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Modern approach of financial management provides a conceptual and analytical framework for financial decision making. According to this approach there are 4 major decision areas that confront the Finance Manager these are:1. 2. 3. 4. Investment Decisions Financing Decisions Dividend Decisions Financial Analysis, Planning and Control Decisions
a) Investment Decisions; Investment decisions are made by investors and investment managers. Investors commonly perform investment analysis by making use of fundamental analysis, technical analysis, screeners and gut feel. Investment decisions are often supported by decision tools. The portfolio theory is often applied to help the investor achieve a satisfactory return compared to the risk taken. b) Financing Decisions; What are the three types of financial management decisions? For each type of decision, give an example of a business transaction that would be relevant. There are three types of financial management decisions: Capital budgeting, Capital structure, and Working capital management. Capital budgeting is the process of planning and managing a firm's long-term investments. The key to capital budgeting is size, timing, and risk of future cash flows is the essence of capital budgeting. For example, yesterday I received a call from our manager over our Sand & Gravel Operations. He is looking into buying a new crusher (to crush stone into gravel and sand). I helped him today evaluate the return on investment for this opportunity. It quite a lot of work, but we determined that buying the new crusher would bring in 60,000 more tons of production/sales within the 1st year of owning the machine. Capital Structure refers to the c) Dividend Decisions
The Dividend Decision is a decision made by the directors of a company. It relates to the amount and timing of any cash payments made to the company's stockholders. The decision is an important one for
the firm as it may influence its capital structure and stock price. In addition, the decision may determine the amount of taxation that stockholders pay. There are three main factors that may influence a firm's dividend decision: Free-cash flow Dividend clienteles Information signalling Under this theory, the dividend decision is very simple. The firm simply pays out, as dividends, any cash that is surplus after it invests in all available positive net present value projects. A key criticism of this theory is that it does not explain the observed dividend policies of real-world companies. Most companies pay relatively consistent dividends from one year to the next and managers tend to prefer to pay a steadily increasing dividend rather than paying a dividend that fluctuates dramatically from one year to the next. These criticisms have led to the development of other models that seek to explain the dividend decision. Dividend clienteles A particular pattern of dividend payments may suit one type of stock holder more than another. A retiree may prefer to invest in a firm that provides a consistently high dividend yield, whereas a person with a high income from employment may prefer to avoid dividends due to their high marginal tax rate on income. If clienteles exist for particular patterns of dividend payments, a firm may be able to maximise its stock price and minimise its cost of capital by catering to a particular clientele. This model may help to explain the relatively consistent dividend policies followed by most listed companies. A key criticism of the idea of dividend clienteles is that investors do not need to rely upon the firm to provide the pattern of cash flows that they desire. An investor who would like to receive some cash from their investment always has the option of selling a portion of their holding. This argument is even more cogent in recent times, with the advent of very low-cost discount stockbrokers. It remains possible that there are taxation-based clienteles for certain types of dividend policies. Information signalling
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Master of Business Administration - MBA Semester 2 MB0045 Financial Management - 4 Credits (Book ID: B1134) Assignment Set- 2 (60 Marks)
Roll No : 521026396
However, in course of fulfilling the same, a manager might opt for risky decisions which can put on stake the owners objectives. Hence, a manager should align his/her objective to broad objective of organization and achieve a tradeoff between risk and return while making decision; keeping in mind the ultimate goal of financial management i.e. to maximize the wealth of its current shareholdershe objections are:(i) Profit cannot be ascertained well in advance to express the probability of return as future is uncertain. It is not at possible to maximize what cannot be known. (ii) The executive or the decision maker may not have enough confidence in the estimates of future returns so that he does not attempt future to maximize. It is argued that firm's goal cannot be to maximize profits but to attain a certain level or rate of profit holding certain share of the market or certain level of sales. Firms should try to 'satisfy' rather than to 'maximize' (iii) There must be a balance between expected return and risk. The possibility of higher expected yields are associated with greater risk to recognise such a balance and wealth Maximization is brought in to the analysis. In such cases, higher capitalisation rate involves. Such combination of expected returns with risk variations and related capitalisation rate cannot be considered in the concept of profit maximization. (iv) The goal of Maximization of profits is considered to be a narrow outlook. Evidently when profit maximization becomes the basis of financial decisions of the concern, it ignores the interests of the community on the one hand and that of the government, workers and other concerned persons in the enterprise on the other hand. Keeping the above objections in view, most of the thinkers on the subject have come to the conclusion that the aim of an enterprise should be wealth Maximization and not the profit Maximization. Prof. Soloman of Stanford University has handled the issued very logically. He argues that it is useful to make a distinction between profit and 'profitability'. Maximization of profits with a vie to maximising the wealth of shareholders is clearly an unreal motive. On the other hand, profitability Maximization with a view to using resources to yield economic values higher than the joint values of inputs required is a useful goal. Thus the proper goal of financial management is wealth maximization.
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