Financing decision

The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerned with the borrowing and allocation of funds required for the investment decisions

1. Financing Decision Dr. D.Shoba MBA, M.Phil , Ph.D

2. Financing Decision The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerned with the borrowing and allocation of funds required for the investment decisions Dr. D.Shoba MBA, M.Phil, Ph.D

3. Sources of Financing decision The financing decision involves two sources from where the funds can be raised: Using a company’s own money, such as share capital, retained earnings Borrowing funds from the outside in the form debenture, loan, bond, etc. Dr. D.Shoba MBA, M.Phil, Ph.D

4. Types of Financing Decision Investment decision Financing Decision Dividend Decision Dr. D.Shoba MBA, M.Phil, Ph.D

5. Investment Decisions 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. Dr. D.Shoba MBA, M.Phil, Ph.D

6. Factors influencing Investment decisions 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 most critical criteria in choosing the venture are the rate of return it will bring for the organization in the nature of profit . Investment Criteria : Different Capital Budgeting procedures are accessible to a business that can be utilized to assess different investment propositions. Dr. D.Shoba MBA, M.Phil, Ph.D

7. Investment decisions encompass wide and complex matters involving the following areas Cost of Capital Cost of Capital Measuring Risk Management of Liquidity and current assets Expansion and contraction involving business failure and re- organisations . Buy or hire or lease an asset. Dr. D.Shoba MBA, M.Phil, Ph.D

8. 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 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. Dr. D.Shoba MBA, M.Phil, Ph.D

9. Factors influencing 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. Dr. D.Shoba MBA, M.Phil, Ph.D

10. Factors influencing Financing decisions 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. Dr. D.Shoba MBA, M.Phil, Ph.D

11. Dividend Decisions 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. Dr. D.Shoba MBA, M.Phil, Ph.D

12. Factors Influencing 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. Dr. D.Shoba MBA, M.Phil, Ph.D

13. Simulation of Financing Decisions Firms regularly make new investments; the needs for financing and financial decisions are ongoing. Hence, a firm will be continuously planning for new financial needs. The financing decision is not only concerned with how best to finance new assets, but also concerned with the best overall mix of financing for the firm. A finance manager has to select such sources of funds which will make optimum capital structure. The important thing to be decided here is the proportion of various sources in the overall capital mix of the firm. The debt-equity ratio should be fixed in such a way that it helps in maximizing the profitability of the concern. Dr. D.Shoba MBA, M.Phil, Ph.D

14. Simulation of Financing Decisions The raising of more debts will involve fixed interest liability and dependence upon outsiders. It may help in increasing the return on equity but will also enhance the risk. The raising of funds through equity will bring permanent funds to the business but the shareholders will expect higher rates of earnings. The financial manager has to strike a balance between various sources so that the overall profitability of the concern improves. If the capital structure is able to minimize the risk and raise the profitability then the market prices of the shares will go up maximizing the wealth of shareholders. Dr. D.Shoba MBA, M.Phil, Ph.D

15. Decision Criteria A fair decision criterion should follow the following two fundamental principles Bigger and Better A Bird in Hand is Better than Two in the bush A bigger benefits are preferable to smaller ones Early benefits are preferable to later benefits Dr. D.Shoba MBA, M.Phil, Ph.D

16. Decision Criteria Urgency Pay back decisions Rates of Return Undiscounted benefits- Cost ratio discounted benefits- Cost ratio Present Value method Internal rate of returns Dr. D.Shoba MBA, M.Phil, Ph.D

17. Determining the probability of agency cost The agency cost of our model is defined as the difference of the two equity (option) measures. The first is the measure of equity value when the firm is allowed to sell assets to meet debt obligations of current period (E) and the second is the measure of equity value when the firm is prohibited from selling assets to meet debt obligations of current period (E). Dr. D.Shoba MBA, M.Phil, Ph.D

18. Determining the probability of agency cost E*(A,K 1, K 2 , r, σ, h) –E(A,K 1, K 2 , r, σ, h) where A is the asset value of the firm, K 1 is the debt and expense payouts of current period , K 2 is the equivalent debt, is the risk-free rate, σ is the volatility of asset value, and h is the measure time period. Dr. D.Shoba MBA, M.Phil, Ph.D

19. Determining the probability of agency cost The definitions of six variables can be decomposed as the following. The equivalent debt (K 2 ) is defined K 2 =ED =SD+OD *0.75 +LD*0.5 as where ED is the equivalent debt, SD is short term debts, OD is other debts, and LD is long term debts. Dr. D.Shoba MBA, M.Phil, Ph.D

20. Determining the probability of agency cost Total Asset value is A = ME+ED Where, ME is the market value of equity which is defined as = Stock Price × Outstanding Shares . The debt and expense payouts of current period , K 1 is defined as = Interest Expenses + Cost of Sales. Dr. D.Shoba MBA, M.Phil, Ph.D