APC 308 Financial Management

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Contents
Introduction......................................................................................................................................3

Question 1: Cost of capital and Capital structure............................................................................3

a) The calculation of book value and market value and the cost of capital market value with
Trust Plc.......................................................................................................................................3

b) Re-estimating the cost of capital by reflecting the changes with Trust Plc.............................5

c) The explanation about integrating method in the capital structure help to reduce the
weighted average cost of capital (WACC)..................................................................................7

d) The relationship between WACC) and IRR and the effect of agency problem for an
investment decision with Trust Plc..............................................................................................9

Question 2: Investment appraisal techniques..................................................................................9

Conclusion.....................................................................................................................................15

References......................................................................................................................................16

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Introduction
Finance is recognised as the backbone of modern business. Finance plays a crucial role in
investment decisions as well as financial decisions (Aswath, 2013). No organisation can operate
and select a project without the following finance. Today is the age of business, and financial
management is the route to achieve success for individual organisations. Financial management
is the process of planning, organising, and managing financial activities efficiently within an
organisation. It is the core of this modern business arena. A proper investment plan can help an
organisation to achieve the desired objective within a particular period. The report is going to
demonstrate about two questions. The first question is about capital and capital structure and the
second question is about several investment appraisal techniques.

Question 1: Cost of capital and Capital structure

a) The calculation of book value and market value and the cost of capital market
value with Trust Plc
Analysing business performance and the cost of capital is used in several organisations in various
ways. Market value and the book value varies from time to time. It is essential to use it properly
as organisational requirements. The cost of equity for Trust Plc is analysed below for a better
concept.

Year Dividend over year Change rate

2016 21p
2017 23p 9.52%
2018 25p 8.70%
2019 27p 8.00%
2020 28p 3.70%
Average growth rate(g) 7.48%
Here,

Do, is the standard dividend that will be paid for the year 2021= Do (1+g)

= 0.28(1+0.0748)

= 0.30

The cost of equity, Ke = (D1/Po) + g

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= {(0.20/2.65) + 0.0748}*100

= 18.80%

Dividend preference share, D1 = (1*7%) = 0.07%

Cost of preference share, Kp = (D1/Po)

= (0.07/0.75)*100

= 9.33%

The cost of bond, Kd = Kp* (1-corporate tax)

= 10%(1-.30%)

= 7%

The cost of general reserve Kre = Ke

Kre = 18.80%

The calculation o weighted average cost of capital(WACC) by book value method:

Source of capital Amount Cost of capital Total cost

General share 20,000 18.80% 3760
General stock 5,000 18.80% 940
Preference share 10,000 9.33% 933
Bond 15000 7% 1050
Total 50,000 6,683

Now,

The weighted average cost of capital (WACC) = (Total cost / Total capital)

= (683/50,000)*100

= 13.37%

Calculation of cost of capital by following market value system:

Calculation of the weighted average cost of capital(WACC) for Trust Plc.

Source of capital Amount Cost of capital Total cost

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 General share 53,000 18.80% 9964
(2.65*20,000)
Preference share 7500 9.33% 699.75
(0.75*10,000)
Bond (107*100) 16050 7% 1123.5
Total 76550 1187.6
The weighted average cost of capital (WACC) = (Total cost/Total capital)

= (11,787.25/76,550z)

= 15.40%

b) Re-estimating the cost of capital by reflecting the changes with Trust Plc.
Trust Plc employed a new financial manager and decided to recheck the financial structure and
recommended increasing the source of capital from debt. According to the newly employed
financial manager, after taking into account the decision, the cost of capital would be 11%,
reducing the weighted average cost of capital. Assessment this taken decision is required to
justify by an excellent analysis.

