Financial Management Test - 36

VNG Agro Food Ltd. is a famous multinational company. Mr. SK Nagi is its finance manager. He is trying to increase the market value of capital invested by the equity shareholders. He already knew it could be possible only when the price of the shares increases and the price of shares increases only if financing, investment, and dividend decisions are taken optimally. He did the same and achieved success. 'Maximizing the wealth of equity shareholders' objective of financial management has been referred here.

Financial risk of a company increases because of High debt-equity ratio.

A high debt-to-equity ratio comes with high risk. If the ratio is high, it means that the company is lending capital from others to finance its growth. As a result, lenders and Investors often lean towards the company which has a lower debt-to-equity ratio.

Working capital refers to excess of current assets over current liabilities.Higher current ratio, higher risks, higher profits indicates large scale operation thus require large working capital.

Retained earning is the cheapest source of finance.

Financial Planning aims at ensuring that the firm faces neither a shortage nor a glut (excess) of unusable funds. If there is a shortage of funds then the firm will not be able to carry out its planned activities and commitments. On the other hand, if there are excess funds available then it adds to the cost of business and also encourages wastage of funds. Thus, financial planning focuses on ensuring the availability of just enough funds at the right time.

Earning: Dividends are paid out of current and previous year's earnings. More earning then high rate of dividend.

Taxation policy: If tax rate is high then less dividend will be declared whereas tax rate is low then more dividend will be declared.

Cash flow position: Paying dividend means outflows of cash.  In surplus cash then high rate of dividend. If shortage of cash then companies declare low dividend.

Financial leverage: It is relationship between the firms EBIT and earnings available for shareholders.

• The proportion of debt in the overall capital is also called financial leverage.
• Financial leverage is computed as  D/E or D /(D+E) where D is the Debt and E is the Equity.
• As the financial leverage increases, the cost of funds declines because of increased use of cheaper debt but the financial risk increases.

Short term investment decisions are the decisions related with the bills receivables, inventories, levels of cash and debtors etc. These decisions are also known as working capital decisions.

Cost of advertising and printing prospectus is called Floatation cost. Flotation costs include the costs of printing the certificates, paying the underwriters, government fees, and other associated costs etc.

Other things remaining the same, an increase in the tax rate on corporate profits will Make the debt relatively cheaper.

When there is an increase in the tax on corporate profit, the debt becomes relatively cheaper. This is because interest that is to be paid to the debtors is deducted from the total income before calculating the value of tax. Thus, as the value of tax increases, the debt becomes relatively cheaper.