Financial Management Assignment: FIN5FMA, Semester 1, 2019

This document presents a solution to a financial management assignment (FIN5FMA) focusing on capital structure and its relationship with tax rates and investment decisions. The assignment addresses the impact of changes in personal tax rates on interest, dividends, and capital gains, and their effect on a company's capital structure. It also explores the implications of investment choices on operating leverage and business risk. The solution analyzes how organizations should use debt and equity in their capital structures, and how automation levels can affect operating leverage and overall risk. The assignment covers key financial concepts and theories related to capital budgeting and financial decision-making, offering insights into practical applications within the field of finance.

Running head: FINANCIAL MANAGEMENT
Financial Management
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

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Table of Contents
Answer to Question 1:.....................................................................................................................2
Answer to Question 2:.....................................................................................................................2
References:......................................................................................................................................4

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Answer to Question 1:
Capital structure signifies the ratio of various types of securities that an organisation
raises in the form of finance. The securities might constitute of equity, debt, retained earnings or
bonds. A rise in personal tax rate on dividends, capital gains and interest makes both bonds and
stocks of an organisation less attractive to the investors, since it raises the tax payment of interest
income and dividend (Bekaert & Hodrick, 2017). The variations in personal tax rates would have
varying effects, depending on the expectation of the overall return of an investment as interest or
dividend against capital gains.
For instance, increased rate of personal tax has higher effect on the bondholders, since
majority of their returns on bonds would be taxed sooner at the new increased rate. A rise in
personal tax rate would make few investors to transfer their investments to stocks from bonds,
due to the attractive tax deferrals in the form of capital gains. This circumstance increases the
cost of debt, which is relative to equity. Moreover, a lower tax rate increases the benefit of dent
by minimising the advantage of the interest deduction of an organisation, which does not
encourage using debt, instead of equity (Brigham & Daves, 2014). Therefore, the organisations
need to use lower debt and higher equity in their capital structures.
Answer to Question 2:
According to the theory of basic finance, it is possible to make independent financing and
investment decisions and it is recommended by the principles of capital budgeting that an
organisation needs to choose the investment alternative having the highest net present value
(NPV) or at the lowest outflow of present value; in case, it is purely service investment. This

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might be valuable; however, for the organisation to undertake these decisions in combination in
terms of risk concepts and leverage at the time of analysing the processes for adoption. The
increasingly automated process would be capital intensive and it needs new equipment as well as
ongoing utilities expense for operating such equipment, which would increase fixed operating
costs (Finkler, Smith & Calabrese, 2018).
On the other hand, the low automated process would be labour intensive and the variable
costs would be significantly high, which mainly include staffing costs. Hence, the highly
automated process would raise the operating leverage and business risk of an organisation, while
the lower automated process would have minimal operating leverage, since the working hours or
staff members could be modified in accordance with movements in sales (Pandey, 2015). Hence,
this would assist in minimising the business risk of the organisation.

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References:
Bekaert, G., & Hodrick, R. (2017). International financial management. Cambridge University
Press.
Brigham, E. F., & Daves, P. R. (2014). Intermediate financial management. Cengage Learning.
Finkler, S. A., Smith, D. L., & Calabrese, T. D. (2018). Financial management for public,
health, and not-for-profit organizations. CQ Press.
Pandey, I. M. (2015). Essentials of Financial Management, 4th Edtion. Vikas publishing house.