The growth rate of new dividend = average growth rate = (1+20%)

= 7.48% (1+.20)

= 8.98%

Now,

D1 ={0.28 (1+0.08976)}

= 0.3051

= 30.51%

Then, the cost of equity Ke = {(0.3052/2.85)+0.0896)*100)}

= 19.67%

And, the cost of preference share, Kp = (D1/Po) + g

= (0.07/0.68)*100

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= 10.29%

Moreover, the cost of the newly issued bond, Kd = Kd(1-corporate tax)

= 11%(1-0.30)

= 7.7%

Finally, the average cost of debt = (7%*0.50%+7.7%*0.50)

= 7.35%

The cost of general reserve Kre= 19.67%

After analysing the financial situation of Trust Plc, the financial manager rechecked the structure
of capital and suggested that a higher amount of debt funding will be bear effective. The cost of
capital will be reduced. The financial manager suggests that 15 million shares will be sold at a
5% premium, and the amount with premium will be (15,000,000+750,000)= 15,750,000. The
collected fund from the shareholder's Trust Plc can purchase stocks at 2.65 per share, and the
objective will be arranged by 3943, and the number of available shares of Trust Plc will be
(20,00-5943)= 140,56 shares.

Re-computation of Weighted average cost of capital (WACC) by following the book value
method:

Source of capital Amount Cost of capital Total cost

Ordinary 14056 19.67% 2764.81
share(14056*1)
General reserve 5,000 19.67% 983.5
Preference share 10,000 10.29% 1029
Bond 30,000 7.35% 2205
Total 59056 6982.31
The calculation of the weighted average cost of capital (WACC) = (total cost / total capital)

= (6982.31/59056)*100

= 11.82%

The mathematical demonstration above shows that the recommendation of the financial manager
of Trust Plc was a great decision. The average weighted cost of capital was 13.37%, and after the

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recommendation, the cost of capital was reduced by 13.37% to 11.82%. Cost reduction of capital
will bear a great chance of effective investment; as a result, the profit of Trust Plc will increase.
The recommendation of the financial manager was so effective.

c) The explanation about the statement of integrating method in the capital

structure help to reduce the weighted average cost of capital (WACC).
The success of a business depends on effective investment decisions (Bierman and Smidt,2017).
Choosing proper and organisation adequate decision play an applicable role for the success. A
financial manager efficiently directs the financial activities to attain business objectives at the
desired time. The financial manager knows the exact situation of a business and has an idea
about the internal lacking and sp strength. A proper and effective business decision creates by the
financial manager. The weighted average cost of capital or WACC is the process of
understanding the cost of capital from various sources of capital. The WACC affects by various
types of elements. Sometimes it gets increased and sometimes decreased. It follows a unique way
to assess several projects at a particular period. It is already obtained that the financial manager
of Trust Plc recommends increasing debt funding, and the cost of capital will be reduced. By
following this decision, it already decreased and Trust Plc enjoying proper effectiveness in the
competition (Bull, 2014).

Today is the age of business. Because of the modern business arena, there are new innovative
assessing factors are increasing day by day. In this age, the valuation of a project is easier than
before. The gearing integrating method is a financial assessment method that refers to the
comparison of capital and debt. It also implies a particular classification of capital that is
borrowed from debt holders or any organisation. A profitable business understands the market
better than any organisation. So applying systematic and effective investment methods and
factors will bear efficiency in the output of an organisation. Here, the financial manager plays a
vital role in a better output. The gearing integration method normally compares debt and equity.
It can be high or low. The high gearing ratio shows higher debt versus higher equity; on the other
hand, the lower gearing shows lower debt versus low equity. By managing the gearing ratio
properly, an organisation can bear effectively and get the desired objective. Investing in one
project may be high risk, but investing in several projects at the same time reduce the risk easily,

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and that is the portfolio of investment. Every organisation's success depends on a qualitative
capital structure and a potential investment decision (Donald, 2019).

Getting tax incentives while collecting funds for business purposes is essential for the reduction
of the cost of capital. Funding capital from debt bears the tax incentives. Debt funding has no tax
issue. That's why it is so popular among investors and financial organisations. Because of debt
funding, the weighted average cost of capital gets reduced due to tax incentives. The financial
manager of Trust Plc recommends reducing the cost of capital by higher debt funding, and it's
effective. The gearing integrating method helps to compare the capital and debt of Trust Plc
essentially. But the organisation may be ineffective if there doesn't exist consistency like this
present situation. Proper following of gearing interaction and maintaining the combination of
debt and capital is an important task. Proper management of gearing integration is important for
measuring efficiency (Geltner, 2016).

