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# Leverages Problems

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### Leverages Problems

1. 1. Leverages 1. Given the data below: Selling price per unit Rs.120, Variable cost per unit Rs.80, Fixed cost Rs.6,00,000 Interest Rs.2 lakhs, Number of units sold 30,000, Calculate the three types of leverages. [Oct.'01] 2. From the following data calculate financial, operating and combined leverage. Sales 10,000 units, Rs.25 per unit as the selling price. Variable cost Rs.5 per unit Fixed cost Rs.30,000. Interest cost Rs.15,000. [Ap. '02] 3. A firm has sales of Rs.10,00,000, Variable cost Rs.7,00,000, fixed cost Rs.2,00,000 and Rs.5,00,000 debt at 10% interest. What are the operating, financial and combined leverages? [Nov. '99] 4. From the following information calculate: Financial leverage, Operating leverage and combined leverage Sales Rs.9,60,000, Variable cost Rs. 5,60,000, Fixed cost Rs. 2,40,000 Interest Rs.60,000, Tax Rs.50,000. [Ap. '00, Oct. '02] 5. NEKO Ltd. has a capital of Rs.50,00,000. The EBIT are Rs.10,00,000. What would be its financial leverage [DFL]? Assuming the EBIT being Rs.7,50,000 and Rs.12,50,000, how would the EPS be affected? Assume a tax rate of 50%. The equity share value of Rs.10 each. [Ap. '99] 6. Total sales of a company Rs. 5,00,000, Total variable cost Rs. 3,00,000 Total fixed cost Rs.1,00,000, 6% Debenture capital is Rs.10,00,000. Find three leverages [Oct. '00] 7. The Earnings After Tax (EAT) is Rs.61,500. Income Tax rate is 38.5%. Interest is Rs.20,000 find out EBIT [Oct. '01, '02] 8. Calculate all 3 leverages for the following firms Particulars P Q R Output [Units] 3,00,000 75,000 5,00,000
2. 2. Fixed cost Rs.3,50,000 Rs.7,00,000 Rs.75,000 Unit Variable cost Re.1.00 Rs.7.50 Re.0.10 Interest Expenses Rs.25,000 Rs.40,000 NIL Unit selling price Rs.3 Rs.25 Re.0.50 9. The following details relate to X Ltd. Selling price per unit Rs.120 Variable cost per unit Rs.70 Total fixed cost Rs.2,00,000 Interest Rs.20,000 A] What are the operating and financial leverages when X Ltd. produces and sells 6,000 units B] What is the % change that will occur in the EBIT of X Ltd. if the output increases by 5% 10. Calculate operating, financial and combined leverages under situations where the fixed cost A] Rs.5,000 & B] Rs.10,000 and Financial plans I & II respectively from the following data Total assets Rs.30,000 Total assets turnover 2 Variable cost as a % of sales 60 Financial Plan I II Equity Rs.30,000 Rs.10,000 10% debentures Rs.10,000 Rs.30,000 11. Calculate all leverages under situations A,B, & C and Financial Plans I,II, & III respectively from the following information Installed capacity 1,200 units, Actual production and sales 800 units Selling price per unit Rs.15, Variable cost per unit Rs.10 Fixed cost : Situation A - Rs.1,000 Situation B - Rs.2,000 Situation C - Rs.3,000 Capital structure Plan I Plan II Plan III Equity (Rs.) 5,000 7,500 2,500 Debt (Rs.) 5,000 2,500 7,500 Cost of debt 12% 12. The capital structure of Priya Ltd. consists of Equity share capital of
3. 3. Rs.10,00,000 and Rs.10,00,00 of 10% debentures. Sales increase from 1,00,000 to 1,20,000 units The existing selling price is Rs.10 per unit The variable cost amounted to Rs.6 per unit Fixed cost amounted to Rs.2,00,000 The income tax rate is 50% You are required to calculate A] percentage increase in EPS assuming that the face value of each share is Rs.100 B] degree of financial leverage at 1,00,000 and 1,20,000 units C] degree of operating leverage at 1,00,000 and 1,20,000 units 13. ABC Ltd. provide the following data Variable cost as % of sales 50 Interest Rs.40,000 Degree of operating leverage 3 Degree of financial leverage 2 Tax rate 50% Prepare the income statement 14. The following is the Balance sheet of a Company Liabilities Rs. Assets Rs. Equity capital [@Rs.10 per share] 60,000 Fixed assets 1,50,000 10% Long term debt 80,000 Current assets 50,000 Retained earnings 20,000 Current Liabilities 40,000 2,00,000 2,00,000 The company's total asset turnover ratio is 3 Its fixed operating costs are Rs.1,00,000 Variable operating cost ratio is 40% The income tax rate is 50% I] calculate all the types of leverages II] determine the likely level of EBIT if EPS is a] Re.1.00 b] Rs.3.00 c] Re.0 15. ABC Ltd. has an EBIT of Rs.1,60,000. Its capital structure consists of the following securities 10% debentures Rs.5,00,000 12% Preference shares Rs.1,00,000
