Corporate structures and practices

Corporate Qs

Generally speaking, the potential return on any financial decision is commensurate with the risk involved in that decision; the higher the risk in a given scenario/decision, the higher the potential return (as well as the greater the potential loss) (Vishwanath 2007). This basic rule is self-reinforcing, as the market demands a higher potential return for investments and decisions with greater risks, meaning that the stock price of a firm is largely dependent on the risk to return ratio: investors might still drive up the price of a risky stock if there is a large potential payoff, while the price of the stock will drop if the risks are seen as exceeding the potential rewards (Vishwanath 2007). These linkages are important because they can serves as a bellwether for how the market perceives a firm's financial decisions (Vishwanath 2007). A financial manager must carefully balance the needs of a firm's growth while maximizing the risk/return ratio to ensure ongoing returns with substantial enough incentives for continued investment, yet shielding owners' profits (Vishwanath 2007).

2. There are many factors that can influence capital budgeting decisions. Large-scale macroeconomic forces such as fluctuations in the exchange rates between different currencies or political disturbances that disrupt supply chains or add stress to trade relationships can inhibit or quickly erode value in certain capital finance structures (Vishwanath 2007). Capital held in dollars in a U.S. bank, for example, becomes riskier as the dollar falls in value, eroding a capital budget both directly through value loss and indirectly through a higher risk with lower returns on the stock the company could issue. Political upheavals can work in a similar fashion, increasing the perceived risk of an investment without a direct corresponding increase in the potential rewards, as well as directly threatening the ability to transport goods, access and move capital, etc. (Peterson & Fabozzi 2002).

Differences in tax laws could also make it advantageous for firms to restructure their capital budget to show income and expenditures in the nations that have the most favorable tax incentives for such transactions, and can also heavily influence where capital is stored based on interest growth tax rates (Peterson & Fabozzi 2002). Transfer pricing also takes place with both parties attempting to maximize their return, agreeing on certain currencies of exchange, adjustment procedures, etc., contributing in no small way to the strategic budgeting and financing of a firm (Peterson & Fabozzi 2002; Vishwanath 2007). Strategic decisions that take into account non-financial consideration can also greatly influence capital budgeting structures, such as the various methods of reorganization that the U.S. auto manufacturers recently underwent.