It will be effective for Trust Plc; after getting tax incentives, the cost of capital will be reduced,
and the efficiency increases. Nowadays, it is popular among investors because having more tax
increases the cost of capital and getting tax incentives helps an organisation to achieve the
business goal easily by similar way of investment. It is effective getting the loan and having the
chance of enjoying tax incentives, but Trust Plc may face trouble if the organisation gets unable
interest rate regularly because higher lean funding bears higher interest rate. So it is important to
plan funding capital, and the cost of capital is essential as the ability and the capital structure of
the organisation. By following the gearing integration, method Trust Plc can easily manage those
incoming investments and the funding from debt. Proper management of the gearing method is a
crucial decision for the financial manager of any organisation. Proper management and
integration of gearing may increase profitability. An organisational profit earning and efficient
investment plan is required for an organisation to get the peak of success, and there will increase
the great rate of return of investment.

For maintaining business operation and investment funding Trust Plc is using the shareholder's
fund. The previous weighted average cost of capital was 13.37%. With the suggestion of bond
refinancing, the cost will be reduced after the assessment of the financial manager of Trust Plc
and getting debt funding reduced the weighted average cost of capital by 11.82%. Trust plc is
enjoying proper management and cost of capital as well as investment decision if there is

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required any step of initiative should be taken. The overall systematic process and estimation is
sunning well in this consistency run for long there will be a huge profit, and the shareholders will
increase rapidly (Gray and Larson, 2020).

d) The relationship between WACC) and IRR and the effect of agency problem for
an investment decision with Trust Plc
The weighted average cost of capital(WACC) or internal return are the two most important
investment decision determinants that play a crucial role in all types of financial institutions.
Both are important for an organisation during the project selection for a better investment. The
weighted average cost of capital refers to an organisation's different types of capital sources'
percentage. On the other hand, the internal rate of return refers to assessing a particular rate of
return for a project, and it is the way of getting the net present value to be zero. The actual
relationship between these two in the investment decision and analysing the future cost of funds.
The higher cost of capital contained projects, on the other hand, the higher IRR contained
projects, gets rejected because there has a lack of enough profitability. By maintaining a proper
balance of WACC and IRR, Trust Plc can obtain success and bears more efficiency than before.
So there is no alternative way to get a proper investment project by assessing WACC and IRR.

Effects of agency problem for an investment decision with Trust Plc

Agency problem refers to a clash between the managers and shareholders (Herbert, 2019).
Management and shareholders are two vital elements for an organisation. Sometimes managers
decide without informing shareholders; as a result, there arises a communication gap, and unit
decision implies which creates the agency problem. For the betterment of the organisation, Trust
Plc should reduce all types of problems because shareholders are the bool circulation for an
organisation.

Question 2: Investment appraisal techniques

a) The valuation of the machine by different investment appraisals techniques and analysis
of the economic feasibility for the machine.

i) Calculation of payback period with Super Tasty Soup Limited:

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The payback period is one of the popular appraisal techniques that refers to measuring a specific
period when the invested capital will return (Marseguerra, 2018). For calculating the payback
period, here is the cash flow statement of Super Tasty Soup Limited.

Particulars Years
st nd rd
1 year 2 year 3 year 4th yar 5th year 6th year
Cash inflow 223,600 223,600 223,600 223,600 223,600 223,600
Less: 32,700 32,700 32,700 32,700 32,700 32,700
maintenance
and
operation
cost
Net cash 190,900 190,900 190,900 190,900 190,900 190,900
inflow

Year Cash inflow Cumulative cash inflow

1 190,900 190,900
2 190,900 381,800
3 190,900 572,700
4 190,900 763,600
5 190,900 954,500
6 190,900 11,45,400
Here,

PBP = A + (NC0-C)/D

= 3 + (588300-572700)/190900

= 3.082 years

The project will be able to get the investment back after 3.082 years.

ii) ARR calculation with Super Tasty Soup Limited.