4. 4. Equity shares of Rs.100 each Rs.4,00,000 The company is in the 55% tax bracket. You are required to determine (i) The company's EPS (ii) The percentage change in EPS associated with 30% increase and 30% decrease in EBIT (iii) The degree of financial leverage LIQUIDITY DECISIONS/ WORKING CAPITAL MANAGEMENT Meaning “ The excess of current assets over currents liabilities” also known as circulating, revolving or fluctuating capital Components of wc TYPES • Gross working capital & net working capital • Permanent working & temporary working capital • Positive working & negative working capital • Balance sheet working cap & cash working cap Methods of estimating working capital. • Conventional method- cash inflows & cash outflows are matched together. Emphasis is on liquidity & its ratios. • Operating cycle method It considers the production and other business operations. It emphasis on profitability & liquidity of the firm Factors determining WC requirements – Nature of business 11. Growth of business – Manufacturing cycle 12. Market conditions – Production process 13. Supply situations – Business cycle 14. Environment factors – Seasonal variations – Scale of operations – Inventory policy – Credit policy – Accessibility of credit – Business standing
5. 5. Working capital management Working capital management refers to the management of working capital with twin objectives of Liquidity & profitability. Working capital management establishes the best possible trade-off between the profitability of net current assets employed and the ability to pay current liabilities as they fall due. Objectives: • Optimize investments in current assets. • To see that the company meets its current liabilities obligations • Manage current assets to see that the return on current assets is more than cost of capital • Proper balance between current assets & current liabilities Components of WCM • INVENTORY MANAGEMENT • CASH MANAGEMENT • RECEIVABLES MANAGEGMENT INVENTORY MANAGEMENT Meaning- Objectives- • For continuous supply for uninterrupted production • To reduce wastage & losses • To introduce scientific inventory management techniques • To reduce cost of purchase & storage • To reduce excessive or shortage of inventory • To have uninterrupted production • for effective utilization of store space • To provide right material at right time, from right source & at right prices. TOOLS OF INVENTORY MANAGEMENT • Fixation of levels- Maximum level Minimum Level Reorder level Danger level 2. Fixation of EOQ- √2AO÷C • ABC analysis
6. 6. • VED analysis • FSN /FNSD analysis • Perpetual inventory system • Periodic inventory system • Inventory turnover ratios • JIT Analysis CASH MANAGEMENT Objectives- To make prompt cash payments To maintain minimum cash reserve Motives of holding cash- Transaction motive Precautionary motive Speculative motive compensatory motive Cash management strategies - • Cash planning • Managing the cash flows • Optimum cash balance • Investing idle cash. • Cash planning – It is a technique to plan for & use of cash. It involves cash forecasting and budgeting. Cash budgets & forecasting – Short term cash forecasting Long term cash forecasting Methods of cash forecasting – 1. Receipt & Disbursement method 2. Adjusted net income method 2. Managing cash flows Accelerating cash collection • Prompt payment by customers • Lock box system • Concentrating banking • Electronic fund transfer • Decentralize collection Controlling Disbursement • Playing the Float-collection float payment float • Payment on last day & by drafts • Centralisation of payments
7. 7. 3. Determining optimum cash balance 4. Investment in marketable securities. Selection of securities Safety Maturity Marketability RECEIVABLES MANAGEMENT Meaning – Determinants of accounts receivable/credit sales- • Credit sales volume • Credit policies • Business terms- time period, discounts • Competition • Location • New products Cost of receivables/trade credits- • Carrying cost • Defaulting cost • Administration cost Management of receivables • Forming of credit policy • Executing credit policy • Formulating & executing collection policy Credit rating-5 C’s (character, capacity, capital, collateral & condition) Ageing schedules-it is a statement prepared to determine quality of individual debtors. No of days, period ending, % age of debt etc. Factoring- Services-finance, maintenance of accounts, collection of data or protection against credit risks. Capital Budgeting  Meaning of capital budgeting  Significance  Capital budgeting process  Investment criteria  Methods of capital budgeting
8. 8. Meaning  The process through which different projects are evaluated is known as capital budgeting  Capital budgeting is defined “as the firm’s formal process for the acquisition and investment of capital. It involves firm’s decisions to invest its current funds for addition, disposition, modification and replacement of fixed assets”.  “Capital budgeting is long term planning for making and financing proposed capital outlays”- Charles T Horngreen.  “Capital budgeting consists in planning development of available capital for the purpose of maximising the long term profitability of the concern” – Lynch  The main features of capital budgeting are a. potentially large anticipated benefits b. a relatively high degree of risk c. relatively long time period between the initial outlay and the anticipated return. - Oster Young Significance of capital budgeting  The success and failure of business mainly depends on how the available resources are being utilised.  Main tool of financial management  All types of capital budgeting decisions are exposed to risk and uncertainty.  They are irreversible in nature.  