Sources of Corporate Finance: Retained Earnings

Question 1

Retained Earnings

Answer 1

It is defined as the percentage of net earnings that are kept by the company in order to pay debt or to be reinvested in its core business.
Cash available to invest into real assets.

Question 2

Real Assets

Answer 2

They are tangible assets that have value. They are not financial assets and their value depends on their own intrinsic and inherent qualities,

• Commodities and precious metals
• Machinery and Equipment
• Real estate and agricultural land

Question 3

How much will we pay out to shareholders?

Answer 3

• The more paid out as dividend, the less that is retained for reinvestment.
• Some companies will just buy back shares instead of issuing dividends.

Question 4

Where will we get the rest from to make the investment?

Answer 4

Debt and Equity

Question 5

Advantages of Retained Earnings

Answer 5

• Available
• Easy to access
• No issue costs
• First choice in ‘pecking order’ theory

Question 6

Disadvantages of Retained Earnings

Answer 6

• Avoids market discipline (companies don’t have any particular obligation to set constraints on where to invest)
• Managers can avoid having to explain and promote a project if they do no raise funds externally