Question 2.1: Describe the factors influencing the relative proportions of...
Describe the factors influencing the relative proportions of internal and external finance used in capital investment.
This topic is discussed in Section 2.1.3.
Retained earnings, the major source of internal finance, may be preferred to external finance by companies for several reasons:
Retained earnings are seen as a ready source of cash.
The decision on the amount to pay shareholders (and hence on the amount to retain) is an internal one and so does not require a company to present a case for funding to a third party. (2.1.3)
The main factors influencing the split between
internal and external finance are as follows:
– the level of finance required;
– the cash flow from existing operations;
– the opportunity cost of retained earnings;
– the costs associated with raising external finance;
– the availability of external sources of finance;
– dividend policy.