The Impact of Financial Management Decisions on a Firm's Value

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Do financial management decisions influence firm value?

Table of contents

2.Background overview3
2.1 Financial management decisions3
2.1.1 Capital budgeting4
2.1.2 Capital structure4
2.1.3 Working capital management5
2.1.4 Relationship5
2.2 Efficiency of the capital markets5
3.Empirical study6
3.1 Select a FTSE 100 company—HSBC Holdings PLC6
3.2 Financial decisions taken over in the past three years7
3.3Appraise the financial management decisions8
3.4Impacts the financial management decisions have on the company’s value9

1. Introduction

The financial management is a comprehensive and complex work to plan the expenditure and revenue in detail, so as to accumulate more profit guarantee the future expansion and daily normal operation. Financial management decisions are the strategies to achieve their financial objectives which mainly include capital budgeting, capital structure, and working capital management. Scholars have been devoting themselves into this discipline for a long time, especially the research of capital structure. Modigliani and Miller (1958) even got their Nobel Prize in economics for their study of the relationship between capital structure and corporate value, with and without corporate tax. But whether financial management decisions influence the firm value and how policies affect it are still open for discussion, for there are still plenty of uncertainties. This paper makes a brief overview of the related theories about financial management and the efficiency of capital market, and then carries on an empirical study to test related theories by citing an example of a FTSE 100 company, HSBC Holdings PLC.

2. Background overview

2.1Financial management decisions

The management’ primary mission is to make sure all scarce resources are utilized in a most efficient way to fulfill their financialtargets in business, achieve profit or value maximization and revise the policy if anything goes wrong.Main financial management decisions taken by a firm are capital budgeting, capital structure, and working capital management.

2.1.1 Capital budgeting

Capital budgeting is a comprehensive process of long run overall arrangement in order to make timely and reasonable investments when necessary, and main techniques adopted in the field are Net Present Value (NPV), Internal Rate of Return (IRR), Equivalent Annual Cost (EAC) and so on. It is crucial for corporate operation because only in this way could they make an appropriate choice with positive NPV (Ross et al, 2009). And when a company has an objective, capital budgeting helps it estimate the cash flow and risks of each option scientifically.

2.1.2 Capital structure

Capital structure mainly refers to the massive arrangement of financing resources in a company, and people usually use the Gearing Ratio or Leverage Ratio to describe it. The resources of financing include corporate bonds, firm equity, hybrid securities and so on. Modigliani and Miller (1963) pointed out that the existence of liabilities in a company can enhance the firm value under a series of assumptions. But Ross et al(2009) claimed that the utilization of debt has limitation. Graham and Harvey (2001) studied the factors that affect the utilization of debt. Myers (1983) put forward the Pecking order theory that the order of financing a company tends to choose is internal funds, debt, and then equity. Others proposed a Trade-off Theory of Capital Structure that a company should balance the benefit of debt and the risk of agency costs.

2.1.3 Working capital management

Working capitalis the difference between current assets and current liabilities, which shows the firm’s ability to pay off short-term debtWorking capital management mainlyinvolves the arrangement of short-term financing and investment, or rather liabilities and...
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