Week 5 Discussion
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Finance
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Feb 20, 2024
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Is expanding debt a good idea? Why or why not and should our given assets impact this decision?
Expanding debt and the role played by assets is a pivotal element in financial management. An increase in debt levels can elevate financial leverage, intensifying the impact of operating income
changes on the firm's earnings per share. Concurrently, assets are crucial in determining the company's ability to fulfill debt obligations. Effective asset management is indispensable for preserving liquidity and ensuring the company's long-term solvency (Block et al., 2022). Myers (1984) highlights the strategic potential of leveraging when assets generate ample cash flow to cover debt payments. However, Jensen (1986) issues a cautionary note, emphasizing that excessive debt can worsen financial risk.
In our economic environment, should we issue bonds, common stock, or preferred stock? What would be some pros and cons?
Block et al. (2022) emphasized the need for a meticulous analysis when contemplating the repurchase of outstanding common stock, considering market conditions and the company's financial position. While the act of buying back stock can convey confidence in the market and enhance earnings per share, it simultaneously diminishes available capital for alternative investments. Hence, a comprehensive evaluation of both current market conditions and the company's financial health is indispensable to determine the favorability of stock repurchase. This stresses the crucial importance of analyzing the current economic context, as highlighted by
Brealey & Myers (2003), in understanding the pros and cons of each option before making a significant decision to expand capital.
Or should we forego this immediate opportunity and buy back some of our outstanding common stock? What market conditions would make this a good move; what might be some pros and cons?
Careful analysis is essential when repurchasing outstanding common stock, considering market conditions and the company's financial position. Although buying back stock can convey confidence to the market and boost earnings per share, it comes with the trade-off of reducing available capital for alternative investments. Therefore, a thorough assessment of the current market conditions and the company's financial health is crucial to ascertain the favorability of stock repurchase (Block et al., 2022; Jensen, 1986).
Should we issue a dividend, or should we retain cash in the company for future opportunities? How might this impact future growth? Are we obligated to pay our shareholders a dividend?
The choice between issuing a dividend or retaining cash in the company has substantial implications for future growth. Distributing dividends rewards shareholders, whereas retaining cash opens avenues for potential future opportunities and investment in growth initiatives. Al-
Malkawi et al. (2010) note that the company is not obligated to pay dividends, but such actions can influence investor sentiment. Jensen (1986) suggests that paying dividends provides flexibility to retain cash for future opportunities.
References
Al-Malkawi, H., Rafferty, M., Pillai, R. (2010). Dividend Policy: A Review of Theories and Empirical Evidence. https://www.researchgate.net/publication/230720120_Dividend_Policy_A_Review_of_Theories
_and_Empirical_Evidence
Block, S. B., Hirt, G. A., & Danielsen, B. R. (2022). Foundations of financial management. McGraw Hill.
Brealey, R. A., & Myers, S. C. (2003). Principles of Corporate Finance (7th ed.). McGraw-Hill.
Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. The American Economic Review, 76(2), 323–329. https://papers.ssrn.com/sol3/papers.cfm?
abstract_id=99580
Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 575–592. https://www.nber.org/system/files/working_papers/w1393/w1393.pdf
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