Question

Which of the following statements is/are correct?

a. in a maturing company that is not paying out cash to shareholders, the stock price will begin to stagnate.
b. shareholders' taxes can be affected by the firm's decision to pay out cash or retain it.
c. when positive npv projects are scarce, the maturing firm's cash flow is decreased.
d. accumulation of cash by a mature firm can lead to problems like overinvestment and excessive perks.

Answer 1

Excessive cash reserves in a mature firm can lead to overinvestment and excessive perks, reducing financial discipline and potentially decreasing shareholder value. Firms must strategically choose between loans, bonds, or issuing stock to balance cash flow, control, and obligations.

Step-by-step explanation:

Excessive cash reserves

The statement in question, which addresses the accumulation of cash by a mature firm, suggests that holding excessive cash reserves can indeed lead to problems such as overinvestment and the provision of excessive perks for managers or employees. This can occur because a significant cash reserve may lessen the financial discipline within a company, as there is a tendency for firms with more cash to invest in projects with lower returns or to spend on non-essential benefits. These practices can lead to a decrease in shareholder value as funds are not utilized effectively for growth or returning value to investors.

Issues related to financial markets and capital access often require firms to make strategic decisions about financial capital sourcing. A firm may choose to secure loans, issue bonds, or sell equity through stocks. Each of these options has its own implications for a company's cash flow, control, and obligations towards lenders or investors.