Core Professional Obligations, Values, And Operations Of Organizations

Submitted By Bleublue194
Words: 1296
Pages: 6

Section A: Core professional obligations, values and operations of organisations including sustainability
5 aspects of industry structure that determines which industries are able to provide sustained economic rents:
+ Rivalry (competition) among existing competitors
+ Likelihood of new competition
+ Threat of substitutes.
+ Bargaining power of suppliers.
+ Bargaining power of customers
Payout policy and the life cycle of the firm
In MM’s analysis, firm should make investment and financing decisions, and then payout whatever cash is left over. Decision about how much to payout should therefore change over the life cycle of the firm.
Many of the market imperfections are also reinforce the life cycle of payout. Younger companies with profitable investment opportunities don’t payout cash and rarely repurchase stock. Growth companies finance investment as much as possible with internally generated cash flow. Retaining cash avoids the cost of issue securities and minimises shareholders’ taxes. But as the firms mature, growth opportunities gradually fade away and surplus cash accumulates. Then, investors press for payout because they worry that managers will overinvest if too much idle cash is lying around. A firm will probably start by repurchasing shares, which is more flexible than dividends.
Once a company announces a regular cash dividend, investors expect the dividend to continue unless the company encounters serious financial trouble. As firm ages, more and more payout is called for. The payout may come as higher dividends or larger repurchases. Cash is surplus and payout is called for when these 3 criteria are met:
+ The firm is generating positive free cash flow after making all investments with positive NPVs and the positive free cash flow is likely to continue.
+ The firm’s debt level is prudent and manageable.
+ The firm has a sufficient war chest for unexpected opportunities.
Apple’s case
In March 2012, Apple met all 3 criteria: it was continuing to accumulate cash at a rate of $30 billion per year, it had no debt and no conceivable investment or acquisition to soak up its excess cash flow. Apple announced a combination of quarterly dividend of $2.65 per share and share buyback of $10 billion, a total of $45 billion in payout over the following 3 years. Apple initiated repurchases not because its stock was undervalued but because it had surplus cash.
Section B: Work ready disciplinary knowledge
The pecking-order theory of capital structure
The theory states that firms prefer to use internally generated cash flow to finance investments, if external funds are required, firm will prefer new issues of debt. This explains why the most profitable firms within an industry borrow less – because they don’t need outside money. Less profitable firms borrow more because debt is next on the pecking order when internal funds are exhausted.
The pecking-order theory of cash management
The theory states that firms finance investments first with retained profits (internal cash flow), then with debt, and finally with equity. Firms don’t have target cash levels.
When current earnings are insufficient to meet new investments, firms use accumulated cash holdings and if needed, issue debt.
When current operational cash flows are more than the amount required for new investments, firms use the free cash flow to repay debt and to accumulate cash.
Pecking order theory: relevant characteristics
Investment opportunities (+): Greater the opportunities, larger demand for cash because cash shortfalls -> force a firm to forgo (give up) profitable project.
Leverage(-): Cash holdings follow an inverse pattern to debt as firms will choose to borrow only when they run out of cash.
Size (+): Firms that are larger presumable have been more successful and should have more cash after controlling for investments
Cash flow (+): Firms with high cash flow will have more cash after controlling for other variables
Free cash flow theory of cash management