Capital rationing gives sufficient scope for the financial manager to evaluate different proposals and only viable project must be taken up for investments.  Capital budgeting offers effective control on cost of capital expenditure projects.  It helps the management to avoid over investment and under investments. Capital budgeting process involves the following 1. Project generation: Generating the proposals for investment is the first step. The investment proposal may fall into one of the following categories:  Proposals to add new product to the product line,  proposals to expand production capacity in existing lines  proposals to reduce the costs of the output of the existing products without altering the scale of operation.  Sales campaining, trade fairs people in the industry, R and D institutes, conferences and seminars will offer wide variety of innovations on capital assets for investment.  Project Evaluation: it involves two steps
9. 9.  Estimation of benefits and costs: the benefits and costs are measured in terms of cash flows. The estimation of the cash inflows and cash outflows mainly depends on future uncertainities. The risk associated with each project must be carefully analysed and sufficeint provision must be made for covering the different types of risks.  Selection of an appropriate criteria to judge the desirability of the project: It must be consistent with the firm’s objective of maximising its market value. The technique of time value of money may come as a handy tool in evaluation such proposals.  Project Selection: No standard administrative procedure can be laid down for approving the investment proposal. The screening and selection procedures are different from firm to firm.  Project Evaluation: Once the proposal for capital expenditure is finalised, it is the duty of the finance manager to explore the different alternatives available for acquiring the funds. He has to prepare capital budget. Sufficient care must be taken to reduce the average cost of funds. He has to prepare periodical reports and must seek prior permission from the top management. Systematic procedure should be developed to review the performance of projects during their lifetime and after completion. The follow up, comparison of actual performance with original estimates not only ensures better forecasting but also helps in sharpening the techniques for improving future forecasts. Factors influencing capital budgeting  Availability of funds  Structure of capital  Taxation policy  Government policy  Lending policies of financial institutions  Immediate need of the project  Earnings  Capital return  Economical value of the project  Working capital  Accounting practice  Trend of earnings Methods of capital budgeting Traditional methods  Payback period  Accounting rate of return method
10. 10. Discounted cash flow methods  Net present value method  Profitability index method  Internal rate of return Pay back period method It refers to the period in which the project will generate the necessary cash to recover the initial investment. It does not take the effect of time value of money. It emphasizes more on annual cash inflows, economic life of the project and original investment. The selection of the project is based on the earning capacity of a project. It involves simple calcuation, selection or rejection of the project can be made easily, results obtained is more reliable, best method for evaluating high risk projects. Cons  It is based on principle of rule of thumb,  Does not recognize importance of time value of money,  Does not consider profitability of economic life of project,  Does not recognize pattern of cash flows,  Does not reflect all the relevant dimensions of profitability. Accounting Rate of Return method IT considers the earnings of the project of the economic life. This method is based on conventional accounting concepts. The rate of return is expressed as percentage of the earnings of the investment in a particular project. This method has been introduced to overcome the disadvantage of pay back period. The profits under this method is calculated as profit after depreciation and tax of the entire life of the project.  This method of ARR is not commonly accepted in assessing the profitability of capital expenditure. Because the method does to consider the heavy cash inflow during the project period as the earnings with be averaged. The cash flow advantage derived by adopting different kinds of depreciation is also not considered in this method. Accept or Reject Criterion: Under the method, all project, having Accounting Rate of return higher than the minimum rate establishment by management will be considered and those having ARR less than the pre-determined rate. This method ranks a Project as number one, if it has highest ARR, and lowest rank is assigned to the project with the lowest ARR. Merits  It is very simple to understand and use.  This method takes into account saving over the entire economic life of the project. Therefore, it provides a better means of comparison of project than the pay back period.
