Final answer:
Finish Inc plans to reinvest its earnings for specified periods: 100% for three years, 40% for the next two, and 20% thereafter, aiming for a 25% return on investment from new projects. These decisions illustrate the balance between reinvesting for growth and providing shareholder dividends.
Step-by-step explanation:
Finish Inc is a firm anticipating earnings of $6 million in the upcoming year and has a strategic plan regarding the retention and investment of its earnings. For the first three years, the firm will retain 100% of its earnings, followed by retaining 40% for the next two years, and then retaining 20% of its earnings indefinitely. It is assumed that the firm will invest the retained earnings into new projects with an expected return of 25% per year. Any earnings not retained will be distributed as dividends. This exercise reflects the real-life decisions that firms make in terms of growth and financial capital allocation, balancing reinvestment against shareholder dividends.
Earnings Reinvestment and Growth
Firms like Finish Inc. make critical decisions to reinvest profits to stimulate growth. By reinvesting, a company can finance expansion through improved facilities, more labor, or new technology. This increased capacity can lead to more sales and a larger cash flow, contributing further to the firm's expansion. As profits from these investments materialize, a portion is distributed as dividends to shareholders, rewarding them for their investment and providing them with an expected rate of return through either dividends or capital gains.