K-Force Ltd, a newly established security company, has constituted its first board of directors. The directors are expected, among others, to take financial decisions in the areas of investment, financing, and dividend payment. A consultancy firm has been engaged to run an orientation program for the directors in the coming week.
You work with the consultancy firm that has been engaged to run the orientation program for the new directors. You have been asked by your boss to prepare briefing notes on the specific roles the directors are expected to play in the three fundamental decision areas and the constraints that government policies might impose on them.
Required:
Prepare a briefing note on the nature of the three fundamental decision areas. Specifically, the briefing notes should cover the objective of each class of decision; TWO (2) specific decisions the directors are expected to take in each class of financial decisions; and TWO (2) factors in the external environment they should consider when making financial decisions. (10 marks)
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Investing decisions
Investing decisions are decisions that relate to the acquisition and disposition of assets that would generate cash flows for the firm. The objective of investing decisions is to achieve optimal allocation of limited resources to investment opportunities.
Directors are expected to make investing decisions such as the following:
- Deciding on growth strategy; whether to employ an internal growth strategy, which involves pursuing internally developed projects, or external growth strategies, which involves acquisitions and mergers.
- Deciding on the proportion of the components of assets needed to achieve the objectives of the firm. For instance, the proportion of property, plant and equipment in the total portfolio of assets.
- Deciding on the replacement of assets.
- Deciding on disinvestments.
- Deciding on how much to allocate to competing investment opportunities.
[Marks allocation: objective = 1; 2 decisions @ 1 mark each = 2 marks]
(3 marks)
Financing
Financing decisions are related to the mix of the various types if finance the firm should use. The objective of financing decisions is to minimise the risk and cost of finance.
The directors are expected to financing decisions such as the following:
- Deciding on the blend of equity and debt in the financing structure.
- Deciding on the proportion of prior-charge capital in total capital.
- Deciding on the method of issuing new securities.
- Deciding on whether to obtain a stock market listing.
- Deciding on whether to issue securities in international markets.
[Marks allocation: objective = 1; 2 decisions @ 1 mark each = 2 marks]
(3 marks)
Dividend
Dividend decisions are related to payment of dividend and retention of earnings for reinvestment. The objective of dividend decisions is to achieve a balance between meeting shareholders expectation of current dividend and reinvesting enough earnings to achieve targeted growth.
The directors are expected to make dividend decisions such as the following:
- Deciding on whether to recommend payment of dividend or reinvestment of earnings.
- Deciding on the amount of dividend to recommend.
- Deciding on the method of paying a dividend. Whether to pay cash dividends or use alternatives such as stock dividends and share repurchase.
- Deciding on whether to capitalize previously retained earnings through a bonus share issue.
[Marks allocation: objective = 1; 2 decisions @ 1 mark each = 2 marks]
(3 marks)
Relevant factors in the external environment
Directors should consider the following factors in the external business environment when making financial decisions:
- Laws and regulations
- Economic factors
- Ecological issues
- Ethical issues
[Marks allocation: 2 factors @ 0.5 marks each = 1 mark]