11. 11.  This method through the concept of "net earnings" ensures a compensation of expected profitability of the projects and  It can readily be calculated by using the accounting data. Demerits  1. It ignores time value of money.  2. It does not consider the length of life of the projects.  3. It is not consistent with the firm's objective of maximizing the market value of shares.  4. It ignores the fact that the profits earned can be reinvested. - Discounted cash flow method Time adjusted technique is an improvement over pay back method and ARR. An investment is essentially out flow of funds aiming at fair percentage of return in future. The presence of time as a factor in investment is fundamental for the purpose of evaluating investment. Time is a crucial factor, because, the real value of money fluctuates over a period of time. A rupee received today has more value than a rupee received tomorrow. In evaluating investment projects it is important to consider the timing of returns on investment. Discounted cash flow technique takes into account both the interest factor and the return after the payback 'period. Discounted cash flow technique involves the following steps:  Calculation of cash inflow and out flows over the entire life of the asset.  Discounting the cash flows by a discount factor  Aggregating the discounted cash inflows and comparing the total so obtained with the discounted out flows. Net present value method It recognises the impact of time value of money. It is considered as the best method of evaluating the capital investment proposal. It is widely used in practice. The cash inflow to be received at different period of time will be discounted at a particular discount rate. The present values of the cash inflow are compared with the original investment. The difference between the two will be used for accept or reject criteria. If the different yields (+) positive value , the proposal is selected for invesment. If the difference shows (-) negative values, it will be rejected. Pros: It recognizes the time value of money. It considers the cash inflow of the entire project. It estimates the present value of their cash inflows by using a discount rate equal to the cost of capital. It is consistent with the objective of maximizing the welfare of owners.
12. 12. Cons: It is very difficult to find and understand the concept of cost of capital It may not give reliable answers when dealing with alternative projects under the conditions of unequal lives of project. Internal Rate of Return It is that rate at which the sum of discounted cash inflows equals the sum of discounted cash outflows. It is the rate at which the net present value of the investment is zero. It is the rate of discount which reduces the NPV of an investment to zero. It is called internal rate because it depends mainly on the outlay and proceeds associated with the project and not on any rate determined outside the investment. Merits of IRR method  It consider the time value of money  Calculation of casot of capital is not a prerequisite for adopting IRR  IRR attempts to find the maximum rate of interest at which funds invested in the project could be repaid out of the cash inflows arising from the project.  It is not in conflict with the concept of maximising the welfare of the equity shareholders.  It considers cash inflows throughout the life of the project. Cons  Computation of IRR is tedious and difficult to understand  Both NPV and IRR assume that the cash inflows can be reinvested at the discounting rate in the new projects. However, reinvestment of funds at the cut off rate is more appropriate than at the IRR.  IT may give results inconsistent with NPV method. This is especially true in case of mutually exclusive project. Step 1:Calculation of cash outflow Cost of project/asset xxxx Transportation/installation charges xxxx Working capital xxxx Cash outflow xxxx Step 2: Calculation of cash inflow Sales xxxx Less: Cash expenses xxxx PBDT xxxx Less: Depreciation xxxx PBT xxxx
13. 13. less: Tax xxxx PAT xxxx Add: Depreciation xxxx Cash inflow p.a xxxx Note:  Depreciation = St.Line method  PBDT – Tax is Cash inflow ( if the tax amount is given)  PATBD = Cash inflow  Cash inflow- Scrap and working capital must be added. Step 3: Apply the different techniques  Pay back period= No. of years + Amt to recover/ total cash of next years.  ARR = Average Profits after tax/ Net investment x 100  NPV= PV of cash inflows – PV of cash outflows  Profitability index = PV of cash inflows/ PV of cash outflows  IRR : Pay back factor: Cash outflow/ Avg cash inflow p.a. Find IRR range PV of Cash inflows for IRR range and then calculate IRR Thank You Capital Structure Meaning Factors influencing capital structure Optimal capital structure Point of Indifference Leverages Types of leverages Definition “ Capital structure of a company refers to the composition of its capitalisation and it includes all long term capital sources i.e., loans, reserves, shares and bonds”. – gerestenbeg “ the Capital structure of business can be measured by the ratio of various kinds of permanent loan and equity capital to total capital”. - Schwarty Factors affecting capital structure INTERNAL  Financial leverage  Risk  Growth and stability
