## Finance Functions and Decisions

### The Core Formula

$$V = f(I, F, D)$$

The value of a firm is a function of its:

I — Investment Decisions
F — Financing Decisions
D — Dividend Decisions

All major financial decisions ultimately affect firm value through this relationship.

---

### Long-Term Finance Functions

#### (i) Financing Decisions (F)

Choosing the right mix of debt and equity (capital structure)
Goal: ensure fund availability at the lowest cost with manageable risk
Key considerations:
Difference between profit and cash flow
Risks like currency fluctuations or excessive leverage

#### (ii) Investment Decisions (I)

Selecting assets in which funds will be invested
Covers two types:
Long-term assets: plant, machinery, new projects (evaluated via capital budgeting)
Current assets: inventory, receivables
Techniques used: NPV, IRR, payback period to assess viability, risk, and returns

#### (iii) Dividend Decisions (D)

Determining how much profit to distribute as dividend vs. retain for growth
Balances:
Rewarding shareholders (income preference)
Retaining funds for reinvestment (growth preference)
Dividend policy also affects the market price of shares

---

### Short-Term Finance Functions

Management of current assets (cash, receivables, inventory) and current liabilities (payables, short-term borrowings)
Aim: maintain liquidity, ensure smooth daily operations, and avoid:
Cash shortages (liquidity crisis)
Idle/excess funds (opportunity cost)

---

### Summary Diagram

```

Finance Functions

│

┌─────────┴──────────┐

Long-Term Short-Term

│ │

┌─┴──────────┐ Working Capital

F I D Management

```

Worked example

### Example 1

Example — V = f(I, F, D) in practice:

Company A invests in a high-return project (good I), finances it with optimal 60:40 debt-equity mix (good F), and pays a steady 40% dividend while retaining 60% for growth (balanced D). Each decision adds to firm value — the share price rises, reflecting V = f(I, F, D).

### Example 2

Example — Poor investment decision destroying value:

A firm raises ₹5 crore debt at 14% and invests it in a project yielding only 10% ROI. The investment decision (I) is poor — the firm destroys value rather than creating it, because cost of funds exceeds returns.

⚠️ Common exam mistakes

Treating the three decisions as independent — all three are interconnected; a dividend decision affects how much is available for reinvestment, which affects investment decisions.
Forgetting short-term functions exist — students sometimes focus only on I, F, D and overlook working capital management.
Confusing financing decision with investment decision — financing = WHERE to get money; investment = WHERE to put money.

Reference:

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Finance Functions and Decisions — V = f(I, F, D)

Worked example

⚠️ Common exam mistakes