Retained Earnings Assignment Help
1. If the financial managers pay dividends to stockholders in the amount of one million dollars (half of the net income amount), what effect does this have on the statement of retained earnings? What account(s) would be affected?
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Retained earnings are the amount of the profit which is retained by the firm after meeting all the expenses and payment of dividend. So in effect the changes in retained earnings is the amount of profit less the amount of dividend paid to the shareholders. Hence if the hospital management decides to pay off $1 million as dividend then the profit retained would be $1 million. Hence the action of the management to pay dividend from the net profits would increase the RE by $1 million.
2. Discuss the advantages or disadvantages of retaining the money in the business versus paying a dividend to the stockholders.
Retaining money earned in the formof net earnings are beneficial for the firm as:
a) It increases stockholders equity and book value of the shares.
b) It also helps to increase stability of the business by providing more and more liquidity
c) The same can be used as part of internal funding instead of going for more debts in case of expansion needs of the business.
d) Funds form internal sources are generally low cost and does not involve paying interest costs and hence might be preferred by managers.
However the paying dividend by a firm can also have some merits like:
a) Payment of dividends increases the returns generated by stockholders which is immensely helpful for increasing demand for the firms stock and thus increases stock prices and firms value.
b) When profits are retained rather than distributed, even a highly profitable corporation may be less attractive to investors than another firm which decides to pay dividends on a regular basis.
3. Suppose you are a financial manager at Care-4-You Hospital. You discover that a new piece of equipment costing $1 million would allow the hospital to expand its services. In two years, the hospital would recover all initial costs of the machine. As the financial manager, would you recommend purchasing the equipment? Why or why not? What impact does your decision have on the hospital, the stockholders and other users of financial information?
The new equipment would cost $1 million and if the same is implemented as an investment the management is assured of the recovery of the investment in 2 years. This means the payback period of the investment is 2 years. If we ignore the opportunity cost of capital then the investment is a good one as all the costs incurred is received back in 2 years time and probably very good strategy.
However this strategy doesnot make use of the net present value and ignores TVM. Hence we don't know whether the investment can increase the value of the firm if investment is made. For example if the opportunity cost of capital or the discount rate is 12%, then (assuming) the NPV is $200,000. This shows that the firms value would definitely increase by $200,000 if investment in the equipment is made. So as TVM is ignored we arenot able to estimate if the firms value would increase or not.
However if we ignore the TVM and cos of capital, the investment is good one as only 2 years would be neededto recover the investments and it would help the firm recover more as the equipment's life is expected to be more than just two years. On the face of it , it seems to be a good option in the absenceof other opportunities.
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