14. 14.  Retaining control  Cost of capital  Cash flows  Flexibility  Purpose of finance  Asset structure EXTERNAL  Size of the company  Nature of the industry  Investors  Cost of inflation  Legal requirements  Period of finance  Level of interest rate  Level of business activity  Availability of funds  Taxation policy  Level of stock prices  Conditions of the capital market Optimal capital structure The OCM can be defined as “ that capital structure or combination of debt and equity that leads to the maximum value of the firm” OCM maximises the value of the company and hence the wealth of its owners and minimise the company’s cost of capital. the following consideration should be kept in mind while maximising the value of the firm in achieving the goal of the optimal capital structure:  If ROI > the fixed cost of funds, the company should prefer to raise the funds having a fixed cost, such as, debentures, Loans and PSC. It will increase EPS and MV of the firm.  If debt is used as a source of finance, the firm saves a considerable amount in payment of tax as interest is allowed as a deductible expense in computation of tax.  It should also avoid undue financial risk attached with the use of increased debt financing  The Capital structure should be flexible. Point of indifference / Range of earnings The earnings per share, ‘equivalent point’ or ‘point of indifference’ refers to that EBIT, level at which EPS remains the same irrespective of Different alternatives of Debt-Equity mix. At this level of EBIT, the rate of return on capital employed is equal to the cost of debt and this is also known as the break-even level of EBIT for alternative financial plans Capital Gearing CG means the ratio between the various types of securities in the capital structure of the company. A company is said to e high-gear when it has proportionately higher/larger
15. 15. issue of Debt and PS for raising the LT resources. Whereas low-gear stands for a proportionately large issue of equity shares. Leverage Leverage-an Increased means of accomplishing some purpose In financial management, it is the firms ability to use fixed cost assets or funds to increase the returns to its owners; Financial leverage- the use of long term fixed income bearing debt and preference share capital along with the equity share capital is called financial leverage or trading on equity A Firm is known to have a favourable leverage if its earnings are more than what debt would cost. On the contrary, if it does not earn as much as the debt costs then it will be known as an unfavourable leverage. Impact of financial leverage When the d/f b/w the earnings from assets financed by fixed cost funds and cost of these funds are distributed to the equity stockholders, they will get additional earnings without increasing their own investment. Consequently, the EPS and the Rate of return on ESC will go up. On the contrary, if the firm acquires fixed cost funds at a higher cost than the earnings from those assets then the EPS and return on equity capital will decrease. Significance of financial leverage  Planning of capital structure  Profit planning Limitations of FL/ trading on equity  Double-edged weapon  Beneficial only to companies having stability in earnings  Increases risk and rate of interest  Restriction from financial instruments Operating leverage Operating leverage results from the presence of fixed costs the help in magnifying net operating income fluctuations flowing from small variations in revenue. The changes in sales are related to changes in the revenue. The fixed costs do not change with the changes in sales, any increase in sales, FC remaining the same, will magnify operating revenue OL shows the ability of a firm to use fixed operating cost to increase the effect of change in sales and the charges in fixed operating income. Combined leverage  The OL affects the income which is the result of production. On the other hand, FL is the result of financial decisions. The CL focuses attention on the entire income of the concern  This leverage shows the relationship between a change in sales and the corresponding variation in taxable income. Working capital leverage This leverage measures the sensitivity of ROI of changes in the level of current assets. Dividend Decisions Meaning
