Dividends

When it comes to shares-related issues, dividend is one of the important aspects that investors are keen on. It is not how much of dividend they would receive. Investors mostly acknowledge that company does not compulsorily pay dividends to ordinary shareholders. What they are principally concerned about is company’s dividend policy (Modigliani & Millar, 1961). It is also approved that the amount of dividend paid to shareholders does not reflect shareholders’ value.

There are some ways company can spend its profits on. In majority, profits are retained to invest in business projects rather than distribute to shareholders. Investing is how company enlarge operating profits which is in accordance with maximizing shareholders’ wealth. When profits exceed investment funds, the remaining can be recorded as dividends. Inversely, if what company earns cannot cover the costs of planned projects which are believed to potentially create high returns, it is advised to use profits as well as borrow money to invest instead of paying dividends to shareholders. The former is properly more risky, but it is more strategic as well. This is what most big investors are looking for. Indeed, the fact shows that almost every stock investor is more likely to care about how much company’s shares are worth than how much company pays to them or whether company pays them regularly.

On the other hands, it is not favourable if company always use investments as excuse to ignore shareholders’ dividends. Since investing aims at accumulating profits, company should show the accomplishments to create belief. In personal point of view, it is not important to show business prosperity by recording high dividends amount, but presenting rational strategic plans of how to make use of profits.

Capital Structure - Debts or Equity

Capital can be generally divided into three kinds which are debts, equity and private capital. In the past, people mostly use their own money to start and finance their businesses. When companies expand, much more capitals are required, so businessman has thought about exterior sources of finance. There have been a number of discussions around effectiveness and benefits of using rather debts or equity to finance business. Each of them has its own benefits and losses to businesses. This obviously depends on which industry company is in and standing of business world to structure capitals by better debts or equity.

In theory, as regarding debts, in most of non-financial opinion, this seems to bring higher risks to company. In order to borrow money, for instance from bank, company has to prove their capability to pay off debts and also, mortgage its properties. It is compulsory to pay interest to creditor regularly even though company makes losses. If debts are not paid back on time, company can pay fee to extend the debts, otherwise, will lose its mortgaged properties. Whilst, company does not have responsibility for holding any properties as securities for shareholders in case they cannot get their money back. This can be counted as one of benefits when financing business by equity. However, financing by debt possibly brings some benefits/profits to business. Since corporate tax becomes central matter to business, interest paid to creditors can help to reduce tax, while dividends paid to shareholders cannot. Because interest is considered as not belong to company, it must be withdrawn from profits used to calculate tax. Comparing to equity financing, this method can help company to save more money. Dividends are, inversely, computed on firm’s profit after taxation because company does not have to pay dividends to shareholders, especially when it makes losses. This is also an advantage of using equity. Nonetheless, when company issues shares, it will face risk of dilution of control because shareholders are company’s owners. They have power over directors’ decisions which might affect shareholder’s value. Most of creditors do not have this power. On balance, it cannot easily conclude which financing methods can bring more benefits to business. There is merely general inference that the most favourable strategy is creating the balance between using debts and equity as capital.

In practical example, we can have a look at capital structure of Yell in 2009 and 2010 to see how it wants and tends to finance their business.

	2010	2009
Gearing (%)	283.88	733.08

In general, it can be said that in 2010, Yell had high gearing ratio, yet it decreased by 449.2% comparing to last year’s due to plan of refinancing long-term loans (pay off £676.2 billion in 2010). In this year, the company also manages its long-term capital structure by issuing 3,149,336 new shares (during the period from 1 April 2009 to 31 March 2010) leading to the increase of share capital by £622.3 million. It indicates that with new strategy, the Group has tendency of funding business by equity rather than debts. That helps company to avoid interest payment problems and problems of controlling a risky, high level of long-term debts. Under shareholders’ point of view, this can be considered as good news because they would probably have their share value and dividends. When the company is less likely to face risks affecting its money, it would have more space to continue to invest in the business and future. This matches with big strategy of Yell.

In brief, although the idea of keeping balance in using debt and equity is practical and reasonable, in different situations, businesses are suggested focus on one of two methods. It depends on purpose of directors and company’s strategies.

Investment Appraisal Tools

Investment seems to be more concerned in the business world nowadays. There are not only entrepreneurs and SMEs searching for investments, but also big firms. They (including investors and investees) seek for investments with a similar principal purpose of enlarging capitals. Naturally, investments come along with risks (may be high or low), which are mostly for investors. The measurement of risk level depends on many elements such as types of projects, time, amount of investment, environment factors and so on. Of them, some can be statistically calculated, while some, mostly considered as unexpected factors, cannot. Then again, high risk investments are those without thorough preparation in advance.

There are many tools investors can use to estimate risks and mainly, to calculate effectiveness and potential returns/rates of return of investments/assets. The investment appraisals techniques, in theory, include Payback period, Accounting Rate of Return (ARR), Net Present Value (NPV), Internal Rate of Return (IRR), Equivalent Annual Cost (EAC), Profitability Index and Discounted Cash Flow (DCF). Of those, NPV and DCF are most mentioned as they show more concerns and effects of elements and factors involved in. These two are also used commonly in practice to assess whether projects are worth investing. This has really contributed to number of successful investments since preparation and planning can help investors to forecast potential risks so as to avoid them, and to produce adequate budgets.

On the other hand, there are existing shortcomings which limit the precision of investors’ estimation. Ritter and Kim (1999) outlined three main inadequacies of DCF identified which are difficulty to estimate future cash flows, to select an appropriate discount rate and to choose suitable and excellent proxy peers group average unlevered beta. These are disadvantages of DCF in term of implementation. In another study, NPV and DCF are believed to restraint strategic decisions and good opportunities (Christensen, Kaufman and Shih, 2008). Investors depends too much on the use of assessment tools, so sometimes, they miss potentially lucrative deals or seriously suffer unexpected risks. For example, investors normally hesitate to place money in poor and developing countries’ projects due to their low rate of return, chance of success and, mayhap, high risks, whereas prefer already successful objects. When unexpected crisis occurs, the later has more possibility to suffer loss due to its wider range of business link. We can take 2008’s crisis as practically representative example. And recently, Japanese’s disasters are considered as unexpected matter leading to sudden losses. It is obvious that we cannot foresee what is going to happen, so all estimations are just relative. Investors, as a result, ought to be flexible rather than dependable on calculations.