Introduction
Every decision established in the company has a decision that involves the use of funds this is referred to as a financial decision. In the process of making financial decisions, the conventional corporate finance theory assumes that the main objective is to optimize the value of the company, which is referred to as maximizing shareholder wealth. Since the key objective in the corporate finance is to optimize company value, any financial decision that increases this value should be regarded good, while that reduces value is deemed poor. Therefore, the value of the company is determined based on three main financial decisions such as financial, investment and dividend (distribution), which we will discuss. Similarly, the paper will focus on the published accounts of Unilever Limited to demonstrate the three types of financial decisions and intended strategic impact of these decisions.
An investment decision is referred to as a decision that helps the company to make a cash outlay with the aim of receiving the future cash inflows. Capital investment decisions are mainly long-term corporate financial decisions based on fixed assets. Therefore, management must allocate limited resources among competing opportunities in the process referred to as capital budgeting. The degree of the investment varies significantly depending the industry in which the company operates. There is a significant difference between the asset the company has already obtained which is referred to as an asset in place, and the asset which the company is expected to invest in the future, which are referred to as a growth asset (Baker & Martin, 2011, PP. 123).
Growth asset includes internal and external development projects such as investing in the new technologies, which create future investment opportunities. These investment present managerial and valuation challenges and may lead to incorrect investment decisions.
Investment appraisal process and ultimate decision may face agency linkages, which arise between the owner and the manager because of asymmetric information. The research indicates that managers have the motivation to expand their companies beyond the optimal size and anticipate agency conflict lead to overinvestment (Pike, Neale & Linsley, 2012, PP. 56). On the other hand, contrasting theory anticipates that asymmetric information between informed managers and the public market causes underinvestment.
Financing decisions
All corporate despite their size or complexity, are mainly financed by a mix of debt and equity. The debt is the borrowed money, whereas equity is the owner’s capital. The main issues to be considered in financial decisions is the availability and suitability of the various sources of finance and whether the current mix of debt and equity is appropriate. Debt finance is considered to be cheaper than equity finance because the costs and tax benefits are lower, but it increases considerations of financial risk. On the other hand, equity finance is considered more expensive, but the financial markets tend on average to respond to negative equity linkages.
In the UK, companies mainly depend on retained earnings as a source of finance based on the theory of the pecking order. This theory assumes that corporation tends to avoid both external financing when internal financing is available, and avoid new equity financing when these new equity finances can be sourced at a reasonable cost (Pogue, 2010, PP. 8). Once the company establishes the optimal financing mix, the time of the financing can be addressed with the emphasis being that it should match the time when the assets are being financed.
However, companies may opt to finance using short term finance to finance long-term assets. Similarly, they can choose to match long term finance with short term assets based on the cost and risks linkages. Therefore, the efficient capital market theory argues that a stock market is efficient if the market price of the company’s securities accurately show all relevant information. For example, share prices can be used to reflect the economic worth of shares. This implies that attempting to time the issue of the new financing is a futile decision.
Distribution Decisions
The distribution decisions also referred to as Dividend decisions the third key category of company’s long-term financial decision and most elusive and controversial (Baker & Martin, 2011, PP. 129). As with financing and investment decisions, the question is whether the pattern of dividend policy can influence the shareholder wealth. The main issue that face companies about the distribution decision is splitting the after-tax cash flows between dividend payments to the shareholders and retentions within the company (Pogue, 2010, PP. 9). The dividend irrelevancy theory suggests that dividends should be treated as a residual after desired investments are made. However, such suggestion is not valid based on the variety of assumptions incorporated into the analysis of perfect capital market, lack of taxation, transactions cost and floatation coats.
Despite this assumption, there could be a remarkable preference for or against dividends from either the shareholders or the company. Similarly, there could be exogenous pressure on companies to maintain their dividend payouts.despite such pressure, the trend in the past years indicate decreasing number of companies willing to pay dividends and increased popularity of share buybacks. The current economic condition continues to put further downward pressure on dividend payouts.
Part 2
In order to demonstrate the financial decisions, we will examine the accounts of Unilever Limited which is registered in the Netherlands. The main objective of Unilever is to maximize the value of the company, which is maximizing shareholder wealth. There, any financial decision that increases Unilever value is regarded good, while that reduces value is deemed poor. Therefore, the value of the Unilever is determined based on three main financial decisions such as financial, investment and distribution decisions.
The financial decisions of Unilever Limited experienced a variety of external financial risks. The fluctuation of the relative value of currencies could have a critical impact on the business results. Unilever consolidates its financial accounts in Euros, which is subjected to exchange rate risks linked with the translation of the fundamental net assets and earnings of its foreign subsidiaries (Unilever Inc, 2012, PP. 85). The company is also subject to the imposition of exchange controls by other countries which limit their capabilities to remit dividends to the parent company. Therefore, currency rates together with demand cycles are current economic climate which influences the financial decisions.