16. 16. Types of Dividend policies Factors influencing dividend policy Forms of dividend Meaning The term dividend refers to that part of profits of a company which is distributed by the company among its shareholders. It is the reward of the shareholders for investments made by them in the shares of the company. Dividend policy and significance of dividend policy It refers to the policy that the management formulates in regard to earnings for distribution as dividends among shareholders. it determines the division of earnings between payments to shareholders and retained earnings. Significance of dividend policy  The firm has to balance between the growth of the company and the distribution to the shareholders  It has a critical influence on the value of the firm  It has to also to strike a balance between the long term financing decision( company distributing dividend in the absence of any investment opportunity) and the wealth maximisation Contd.....  The market price gets affected if dividends paid are less.  Retained earnings helps the firm to concentrate on the growth, expansion and modernisation of the firm  To sum up, it to a large extent affects the financial structure, flow of funds, corporate liquidity, stock prices, growth of the company and investor’s satisfaction. Factors influencing the dividend decision  Stability of earnings  Financing policy of the firm  Liquidity of funds  Dividend policy of competitive firms  Past dividend rates  Debt obligation  Ability to borrow Stability of dividends/ regularity It is the desirable policy of the management to distribute the shareholders a certain percentage of earnings as a reward for their investment. It may not always relate to the earnings of the company. Dividend practices:  Constant dividend per share  Constant percentage of net earnings  Small constant dividend per share plus extra earnings  Dividend as a fixed percentage of market value
17. 17. Significance of stability of dividend  Confidence among shareholders  Investors desire for current income  Institutional investor’s requirement  Stability in market prices of shares  Raising additional finances  Spreading of ownership of outstanding shares  Reduces the chances of loss of control  Market for debentures and preference shares. Forms of Dividend  Scrip Dividend- An unusual type of dividend involving the distribution of promissory notes that call for some type of payment at a future date.  Bond Dividend- A type of liability dividend paid in the dividend payer's bonds .  Property Dividend- A stockholder dividend paid in a form other than cash, scrip, or the firm's own stock.  Cash Dividend- A dividend paid in cash to a company's shareholders, normally out of the its current earnings or accumulated profits  Debenture Dividend  Bonus share or Stock dividends- A dividend payment made in the form of additional shares, rather than a cash payout.  Optional Dividend- Dividend which the shareholder can choose to take as either cash or stock. Objectives of stock dividend  Conservation of cash  Lower rate of dividend  Financing expansion programmes  Transferring the formal ownership of surplus and reserves to the shareholders  Enhanced prestige  Widening share market  True presentation of earning capacity Merits of Stock dividend  To the company  Maintenance of liquidity position  Satisfaction of shareholders  Economical issue of capitalisation  Remedy for under capitalisation  Enhance prestige  Widening the share for market  Finance for expansion programmes  Conservation of control Demerits of stock dividend  To the company  Increase in the capitalisation of the company  It results in more liability  Denies other investors to shareholders
18. 18.  Management control not diluted it may lead to fraud DIVIDEND DECISIONS Dividend is the portion of earnings which is Distributed among the shareholders. Dividend policy determines the division of Earnings between payment to shareholders & retained earnings. Dividend policy may be viewed as: • Long term financing decision • Wealth maximisation decision Determinants of dividend policy. • Transaction cost • Personal taxation • Dividend clientele • Dividend payout ratio • Divisible profits • Liquidity • Rate of expansion • Rate of return • Legal provisions • Stability of earnings • Contractual constraints • Cost of financing • Degree of control • Capital Market access • State of economy • Effect of trade cycles • Policy of competitive concerns
19. 19. Dividend policies • Constant dividend payout ratio. • Constant dividend rate policy :- (dividend equalisation fund/reserve) a. constant dividend per share b. constant divided plus extra dividend c. uniform cash dividend plus bonus shares d. Fixed percentage of market value Types of dividends • Cash dividends • Dividend warrants • Bond dividends • Property dividends • Stock dividends/bonus shares STOCK DIVIDENDS/BONUS SHARES • Making partly paid equity shares fully paid up • Issuing fresh equity shares to existing shares objectives- • Conservation of cash • Lower rate of dividends for undercapitalisation • Financing expansion programme • Transferring the surplus reserves • Enhance prestige • Widening share market • True presentation of earning capicity. advantages to company- • Liquidity position • Shareholders satisfaction • Reduced cost of capitalisation • Remedy for undercapitalisation • Enhance prestige • Widening share market
20. 20. • Finance for expansion • Conservation of control Advantages- to investors • Increase in their equity • Marketability of shares is increased • Increase in income • Increases demand for shares Disadvantages for company • Increase in capitalisation • More liability of dividends • Prevents new investors • Control of management is diluted For investors • Loss of cash dividends • Lowers the market value of share