Unformatted text preview: resources in a project.
The financial manager should set the hurdle rate to reflect the
riskiness of the project with higher hurdle rates for riskier
projects. Long-term financing decisions involve the acquisition of
funds needed to support long-term investments. Such
decisions concern the firm’s capital structure, which is the
mix of long-term debt and equity (value of assets after all
liabilities or debts have been paid) the firm uses to finance its
operations. These sources of financing are shown on the rightoperations.
hand side of the balance sheet. Firms have much flexibility in
choosing a capital structure. Typical financing questions facing
the financial manager include:
• Does the type of financing used make a difference?
• Is the existing capital structure the right one?
• How and where should the firm raise money?
• Should the firm use funds raised through its revenues?
• Should the firm raise money from outside the business?
• If the firm seeks external financing, should it bring in other
owners or borrow the money?
owners The financial manager can obtain the needed funds for its
investments and operations either internally or externally.
Internally generated funds represent the amount of earnings
that the firm decides to retain after paying a cash dividend, if
any, to its stockholders.
According to the dividend principle, a firm should return cash
to the owners if there are not enough investments that earn the
hurdle rate. For publicly traded firms, a firm has the option of
returning cash to owners either through dividends or stock
The form of return depends largely on the characteristics of the
27 If the firm decides to raise funds externally, the financial
manager can do so by incurring debts, such as through
bank loans or the sale of bonds, or by selling ownership
interests through a stock offering. The choice of financing
method involves various tradeoffs.
method When making financing decisions, managers should keep
the financing principle in mind.
the The financing principle states that the financial
manager should choose a financing mix that
maximizes the value of the investments made and
matches the financing to the assets being financed.
Matching the cash inflows from the assets being financed
with the cash outflows used to finance these assets
reduces the potential risk.
28 Decisions involving a firm’s short-term assets and liabilities
refer to working capital management.
Net working capital is defined as current assets minus
current liabilities. The financial manager has varying
degrees of operating responsibility over current assets and
Some key questions that the financial manager faces
involving working capital management include:
• How much of a firm’s total assets should the firm hold in
each type of current asset such as cash, marketable
securities (highly liquid-treasury bills, banker’s
acceptance) and inventory?
• How much credit should the firm grant to custome...
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