts of sales and thus cash flow. However, in bad times, that situation is reversed and the industry is in a position where it needs to borrow funds. If an airline becomes too debt ridden, it may have a decreased ability to raise debt capital during these bad times because investors may doubt the airline's ability to service its existing debt when it has new debt loaded on top.

3. Management Style: Management styles range from aggressive to conservative.

The more conservative a management's approach is, the less inclined it is to use debt to increase profits. An aggressive management may try to grow the firm quickly, using significant amounts of debt to ramp up the growth of the company's earnings per share (EPS).

4. Growth Rate
Firms that are in the growth stage of their cycle typically finance that growth through debt, borrowing money to grow faster. The conflict that arises with this method is that the revenues of growth firms are typically unstable and unproven. As such, a high debt load is usually not appropriate. More stable and mature firms typically need less debt to finance growth as its revenues are stable and proven. These firms also generate cash flow, which can be used to finance projects when they arise.

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FACTORS AFFECTING DIVIDEND DECISIONS

1. Magnitude of Earnings: It serves as the introductory point for framing the
dividend policy. This is so because a company can pay dividends either from the current years profit or the past years profit. So, if the profits of a company increase, it will directly influence the dividend declaration as the latter may also increase. Thus, the dividend is directly linked with the availability of the earnings with the company.

2. Desire of Shareholders: The decision to declare the dividends is taken by

Board of Directors but they are also required to consider the desire of the shareholders, which depend on the latters economic condition. The shareholders, who are economically weak, prefer regular dividend policy while the rich shareholders may prefer capital gains as compared to dividends. However, it is very difficult for the board to reconcile the conflicting interests of different shareholders yet the dividend policy has to be framed keeping in view the interest of all the interested parties.

3. Nature of Industry: The nature of industry in which a company is operating,

influences the dividend decision. Like the industries with stable demand 172 throughout the year are in a position to have stable earnings, thus, should have the stable dividend policy and vice-versa.

4. Age of the Company: A companys age also determine the quantum of profits
to be declared as dividends. A new company should restrict itself to lower dividend payment due to saving funds for the expansion and growth as compared to the already existing companies who can pay more dividends. policy and vice-versa.

5. Taxation Policy: The tax policy of a country also influences the dividend policy
of a company. The rate of tax directly influences the amount of profits available to the company for declaring dividends.