The average rate of return of accounting rate of return (ARR) is the way of measuring the
required rate of return from a particular product.

By reducing balance method the calculation of depreciation method:

Year Beginning value Book value Depreciation Ending balance

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 depreciation
1 588300 588300*25% 147,075 441,225
2 441225 441225*25% 110306.25 330,919
3 330919 330919*25% 82729.75 248,189
4 248189 248189*25% 62047.25 186,142
5 186141 186141*25% 46535.5 139,606.50
6 129,606.50 129,606.50*25% 34901.625 104,704.88

Particulars Years
1st year 2nd year 3rd year 4th year 5th year 6th year
Cash inflow 223,600 223,600 223,600 223,600 223,600 223,600
Less:
maintenanc 32,700 32,700 32,700 32,700 32,700 32,700
e and
operation
cost
Net cash 190,900 190,900 190,900 190,900 190,900 190,900
inflow
Less: 147,075 110306.25 82729.75 620,47.25 46535.5 34910.625
depreciation
Net 43,825 80594 108,170 128,853 144,365 155,998
earnings
Now. Average net earning = Total earning / numbers of years

= (43824+80594+108170+128853+144365+155998)

= 110300.8

Average investment = Residual initial investment / 2

= {588300(588300*15%)/2}

= 338,272.5

Again, ARR= (110,300.8/338272.5)*100

= 31.61%

After getting the positive ARR, the machine should be purchased by Super Tasty Soup Limited.

iii) The calculation of NPV with Super Tasty Soup Limited.

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The net present value of NPV is the method of understanding an organisation’s cash inflow and
outflow. It is very popular among investors(Marx and Ronald, 2017).

The calculation of NPV with Super Tasty Soup Limited:

NPV = [[CFn (1-1+r)n/r] + [ CFn / (1+r)n – CFo]

= [[190,900(1-(1+0.10)-6/.10) + [88,245/(1.10)6]-588,300]

= 831,419.27 + 49812 -588,300

= 292,931.27

The above calculation of NPV shows that the result is positive, and it should be accepted by
super tasty soup limited.

iv) The calculation of IRR with Super Tasty Soup Limited.

Internal rate of return or IRR is one of the essential methods for assessing an organisation's
project within a short time. It refers to the profitability of several projects for an organisation. It
is such an impressive valuation method (Mott, 2014).

The calculation of IRR with Super Tasty Soup Limited:

The result of NPV is collected from above that is 292,931.27

= [[190,900(1-(1+0.35)-6/.35)-6/.35+ [88,245/(1.35)-6]-588,300

= 455,326.40 + 14577.65-588300

= 469904.05 – 588300

= -118,395.95

IRR = L + {(positive NPV)/(Positive NPV-Negative NPV)*(H-L)}

= 0.10 + (292,931.27/((292,931.27-(-118,395.95))*(.35-.10)

= 0.10+0.178

= 0.2780

= 27.80%

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The calculation of IRR shows that the rate of the capital cost is 10%, and the IRR is higher,
which is 27.80%. That's why the project is required to be accepted.

b) Discuss the effects of recommendations provided by the financial director of Super Tasty
Soup Limited

The financial director of super tasty soup limited suggests that 40% of the total capital is required
to outlay for the repurchase of equity capital and pay other shareholder's dividends. Though it is
a challenging decision by the director, proper assessment and analysis can achieve the business
goal easily. In this situation, super tasty soup limited should manage enough retained earnings
because if proper management of retained earnings cannot be placed, the organisation will face
liquidity trouble, will be unable to pay dividends; overall, there will be a critical situation.
Afterwards, Super-Tasty Soup Limited will be able to place proper management, and the
recommendation will be effective if there is properly retained earning and liquidity management
held.

c) Analyse the advantages and disadvantages of different types of appraisal techniques.