On the investment decision, the company depends on the funded pension plans, which are implemented within the territories where the projects are located. The company has developed policy guidelines for the allocation of assets to diverse categories with the aim of controlling risk and keeping the right balance between risk and long-term returns in order to limit the cost to the Unilever of the benefits provided. In order to achieve this, Unilever has diversified investments such that the failure of a single investment would not have an impact on overall assets.
The investments continue to capture a reasonable proportion of the assets in equities, which the company supposes it will offer the best returns over long-term commensurate with an acceptable level of uncertainty. Similarly, in order to control risk, the pension funds have critical investments in liability matching bonds and property and other alternative assets. The majority of investments is financed by several external fund managers with a limited proportion financed by the internal source. The company has applied investment strategy which intends to provide its pension plan around the world a simplified external managed investment decision for asset allocation models. The objective is to offer well diversified, cost effective, high quality and risk controlled decisions. The pension plan's investment is managed by the Unilever’s internal investment company.
Based on financing decisions, Unilever considers, total equity, long-term debt and short-term debt are managed capital. The company manages its capital to secure its ability to continue maximizing shareholder returns via a suitable balance of debt and equity. The company has long term credit and short term credit which is maintained by a competitive balance sheet. This provides the company with adequate flexibility for acquisitions and suitable access to the debt and equity markets. The operating subsidiaries are financed via a mixture of retained earnings, third part borrowings and loans from external finances such as central finance companies. It also keeps access to global debt markets via an infrastructure of short-term debt finances such as Euro commercial paper programs.
The company has significant acquisitions and disposals, where in 2012 it announced an ultimate agreement to sell its North America frozen meals business to ConAgra foods company for a total cash of US$265 million (Unilever Inc, 2012). Similarly, the company acquired 18 percent of the outstanding share capital in Concern Kalina in December 2011. On September 2010 the company announced an ultimate agreement to sell its tomato products in Brazil to Cargil which amounted R$ 600 million (Unilever Inc, 2012, PP. 93). Similarly, the company completed the acquisition of Ingman ice cream for an undisclosed sum in December 2011. However, other disposals during this year were not material.
The operating activities offer the funds to service the financing of the financial debt on a day-to day-basis. Unilever Limited intends to finance its liquidity requirements by keeping access to global debt markets via short-term and long-term debt programs. Dividends are recognized on the date that the shareholder’s right to receive payment is determined. This holds for external dividends and internal dividends paid to the parent company. The dividends paid in 2012 were better than that of the previous year 2011. In order to govern any investment and financial risks the Chairman believes that financial reporting risks and risk management offers reasonable assurance that the financial statements do not contain any errors.
Part 3
Despite the differences, the Unilever Limited investment, financing and distribution decisions are necessarily interrelated in that source of cash equals the use of cash. An increase in operating activities in the cash flow could be used to increase capital expenditure (Pogue, 2010, PP. 12). Otherwise, it could be used to reduce debt, increase dividends or finance any combination of investment and financing decisions. Research indicates that increases in cash flow are mainly employed to decrease debt and have an irrelevant influence on capital investment. Moreover, a decision to increase investment can only be accommodated by reducing dividend payments or increasing finance.
However, the increased source of new finance may influence the discount rate used in the appraisal process and may influence the acceptance or rejection of the investment project. For instance, the net cash obtained from operating activities in the cash flow accounts should be large enough to cover the investment and financing activities. In the Unilever Limited, net cash from operating activities is not large enough to cover the investing and financing activities because there is a decrease of net cash of (541) in 2012. These shows the operating activities employed to decrease debt have an irrelevant influence on capital investment because the company uses external finances to finance the capital investment in order to maximize shareholder returns.
Conclusion
In a recap, the paper has examined financial decisions under the corporate finance theory, which assumes that the main objective is to have optimal value of the company, which is referred to as maximizing shareholder wealth. Therefore, the value of the company is determined based on three main financial decisions such as financial, investment and dividend. Although these financial decisions have differences, they are necessarily interrelated in that source of cash equals the use of cash. The paper examines these financial decisions of the Unilever Limited, which is registered in the Netherlands. The main objective of Unilever is to optimize the value of the company, which is maximizing shareholder wealth.
Reference Lists
Baker, H. K., & Martin, G. S. (2011). Capital structure & corporate financing decisions theory, evidence, and practice. Hoboken, N.J., John Wiley & Sons.
Pike, R., Neale, B., & Linsley, P. 2012. Corporate finance and investment: decisions and strategies. New York, Pearson Financial Times / Prentice Hall.
Pogue, M. 2010. Corporate investment decisions: principles and practice. New York, N.Y., Business Expert Press.
Unilever Inc. (2012). Unilever Annual Report and Accounts. Retrieved November 23, 2013, From: http://www.unilever.com/images/ir_Unilever_AR12_tcm13-348376.pdf
Unilever Inc. (2012). Unilever agrees to sell frozen meals portfolio in North America | Media centre | Unilever Global. Retrieved November 23, 2013, from http://www.unilever.com/mediacentre/pressreleases/2012/frozen-meals.aspx
