Three Major Decisions which Every

Finance Manager Has to Take

i. Investment decision

ii. Financing decision

iii. Dividend decision

1. Investment Decision (Capital Budgeting Decision):

This decision relates to careful selection of assets in which funds will be
invested by the firms. A firm has many options to invest their funds but firm
has to select the most appropriate investment which will bring maximum
benefit for the firm and deciding or selecting most appropriate proposal is
investment decision.

The firm invests its funds in acquiring fixed assets as well as current assets.
When decision regarding fixed assets is taken it is also called capital
budgeting decision.

2. Financing Decision:
The second important decision which finance manager has to take is deciding
source of finance. A company can raise finance from various sources such as
by issue of shares, debentures or by taking loan and advances. Deciding how
much to raise from which source is concern of financing decision. Mainly
sources of finance can be divided into two categories:

1. Owners fund.

2. Borrowed fund.

3. Dividend Decision:
This decision is concerned with distribution of surplus funds. The profit of the
firm is distributed among various parties such as creditors, employees,
debenture holders, shareholders, etc.

Payment of interest to creditors, debenture holders, etc. is a fixed liability of

the company, so what company or finance manager has to decide is what to
do with the residual or left over profit of the company.

The surplus profit is either distributed to equity shareholders in the form of

dividend or kept aside in the form of retained earnings. Under dividend
decision the finance manager decides how much to be distributed in the form
of dividend and how much to keep aside as retained earnings.

BOOK VALUE VS. MARKET VALUE WEIGHTS

Book Value WACC is calculated using book value

weights whereas the Market Value WACC is calculated using market value of the
sources of capital. Why the market value weights are preferred over book values
weights:
Explanation: The book value weights are readily available from balance sheet for all
types of firms and are very simple to calculate. On the other hand, for Market Value
weights, the market values have to be determined and it is real difficult task to acquire
accurate data for the same especially the value of equity when the entity is not listed.
Still Market Value WACC is considered appropriate by analysts because an investor
would demand market required rate of return on the market value of the capital and not
the book value of the capital.
Explanation with Example: Assume a firm issued capital at $10 per equity share 5 years
back. Current market value of the share is P30 and book value is P18 and market
required rate of return is 20%. The investors (existing and new) of the company will
expect return on P30 and not P18. Let us see how a rational investor will behave.

Weighted Average Cost of Capital (WACC)