How financial management decisions lead to shareholder wealth maximization ?
In this crucial section, we look at a framework for maximizing shareholder wealth through financial management decisions. An organization should have sensible financing, investment, and dividend decisions. These decisions are interrelated, mostly cash flow.
Investment decision
As a financial analyst need to identify investment opportunities, evaluate them, and decide on the optimal allocation of scarce funds between investment.Investment decisions may be the company to new projects within the existing business, the takeover or merger with another company, or selling off a part of the business.Managers have to make decisions in the light of strategic considerations as if the company wants to expand internally (through investment in existing operations) or external (through expansion).
Interaction of investment with financing and dividend decisions
Managers will determine whether additional funding will be required and what the consequences of getting it. They will take into account the demands of suppliers of financing, and particularly shareholders need action dividends.
Financing decision
funding decision includes both long-term (capital structure) and short term (working capital management). The finance manager should determine the source, the cost, and the effect on the risk of possible causes of long term financing. A balance between profitability and liquidity (loan funds available if necessary) must be taken into account when determining the optimal level of short-term financing.
Interaction of financing with investment and dividend decisions
In the financial decisions, managers have to meet the requirements of funding providers; otherwise financing may not be available.This can be particularly difficult in the case of shareholders, as dividends are paid at the discretion of the company.
Another issue managers will take into account is the matching characteristics of investment and finance. Time is critical; an investment that earns long-term returns must be accompanied by funding that requires payment in the long run.
Funding for international investment should also be an essential factor. A company that expects to receive a significant amount of income in a foreign currency will be concerned that the currency may weaken. To deal with this risk, we can use short-term hedging strategies.
Dividend decision
Dividend decisions may influence the opinion that shareholders have long-term prospects of the business, and therefore the market value of shares. When the dividends are high, market value tends to reduce.
Interaction of dividend with investment and financing decisions
The amount of excess cash as dividends paid will have a direct impact on the finance available for investment. Therefore, managers have a difficult decision to make. How much they pay to shareholders every year to keep them happy, and they maintain the level of funds in the business to invest in projects that will generate long-term income? If debt financing is likely to be unavailable, cash flows from retained earnings may be necessary.
