Podcast
Questions and Answers
What is a major determinant in a company's decision regarding dividends?
What is a major determinant in a company's decision regarding dividends?
Which type of earnings position is more favorable for declaring higher dividends?
Which type of earnings position is more favorable for declaring higher dividends?
What is the impact of unstable earnings on dividend declarations?
What is the impact of unstable earnings on dividend declarations?
What do companies generally prefer when it comes to dividends per share?
What do companies generally prefer when it comes to dividends per share?
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How does taxation policy impact dividend payments?
How does taxation policy impact dividend payments?
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What do shareholders generally favor in regards to dividends?
What do shareholders generally favor in regards to dividends?
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Why might a company decide to retain earnings rather than pay out dividends?
Why might a company decide to retain earnings rather than pay out dividends?
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In the context of dividend payments, why might shareholders prefer higher dividends?
In the context of dividend payments, why might shareholders prefer higher dividends?
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What is one significant role of financial planning in a business?
What is one significant role of financial planning in a business?
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Why may a company consider taking on debt?
Why may a company consider taking on debt?
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What might happen if a business takes on too much debt?
What might happen if a business takes on too much debt?
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How does financial planning assist in dealing with uncertainty regarding funds?
How does financial planning assist in dealing with uncertainty regarding funds?
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What is a potential outcome of effective financial planning for a firm?
What is a potential outcome of effective financial planning for a firm?
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Which situation exemplifies a significant use of financial planning?
Which situation exemplifies a significant use of financial planning?
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What should businesses analyze to determine an appropriate level of debt?
What should businesses analyze to determine an appropriate level of debt?
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What may be a consequence of failing to engage in financial planning?
What may be a consequence of failing to engage in financial planning?
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What happens to the cost of equity if the return on investment (RoI) exceeds a certain level?
What happens to the cost of equity if the return on investment (RoI) exceeds a certain level?
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How does the use of higher debt affect earnings per share (EPS)?
How does the use of higher debt affect earnings per share (EPS)?
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What is one of the main considerations when deciding between debt and equity for capital structure?
What is one of the main considerations when deciding between debt and equity for capital structure?
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What role does the tax rate play in determining the cost of debt?
What role does the tax rate play in determining the cost of debt?
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What is referred to as financial risk?
What is referred to as financial risk?
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How does fixed operating costs relate to business risk?
How does fixed operating costs relate to business risk?
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What is the after-tax cost of debt if the debt is raised at a rate of 10% and the tax rate is 30%?
What is the after-tax cost of debt if the debt is raised at a rate of 10% and the tax rate is 30%?
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Which statement accurately describes trading on equity?
Which statement accurately describes trading on equity?
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How does adopting a policy of purchasing components on three months credit while selling complete products in cash affect working capital?
How does adopting a policy of purchasing components on three months credit while selling complete products in cash affect working capital?
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Which of the following best describes financial risk?
Which of the following best describes financial risk?
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Which of the following assets is classified as a current asset?
Which of the following assets is classified as a current asset?
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What is one of the main objectives of financial management?
What is one of the main objectives of financial management?
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Which of the following is NOT one of the three broad financial decisions in financial management?
Which of the following is NOT one of the three broad financial decisions in financial management?
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Why would issuing debentures be considered an irrational decision for Sunrises Ltd.?
Why would issuing debentures be considered an irrational decision for Sunrises Ltd.?
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What effect does working capital have on a business's liquidity?
What effect does working capital have on a business's liquidity?
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What does Prabhu's financial blueprint aim to ensure?
What does Prabhu's financial blueprint aim to ensure?
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What happens to EPS when a company increases its use of debt?
What happens to EPS when a company increases its use of debt?
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What is Trading on Equity primarily concerned with?
What is Trading on Equity primarily concerned with?
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In Situation II with a debt of Rs. 10 lakh, what is the profit after tax (EAT)?
In Situation II with a debt of Rs. 10 lakh, what is the profit after tax (EAT)?
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How does financial leverage affect the profitability of a business?
How does financial leverage affect the profitability of a business?
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Why does Company Y experience a rise in EPS despite taking on higher debt?
Why does Company Y experience a rise in EPS despite taking on higher debt?
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What is the interest expense in Situation III with a debt of Rs. 20 lakh?
What is the interest expense in Situation III with a debt of Rs. 20 lakh?
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What is the significance of EBIT in this context?
What is the significance of EBIT in this context?
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In Situation I, what is the EPS for an unlevered business?
In Situation I, what is the EPS for an unlevered business?
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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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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.
