Dividend Decisions and Financial Planning
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Questions and Answers

What is a major determinant in a company's decision regarding dividends?

  • Market competition
  • Employee salaries
  • Shareholder preferences
  • Earnings (correct)

    • Which type of earnings position is more favorable for declaring higher dividends?

  • Declining earnings
  • Stable earnings (correct)
  • Variable earnings
  • Seasonal earnings

    • What is the impact of unstable earnings on dividend declarations?

  • They only affect future dividends
  • They lead to smaller dividends (correct)
  • They encourage larger dividends
  • They have no influence

    • What do companies generally prefer when it comes to dividends per share?

    <p>Stabilizing them</p> Signup and view all the answers

    How does taxation policy impact dividend payments?

    <p>Higher taxes on dividends usually encourage lower dividend payments</p> Signup and view all the answers

    What do shareholders generally favor in regards to dividends?

    <p>Regular income through dividends</p> Signup and view all the answers

    Why might a company decide to retain earnings rather than pay out dividends?

    <p>To finance new projects</p> Signup and view all the answers

    In the context of dividend payments, why might shareholders prefer higher dividends?

    <p>Dividends are perceived as indicators of financial health</p> Signup and view all the answers

    What is one significant role of financial planning in a business?

    <p>It helps in forecasting future business situations.</p> Signup and view all the answers

    Why may a company consider taking on debt?

    <p>To finance expansion or improve cash flow.</p> Signup and view all the answers

    What might happen if a business takes on too much debt?

    <p>It can lead to financial strain on the business.</p> Signup and view all the answers

    How does financial planning assist in dealing with uncertainty regarding funds?

    <p>It helps in creating multiple alternative plans.</p> Signup and view all the answers

    What is a potential outcome of effective financial planning for a firm?

    <p>It prepares the firm for upcoming challenges.</p> Signup and view all the answers

    Which situation exemplifies a significant use of financial planning?

    <p>Creating plans for various growth scenarios.</p> Signup and view all the answers

    What should businesses analyze to determine an appropriate level of debt?

    <p>Cash flow and industry standards.</p> Signup and view all the answers

    What may be a consequence of failing to engage in financial planning?

    <p>Difficulty in managing unexpected financial situations.</p> Signup and view all the answers

    What happens to the cost of equity if the return on investment (RoI) exceeds a certain level?

    <p>Cost of equity may go up sharply.</p> Signup and view all the answers

    How does the use of higher debt affect earnings per share (EPS)?

    <p>Higher debt increases EPS only when RoI is greater than the cost of debt.</p> Signup and view all the answers

    What is one of the main considerations when deciding between debt and equity for capital structure?

    <p>Flotation costs and associated expenses.</p> Signup and view all the answers

    What role does the tax rate play in determining the cost of debt?

    <p>Lower tax rates reduce the after-tax cost of debt.</p> Signup and view all the answers

    What is referred to as financial risk?

    <p>The inability to meet fixed financial charges.</p> Signup and view all the answers

    How does fixed operating costs relate to business risk?

    <p>Higher fixed operating costs lead to higher business risk.</p> Signup and view all the answers

    What is the after-tax cost of debt if the debt is raised at a rate of 10% and the tax rate is 30%?

    <p>7%</p> Signup and view all the answers

    Which statement accurately describes trading on equity?

    <p>It can increase EPS by using debt effectively.</p> Signup and view all the answers

    How does adopting a policy of purchasing components on three months credit while selling complete products in cash affect working capital?

    <p>It decreases working capital requirements since sales are immediate.</p> Signup and view all the answers

    Which of the following best describes financial risk?

    <p>The chance of losing money on an investment.</p> Signup and view all the answers

    Which of the following assets is classified as a current asset?

    <p>Inventory</p> Signup and view all the answers

    What is one of the main objectives of financial management?

    <p>To maximize shareholder wealth consistently.</p> Signup and view all the answers

    Which of the following is NOT one of the three broad financial decisions in financial management?

    <p>Financial forecasting</p> Signup and view all the answers

    Why would issuing debentures be considered an irrational decision for Sunrises Ltd.?

    <p>Because the cost of debt is 10%, which exceeds their current EBIT.</p> Signup and view all the answers

    What effect does working capital have on a business's liquidity?

    <p>Improves liquidity but may negatively impact profitability.</p> Signup and view all the answers

    What does Prabhu's financial blueprint aim to ensure?

