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INVESTMENT, FINANCING & DIVIDEND DECISIONS ARE INTER RELATED?

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Inter-relationship between Investment,  Financing and Dividend  Decisions: The  finance functions are divided into three  major decisions, viz., investment,  financing and dividend decisions.  It  is  correct  to  say  that  these  decisions  are  inter-related  because  the  underlying objective of these three  decisions  is  the  same,  i.e.  maximisation  of  shareholders’ wealth. Since  investment,  financing  and  dividend  decisions  are  all  interrelated,  one  has  to  consider the  joint  impact  of  these  decisions  on  the  market  price  of  the  company's  shares  and  these decisions  should  also  be  solved  jointly.  The  decision  to  invest  in  a  new  project  needs  the finance  for  the  investment.  The  financing  decision,  in  turn,  is  influenced  by  and  influences dividend  decision  because  retained  earnings  used in  internal  financing  deprive  shareholders of  their  dividends.  An  efficient  financial  management  can  ensure  optimal  joint  decisions. This  is  possible  by  evaluating  each  decision  in  relation  to  its  effect  on  the  shareholders' wealth. The  above  three  decisions  are  briefly  examined  below  in  the  light  of  their  inter-relationship and  to  see  how  they  can  help  in  maximising  the  shareholders'  wealth  i.e.  market  price  of  the company's  shares. Investment  decision:  The  investment  of  long  term  funds  is  made  after  a  careful  assessment of  the  various  projects  through  capital  budgeting  and  uncertainty  analysis.  However,  only that  investment  proposal  is  to  be  accepted  which  is  expected  to  yield  at  least  so  much return  as  is  adequate  to  meet  its  cost  of  financing.  This  have  an  influence  on  the  profitability of  the  company  and  ultimately  on its  wealth. Financing  decision:  Funds  can  be  raised  from  various  sources.  Each  source  of  funds involves  different  issues.  The  finance  manager  has  to  maintain  a  proper  balance  between long-term  and  short'term  funds.  With the total  volume  of  long-term  funds,  he  has  to  ensure  a proper  mix  of  loan  funds  and  owner's  funds.  The  optimum  financing  mix  will  increase  return to equity  shareholders  and  thus  maximise their  wealth. Dividend  decision:  The  finance  manager  is  also  concerned  with  the  decision  to  pay  or declare  dividend.  He  assists  the  top  management  in  deciding  as  to  what  portion  of  the  profit should  be  paid  to  the  shareholders  by  way  of  dividends  and  what  portion  should  be  retained in the  business.  An  optimal  dividend  pay-out  ratio  maximises  shareholders1  wealth The  above  discussion  makes  it  clear  that  investment,  financing  and  dividend  decisions  are interrelated  and  are  to  be  taken  jointly  keeping  in  view  their  joint  effect on  the  shareholders wealth.

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