How do a company’s investment opportunities, capital structure, and working capital

How do a company’s investment opportunities, capital structure, and working capital

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June 1, 2022
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How do a company’s investment opportunities, capital structure, and working capital policies affect its distributions to shareholders?

Answer and ExplanationSolution by a verified expert

Explanation
The shareholders are paid out of the free cash flows earned by the company. This free cash flow has alternative uses, for instance, financing of investment opportunities, repayment of debt and interest, and investment in working capital.

If the investment opportunities are good, company prefer to invest the free cash flows into those opportunities instead of paying out to the shareholders. Also, in case of a highly levered firm, the free cash flows would be low as the interest cost would be quite high, so the distribution to shareholders would decline. Finally, the policies to invest highly in working capital blocks up the free cash flows of the company and reduces the pay-outs to the shareholders.

Verified Answer
Good investment opportunities, high leverage (capital structure), and investment in current assets (working capital policies) inversely impact the distribution to the shareholders.

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