- 5 Marks
Question
When companies retain profits in the business, the increase in the retained profits adds to equity reserves. This view was suggested by SavvyTech plc management team to the board. The Board is not convinced and seek further explanation.
Required:
Explain TWO (2) benefits to the board of directors on what it means to increase long-term capital using retained profits in SavvyTech plc.
Answer
- Avoidance of Share Issuance Costs:
- Raising long-term capital through retained profits helps SavvyTech plc avoid the substantial costs associated with issuing new shares. Issuing shares typically incurs expenses such as underwriting fees, regulatory costs, and administrative charges. By retaining profits, SavvyTech can increase its capital base without incurring these issuance costs, preserving more funds for investment in strategic initiatives like the Utopia acquisition.
- Immediate Availability of Funds:
- Retained profits are an internal source of finance, meaning they are readily available and can be reinvested in the business without delay. This provides SavvyTech with flexibility and speed in financing long-term projects. Unlike external funding, which may require negotiation or waiting for approval, retained earnings can be used immediately to fund capital projects, such as expanding production or acquiring the Utopia subsidiary.
- Tags: Equity, Financial strategy, Long-term Capital, Retained Profits
- Level: Level 3
- Topic: Sources of Finance
- Series: JULY 2023
- Uploader: Theophilus