Net Present Value(NPV): Net present value is the process of understanding an organisation’s
cash inflow and outflow by assessing various types of projects (Posthumus, 2014). It is very
effective and useful for this modern business arena. Some advantages and disadvantages are

Advantages:

1. NPV is so effective in decision making.

2. It uses the time value of money for assessing projects.

Disadvantages:

1. NPV doesn’t take into account any required rate.

2. It has some sunk cost.

The average rate of return(ARR): Average rate of return or the accounting rate of return helps
an organisation to calculate the profitability rate and the profitability of a project. Though it is a
little bit difficult, some organisations freak into it for the advantages (Sandeep, 2015).

Advantages:

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 1. ARR follows accounting rules, regulations and is so informative.
2. It is so effective in measuring any organisation's profitability rate.

Disadvantages:

1. ARR doesn’t use the cash flow statement

2. ARR doesn’t follow the time value of money.

Payback Period(PBP): The payback period is one of the easy and most used valuation
techniques in this modern business age. It refers to estimating or calculating any project's time
that when the initial investment will return. After any particular investment, an investor can
easily determine the period and prepare about required activities for the initial capital to return
(Trotman, 2017).

Advantages:

1. The calculation of PBP is so easy.

2. It is very effective in evaluating short term projects.

Disadvantages:

1. The payback period doesn’t follow any cash inflow

2. It is unsued in a large investment.

Internal rate of return(IRR): Internal rate of return or IRR is a process to get the net present
value zero by capital valuation (Vaida, 2012). It is a combination process of NPV and ARR.
That’s why it is a qualitative valuation method.

Advantages:

1. It helps to calculate a minimum rate of return.

2. It measures a project’s profitability easily.

Disadvantages:

1. IRR cannot measure accurate calculations sometimes.

2. It doesn’t follow any organisation’s capital structure.

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Conclusion
Financial management is the root of modern business's success. It helps an organisation in
various ways. Proper use of financial management on an organisation can bear effectiveness
easily. This report demonstrated about two questions and described that the cost of capital and
different types of investment appraisal techniques appropriately for essential use within a
particular organisation.

References
Aswath Damodaran (2013). Investment valuation: Tools and techniques for determining the
value of any asset. Hoboken, N.J.: Wiley.

Bierman, H. and Smidt, S. (2017). The capital budgeting decision: economic analysis of
investment projects. New York; London: Routledge.

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Bull, R. (2014). Financial ratios: how to use financial ratios to maximise value and success for
your business. Burlington, Ma, USA: Elsevier Ltd.

Donald Eugene Farrar (2019). The investment decision into several projects. Ann Arbor,
University Microfilms.

Geltner, D. (2016). The use of appraisals in portfolio valuation and index construction. Journal of
Property Valuation and Investment, 15(5), pp.423–447.

Gray, C.F. and Larson, E.W. (2020). Project management: the managerial process. New York,
NY: Mcgraw-Hill Education.

Herbert, H. (2019). EMPATHY AND AGENCY: the problem of understanding in the human
sciences. S.L.: Routledge.

Marseguerra, G. (2018). Corporate financial decisions and market value: studies on dividend
policy, price volatility, and ownership structure. Heidelberg: Physica-Verlag.

Marx, J. and Ronald Henry Mynhardt (2017). Investment management. Pretoria: Van Schaik.

Mott, G. (2014). Investment appraisal for managers. Palgrave Macmillan.

Posthumus, L.C. (2014). Principles of financial management. Kenwyn: Juta.

Sandeep Goel (2015). Capital budgeting. New York: Business Expert Press.

Trotman, L.G.S.(2017). Corporate debt securities: a restatement and critical evaluation of

Financial Management. Auckland, N.Z.: Legal Research Foundation.

Vaida, I.C. (2012). The Problem of Agency and the Problem of Accountability in Kant’s Moral
Philosophy. European Journal of Philosophy, 22(1), pp.110–137.

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