    <p>The availability of sufficient funds at appropriate timing.</p> Signup and view all the answers

    What happens to EPS when a company increases its use of debt?

    <p>EPS increases if the cost of debt is lower than the return on investment.</p> Signup and view all the answers

    What is Trading on Equity primarily concerned with?

    <p>Earning a higher return on equity due to fixed financial charges.</p> Signup and view all the answers

    In Situation II with a debt of Rs. 10 lakh, what is the profit after tax (EAT)?

    <p>Rs. 70,000</p> Signup and view all the answers

    How does financial leverage affect the profitability of a business?

    <p>It increases the difference between Return on Investment (RoI) and cost of debt, enhancing EPS.</p> Signup and view all the answers

    Why does Company Y experience a rise in EPS despite taking on higher debt?

    <p>The profit before interest and taxes exceeds the interest costs.</p> Signup and view all the answers

    What is the interest expense in Situation III with a debt of Rs. 20 lakh?

    <p>Rs. 2,00,000</p> Signup and view all the answers

    What is the significance of EBIT in this context?

    <p>It represents the profit earned before deducting interest and taxes.</p> Signup and view all the answers

    In Situation I, what is the EPS for an unlevered business?

    <p>Rs. 0.93</p> Signup and view all the answers

    Study Notes

    Dividend Decisions

    • A company's earnings are a major determinant of its dividend decisions.
    • A company with stable earnings can pay higher dividends than a company with unstable earnings.
    • Companies generally aim for stable dividends per share.
    • Increased dividends are usually decided when the company is confident about the growth of its earning potential, not just current year earnings.
    • Tax policies can influence dividend decisions.
    • Higher tax rates may encourage a company to pay less in dividends.
    • Lower tax rates may encourage a company to pay higher dividends.

    Financial Planning

    • Financial planning is essentially the preparation of a financial blueprint for an organization's future operations.
    • It aims to help a company manage uncertainty regarding funds and helps smooth the company's operations.
    • Financial planning helps to create a plan for different business situations.
    • An example includes a firm planning for a potential growth rate of 20%, 10%, or 30% - by creating plans for each scenario, management can be prepared for any outcome.

    Debt Financing

    • Businesses take on debt to bolster cash flow and finance growth or expansion.
    • Too much debt can negatively impact a company.
    • Understanding the relationship between return on Investment (RoI) and the cost of debt is crucial for making informed debt financing decisions.
    • When RoI is higher than the cost of debt, a company can use debt to increase Earnings Per Share (EPS), which is a favorable financial leverage situation.
    • This practice, called Trading on Equity, increases profit for equity shareholders due to fixed financial charges like interest.
    • Maximising shareholder wealth requires using debt strategically.
    • In the provided example, if a company’s RoI is higher, it has greater ability to utilize debt and increase EPS (trading on equity).
    • If the RoI is lower than the cost of debt, higher debt won't increase the EPS.
    • Debt financing is more beneficial when the cost of debt is lower, the tax rate is higher, and the company is confident in its ability to meet financial obligations.
    • Debt increases financial risk, but can be a tool to manage risk.
    • Raising funds through public issue carries associated costs.
    • Cost of debt is the interest paid on the debt.
    • When the cost of debt is lower than the return on investment, the company can use debt to enhance profitability.
    • In the example provided, the company used debt to increase EPS.
    • The difference between RoI and the cost of debt is what increases EPS.

    Working Capital Management

    • Working capital influences a business's liquidity and profitability.
    • A change in payment terms can affect working capital needs, as shown in the example of the company purchasing components on three months credit and selling the finished product in cash. This will generally decrease the requirement of working capital because the company will have more time to pay for its purchases.
    • This is because the company will have more time to pay for its purchases, which means it will need less cash on hand to cover expenses.
    • This will also change the company's cash flow cycle. The cash flow cycle is the time it takes for a company to convert its inventory into cash. By extending its payment terms to suppliers, the company will be able to lengthen its cash flow cycle.
    • The lengthened cash flow cycle may free up cash that can be used for other purposes, such as investing in the company's growth or expanding operations.
    • It can also give the company more flexibility to manage its cash flow.

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    NCERT Class 12 Business Studies Chapter 9 PDF

    Description

    This quiz explores the interplay between dividend decisions and financial planning within a company. You'll learn how earnings stability, tax policies, and financial blueprints contribute to effective financial management. Test your knowledge on the factors influencing dividend payouts and the importance of strategic financial planning.

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