1.2. Investing & Financing Activities Flashcards
Investing decisions…
Capital budgeting / expenditure decisions - how, where and what to do with money that has been raised.
Can be in tangible or intangible assets (including financial assets).
Must identify an opportunity, evaluate and analyse the benefits and costs, implement the project and then conduct a review.
The more important of the two decisions.
Financing decisions…
Capital structure decisions - how is money raised.
Equity financing:
- Through an IPO, seasoned offerings and retained earnings. May prefer this as there is no interest or principal to repay. However, they must give up a portion of control over the business.
Debt financing:
- Short- or long-term borrowing from a lender. Principal must be repaid plus any interest. May prefer this as it is safer as the firm knows how much they must repay in advance and offers no ownership rights. Interest is also tax deductible.
Four factors affecting financing decisions…
Stage of life cycle: younger firms may find it difficult to get large payments from banks as they are newer and unestablished, so it may prefer equity financing.
Earnings of the business: if a firm has stable revenues, it can afford debt.
Size of the business: smaller-sized firms face difficulties raising long-term borrowings.
Market conditions: in recession / bearish markets, firms may struggle to sell stock on the markets. Debt financing may also be difficult in these situations though as banks are hesitant to loan money.
Goal of maximising stock price…
Maximising stock price represents the prospects of the corporation in the long-term and is considered a good management approach to focus on.
Individuals are rational and will want the best for themselves. This means resources must be efficiently used otherwise investors may look elsewhere for profit. (Shareholders want to be as rich as possible).
However, attempting to maximise the share price may lead to illicit activities, if management attempt to fraudulently increase the stock price.
Overall, the number one aim is to maximise the stock price and maximise the wealth of the shareholder.
Goal of maximising profit…
This is not ideal.
Profit figures can be manipulated by firms to make a corporation appear to be doing better than it actually is.
For example, a corporation may reduce R&D or reduce staff levels, all while actually underperforming still.
This reduces the long-term outlook of the profitability of the firm.
This does not add value to the shareholder.
