Financial Market and Investment Analysis

Financial market and investment analysis
Name
Course
Instructor
Date

Financial, Dividend, Investment policy decisions and Firm valuation
In the financial planning of a business, financial objectives are important because they are the set goals and objectives of an organization. Financial objectives are anchors upon which to plan businesses and ensure long term success. In most cases, the objectives are measurable within a time frame and involve increase in cash flows and profits. The need to improve efficiency and coordination in companies informs managers on the decision- making process. It is through setting financial objectives that companies can deal with growth prospects focusing on internal strengths and weakness, while also dealing with external threats and opportunities (Fan 2000, p.1060). It is critical to take into account policy decisions namely: investment, financing and dividends policy and their impact on a company’s value.
Investment in assets and projects is the main focus of investment decisions, and those investments with higher returns that the hurdle rate is preferred. Riskier investments tend to have higher returns and it is the cash flows of projects that determine their viability. Financing entails decisions on using debt -equity finance, and the mix chosen should maximize returns and match with financing of assets under consideration (Mickelsen 2005, p.11). Dividend payout is typically related to a firm’s value and may help to address the agency problem (Ming & Ming 2013). Firms typically seek to maximize value, and as such they should take into consideration the investment, financing and divided policy decisions. The three policy decisions are interlinked because the value of a firm depends on future expected discounted cash flows, taking into effect riskiness of investments and the optimal financial mix.
Investment in projects affects the cash flow of organizations, and in most cases the levels of cash generated internally are different from the anticipated investments (Bierman 2010, p.175). Consequently, a company typically needs adjustments to deal with the mismatch and this happens through using the investment, dividend or financing policy. The cost benefit analysis informs the decision of choosing investment options with the least costly option being the preferred choices in the long term. Even when coping with cash shortages companies are least likely to reduce an already dividend amount as a temporary coping mechanism (Bierman 2010, p.176). Nonetheless, it is possible to result to a onetime special divided in case there are surplus funds
Walter’s model, Gordon Model and the Modigliani and Miller hypothesis explain the influence of divided policy and the value of an enterprise. The dividend policy is the foundation upon which to value a firm, and in the Walter model the investment policy is inseparable from the divided policy, and it also postulates that dividends are relevant (Bose 2010, p.439). To support the view that dividends are relevant is the observation that there is a relationship between the internal return of an investment (r) and the required ate of return/ cost of capital (k). The optimum dividend policy is dependent on the relationship between the two costs of capitals. There ought to be retained earnings if the rate of return on investment and distribute the earnings if the converse is true (Khan & Jain 2004, p.24-10).
The Gordon’s model also takes into account the role of dividend decisions in influencing the value of firms like Walter’s Model, but unlike the MM hypothesis. The theory assumes that there is no external financing and the internal rate of return remains the same, with the growth factor being constant. This model supposes that the value of a share is equated to the Present value of dividends divided by share receivable. P0=E1 (1-b)/K-br with E current earnings, b is the retention policy, r is internal profitability and P0 is the value of share. The model postulates that there is external financing and the company uses equity only, and the basis of these assumptions is that investors are risk averse and that there are premiums on certain returns with uncertain retains having discounts. Al Hassan et al (2013, p. 9) conducted a study to determine the impact of dividend policy on share price and found out that dividend payout affects the market price more than retention.
The Modigliani and Miller hypothesis postulates that there is dividend irrelevancy, the firm earnings influence the value of firm and the earnings in turn depend on investment policy (Pagano 2005, p.7). Given that the investment decisions is given dividends then become irrelevant, the rate of return depends the dividends, capital gains and the discount rate, r=D+(P1+P0)/P0 with D being the dividends and P0 being current market price and P1 market price at time 1. A further look into the M-M hypothesis shows that the valuation of a firm can be derived as P0=D1+P1/ (1+r). In this hypothesis, it is possible to issue new shares, and dividend payments are also accompanied with optimum investment policy.
Interactions of dividend and financial policies
Internal and external financing affects the capital structure of firms, and if the capital structure is constant one is able to determine the pros and cons of internal versus external financing (Lee et al 2010, p. 25). External financing involves equity financing or debt financing, and the value of a firm is unaffected if dividends are irrelevant. One of the ways where there is interaction between the financing and dividend policy is through the cost of equity capital. In essence, issue of risky debt, while also marinating limited liability for shareholders affects both the financing and investing decisions of a firm. Companies may at times decide to reduce the dividend payout ratio when seeking to increasing funds for reinvestment.
Dividend and financing policies are also related through the default risk, as the Black Scholes model has delved into valuation of claims and liabilities in firms (Lee et al 2010, p. 26). A look into of the model shows that under the arbitrage process and the M-M model it is possible to invalidate the process when there are shareholders with limited liability or if the debt is risky. In any case, the option pricing models supposes that equity holders and liability holders have conflicting interest. However, this follows the assumption that the value of a firm remains unchanged because of wealth transfer effects. Thus, to find the value of corporate debt the default risk comes in place.
Interactions between financing and investment decisions
Interactions between investment and financing decisions are likely to be cause of transaction costs, market imperfections and corporate taxes (Myers 1974) as quoted by (Lee et al 2010, p. 28). Nonetheless, debt obligations make the analysis inadequate and so is the impact of default risk on investment and financing decisions. In choosing between financial and investment decisions firms, financing decisions typically involve external financing. This could include debt levels that are adjustable in the future or debt level with maturity. According to (Childs et al 2005, p. 673), equity holders can either invest in growth options based on whether there is option expansion or replacement of asset in place. Consequently, when there are investment distortions the value of firms changes, while restriction the debt maturity eases investment distortions.
Distributing dividends to shareholders also takes into account the investing and financial decisions of firms because the divided payout ratio determines the amount of retained earnings. Companies that perceive financing and investment decisions as being independent, perceive financing sources and the amount of funds as being irrelevant in valuing a firm (Sheeba, p.341). Nonetheless, dividend and investment policy decisions that require cash outflows are possible with minimal constraints (Sheeba, p.341). However, when dividend and investment decisions are dependent then the amount of funds and source of funds affects the value of a firm.
Foreign Exchange Exposure and Multinational Companies
The rise of globalization has presented new challenges to multi national companies (MNCs) on how to hedge their foreign exchange transactions. In order to diversify, their operations, MNCs have invested in new markets and also used green field investments through mergers and acquisitions, set up of new businesses and take over of operations (Pantaliz et al 2001, p.800). Nonetheless, increased investment on a global scale has been accompanied with increase foreign exchange exposure, and hence companies need to use hedging techniques to reduce exposure to foreign exchange transactions risk through exports and imports. For MNCs economic exposure is the main focus in financial risk assessment and management.
Coca Cola products do not sell at the same price across all countries because of differences in market conditions in the targeted customers. Furthermore, legal requirements and costs associated with transportation and production activities. The hedging process has numerous benefits because it increases a company’s competitive edge through the company’s expected tax payment and overall cost. Uncertainty creates instability in a company, but through hedging the decision making process is clearer. Additionally, there is possibility of increased investment after hedging, because companies can free up funds and also help to lower interest rates on loan spread. Coca Cola uses derivatives to reduce foreign exchange exposure, and adverse fluctuations in interest ...