Financial Management

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Financial Management

Table of Content


Theories of Capital Structure3

Trade-off Theory of Capital Structure3

Pecking Order Theory of Capital Structure4

Comparison of Trade-off and Pecking Order Theory4

Sources of Finance5

Internal sources of finance5

Personal savings6

Retained profits6

Working capital6

Sale of fixed assets6

Ownership capital7

Non-ownership capital7

Choosing an appropriate source of finance8

The cost of the source of finance8

The risk involved9

The duration of finance9

Personal savings -10

Sale of assets -10

Debentures -10

Bank an overdraft -10

Loan -11

Venture a capital -11

Factoring and invoice discounting -11

Importance of financial planning11

Assignment 2:13


Theories of Dividend Policy14

1- Theory of the Irrelevance of Return14

2 - Preference Theory of Return15

3- Tax Preference Theory15



Financial Management

Assignment 1:


The main purpose of this assignment is to discuss the importance of capital structure and the cost of capital in the efficient financial management of large companies. The capital structure and cost of capital is important for efficient financial management in such a way that it cost of capital does not have limitations to the calculation of the relative value of cash payments, which need to list the owners to provide financial resources, but also characterizes the level of profitability (profitability) of invested capital, which should provide the organization, not to reduce its market value.

Theories of Capital Structure

Trade-off Theory of Capital Structure

Trade-off theory of capital structure principally involves compensating the costs of debt against the benefits of debt. Trade-off theory typically has two thoughts - financial distress cost and agency costs. A noteworthy function of this theory is to make clear the fact that businesses have their finance to a certain extent with debt and equity both.

Pecking Order Theory of Capital Structure

Pecking Order theory explains that, businesses looking for to get alternative investments have a preference to make use of finances according to a hierarchy: first internal funds, then debt issuance, and at end equity issuance (Bromwich, 2009, p. 45). This theory arises because financial experts, not wanting to dilute existing shareholders claim, will issue only overvalued securities.

Comparison of Trade-off and Pecking Order Theory

The trade-off theory states that higher debt ratio can find out by keeping equilibrium between the favourable and unfavourable factors of debt financing. The one main benefit of debt financing is that a firm can reduce an amount of tax in interest payments. The cons are the distinct costs of financial problem. As leverage level increases, the marginal tax protection from additional borrowing decreases. This is a main issue of the escalating probability that, with high interest expense, the firm will not have enough amounts to pay tax and get rid of paying tax. On the other hand, the estimated cost of financial distress increases by means of leverage. As leverage increase, the marginal cost of financial distress eventually offset the interest tax shield (Haka, 2007, p. 48). While, in comparison, pecking order theory revolves around the fact that businesses favour to raise finances by means of internal finance and for external finance, if necessary, they choose debt to equity matters. This liking for pecking order is because investors can understand security matters. The equity matters give an idea that directors think the business is ...
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