Investment, financing and dividend decisions are interrelated

The three decisions. Financial management deals with three major problems, the investment, financing and dividend decisions, all taken with one objective: maximising the shareholders' wealth, reflected in the market price of the share.

Why they are interrelated

1. Investment and financing. The investment decision fixes how much finance is needed and when; the financing decision (the mix of debt and equity) fixes the cost of capital, which is the discount rate used to accept or reject the investments. A project acceptable at a 12% cost of capital may be rejected at 15%.
2. Financing and dividend. Earnings not paid as dividend are retained and become a source of finance. If a company pays out most of what it earns, it must depend on external finance (debt or new shares) for its growth; dividend policy therefore affects both long-term financing and the wealth of shareholders.
3. Dividend and investment. Whether to pay a dividend, and how much, depends on the investment opportunities in hand: retained earnings can be invested to maintain or raise the growth rate, and the questions of whether to plough back profits, how much to pay, when and in what form are all inter-related and bear on the firm's growth plans.
4. All three and value. The value of the firm depends on the returns from its investments, the cost of the funds used, and how the returns are shared; a change in any one decision changes the effect of the others on value.

Conclusion. The statement is correct: the three decisions cannot be taken in isolation. The finance manager must choose them jointly so that, together, they maximise the value of the firm.