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Maximizing shareholder value dictates that management return
exces cash to shareholders.. |
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projects
must also be financed appropriately. If no such
opportunities exist |
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goal of Working capital management is to ensure that the
firm is able to continue its operations and that it has
sufficient |
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The general case, however there are exceptions. For
example, investors in a Growth stock, expect that the
company will, almost by definition, retain earnings so as to
fund growth internally. In other cases, even though an
opportunity is currently NPV negative, management may
consider investment flexibility potential payoffs and decide to retain
cash flows; see above and Real options.
financing debt or equity and expenditure framework
within a given economy and under given market conditions.
One last theory about this decision is the Market timing
hypothesis which states that firms look for the cheaper type
of financing regardless of their current levels of internal
resources, debt and equity.
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In general, management must decide whether to invest in additional
projects, reinvest in existing operations, or return free cash as dividends
to shareholders. The dividend is calculated mainly on the basis of the
company's unappropriated profit and its business prospects for the coming
year. If there are no NPV positive opportunities, i.e. where returns exceed
the hurdle rate, then management must return excess cash to investors. These
free cash flows comprise cash remaining after all business expenses have
been met.
One of the main theories of how firms make their financing
decisions is the Pecking Order Theory, which suggests that firms avoid
external financing while they have internal financing available and
avoid new equity financing while they can engage in new debt financing
at reasonably low interest rates. Another major theory is the Trade-Off
Theory in which firms are assumed to trade-off the Tax Benefits of debt
with the Bankruptcy Costs of debt when making their decisions.
There are various considerations: where shareholders pay tax on
dividends, companies may elect to retain earnings, or to perform a stock
buyback, in both cases increasing the value of shares outstanding; some
companies will pay "dividends" from stock rather than in cash. . Today it is generally accepted that
dividend policy is value neutral.
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