Question

Aval Ltd. is engaged in the business of export of canvas goods and bags. In the past, the performance of the company had been upto the expectations. In line with the latest demand in the market, the company decided to venture into leather goods for which it required specialised machinery. For this, the Finance Manager Prabhu prepared a financial blueprint of the organisation’s future operations to estimate the amount of funds required and the timings with the objective to ensure that enough funds are available at right time. He also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds, he is trying to find out alternative sources from outside.

a. Identify the financial concept discussed in the above paragraph. Also, state the objectives to be achieved by the use of financial concept so identified. ( Financial Planning).

b. ‘There is no restriction on payment of dividend by a company’. Comment. ( Legal & Contractual Constraints)

Answer 1

The financial concept discussed in this is called capital budgeting decision, it is decision-related to capital investment in the company which have long term effect on the profitability of the company.

As the company want to invest in new machinery which will require huge investment, and it will affect the operations of the organisation which will affect the profitability of the organisation.

The objective can be achieved by this are following:-

a. Cash flow :- after this investment, new machinery will reduce the operational cost of the products, which will increase the profitability of the organisation. Cash flow needs to be analysed that how the Investment which affects cash inflow over the period.

b. The rate of return :- as the company want to raise fund both from inside and outside the organisation, it is very important to know that the additional return generated from the investment is more than the cost of capital.

c. The investment criteria involved - as mentioned in the paragraph the company is planning to raise fund both from inside and outside the organisation and both have a different cost associated with it. Debt from outside will have a different interest rate associated with it, whereas internal cash can be used for other activity which may have more or less rate of return which needs to be analysed.

Companies pay part of their earning to the shareholders on a regular basis and it is called dividend. There are multiple factors which affect the pay-out of dividends

Legal constraint :- certain provision of the company's actions put the constraint on the pay-out of dividends and those norms need to be followed while paying dividends.

Contractual constraints- Paying the dividend reduces companies' cash as cash is going outside the company, the company’s also raises money in the form of loan from other banks or investors, they can put a restriction of the company to pay dividends, loan agreements need to be analysed.